Premier Financial Bancorp, Form 10-Q, September 30, 2006
 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2006

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

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 whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one)
Large accelerated filer 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 Securities Exchange Act). Yeso No þ.

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date.

Common stock, no par value, - 5,236,899 shares outstanding at October 31, 2006
 
PREMIER FINANCIAL BANCORP, INC.
INDEX TO REPORT
SEPTEMBER 30, 2006


Part I - Financial Information
  
Part II - Other Information  
29



 
PREMIER FINANCIAL BANCORP, INC.
SEPTEMBER 30, 2006


PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

The accompanying information has not been audited by independent public accountants; however, in the opinion of management such information reflects all adjustments necessary for a fair presentation of the results for the interim period. All such adjustments are of a normal and recurring nature. Premier Financial Bancorp, Inc.’s (“Premier’s”) accounting and reporting policies are in accordance with accounting principles generally accepted in the United States of America. Certain accounting principles used by Premier involve a significant amount of judgment about future events and require the use of estimates in their application. The following policies are particularly sensitive in terms of judgments and the extent to which estimates are used: allowance for loan losses, the identification and evaluation of impaired loans, the impairment of goodwill, the realization of deferred tax assets and stock based compensation disclosures. These estimates are based on assumptions that may involve significant uncertainty at the time of their use. However, the policies, the estimates and the estimation process as well as the resulting disclosures are periodically reviewed by the Audit Committee of the Board of Directors and material estimates are subject to review as part of the external audit by the independent public accountants.

The accompanying financial statements are presented in accordance with the requirements of Form 10-Q and consequently do not include all of the disclosures normally required by accounting principles generally accepted in the United States of America or those normally made in the registrant’s annual report on Form 10-K. Accordingly, the reader of the Form 10-Q may wish to refer to the registrant’s Form 10-K for the year ended December 31, 2005 for further information in this regard.

Index to consolidated financial statements:











3
 
PREMIER FINANCIAL BANCORP, INC.
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2006 AND DECEMBER 31, 2005
(DOLLARS IN THOUSANDS)


   
(UNAUDITED)
       
   
2006
  
2005
  
ASSETS
         
Cash and due from banks
 
$
16,266
  
$
16,080
  
Federal funds sold
   
22,070
    
18,812
  
Securities available for sale
    
129,510
    
137,419
  
Loans
    
346,037
    
328,717
  
Allowance for loan losses
    
(6,941
)
  
(7,892
)
Net loans
    
339,096
    
320,825
  
Federal Home Loan Bank and Federal Reserve Bank stock
    
3,221
    
3,060
  
Premises and equipment, net
    
6,852
    
7,126
  
Real estate and other property acquired through foreclosure
    
415
    
2,049
  
Interest receivable
    
2,860
    
2,661
  
Goodwill
    
15,816
    
15,816
  
Other assets
    
3,595
    
4,476
  
Total assets
  
$
539,701
  
$
528,324
  
               
LIABILITIES AND STOCKHOLDERS' EQUITY
              
Deposits
              
Non-interest bearing
  
$
71,311
  
$
69,856
  
Time deposits, $100,000 and over
    
52,636
    
42,169
  
Other interest bearing
    
321,873
    
323,818
  
Total deposits
    
445,820
    
435,843
  
Securities sold under agreements to repurchase
   
9,474
    
9,317
  
Federal Home Loan Bank advances
    
7,632
    
8,334
  
Other borrowed funds
    
6,587
    
-
  
Notes payable
    
-
    
1,402
  
Guaranteed junior subordinated interest debentures
    
8,505
    
15,722
  
Interest payable
    
1,213
    
724
  
Other liabilities
    
1,077
    
2,695
  
Total liabilities
    
480,308
    
474,037
  
               
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;
              
5,233,730 shares issued and outstanding
    
1,108
    
1,105
  
Additional paid-in capital
    
43,586
    
43,458
  
Retained earnings
    
16,023
    
11,442
  
Accumulated other comprehensive income (loss)
    
(1,324
)
  
(1,718
)
Total stockholders' equity
    
59,393
    
54,287
  
Total liabilities and stockholders' equity
  
$
539,701
  
$
528,324
  

 
4
 
PREMIER FINANCIAL BANCORP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005
(UNAUDITED, DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)


   
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
  
   
2006
  
2005
  
2006
  
2005
  
Interest income
                  
Loans, including fees
  
$
6,637
  
$
6,000
  
$
19,130
  
$
17,342
  
Securities available for sale
                          
Taxable
    
1,300
    
1,264
    
3,855
    
3,776
  
Tax-exempt
    
24
    
23
    
69
    
72
  
Federal funds sold and other
    
287
    
176
    
884
    
490
  
Total interest income
    
8,248
    
7,463
    
23,938
    
21,680
  
                           
Interest expense
                          
Deposits
    
2,351
    
1,734
    
6,440
    
4,860
  
Repurchase agreements and other
    
60
    
48
    
175
    
126
  
FHLB advances and other borrowings
    
255
    
124
    
710
    
393
  
Debentures
    
205
    
502
    
672
    
1,626
  
Total interest expense
    
2,871
    
2,408
    
7,997
    
7,005
  
                           
Net interest income
    
5,377
    
5,055
    
15,941
    
14,675
  
Provision for loan losses
    
(38
)
  
(140
)
  
(1,051
)
  
294
  
Net interest income after provision for loan losses
    
5,415
    
5,195
    
16,992
    
14,381
  
                           
Non-interest income
                          
Service charges on deposit accounts
    
775
    
718
    
2,088
    
2,014
  
Electronic banking income
    
129
    
100
    
366
    
285
  
Secondary market mortgage income
    
94
    
66
    
183
    
157
  
Other
    
129
    
103
    
394
    
428
  
     
1,127
    
987
    
3,031
    
2,884
  
Non-interest expenses
                          
Salaries and employee benefits
    
2,314
    
2,241
    
6,846
    
6,940
  
Occupancy and equipment expenses
    
575
    
589
    
1,549
    
1,754
  
Outside data processing
    
525
    
424
    
1,512
    
998
  
Professional fees
    
108
    
79
    
363
    
458
  
Taxes, other than payroll, property and income
    
160
    
71
    
442
    
277
  
Write-downs, expenses, sales of
other real estate owned, net of gains
    
(7
)
  
(30
)
  
(29
)
  
30
  
Supplies
    
77
    
88
    
252
    
280
  
Other expenses
    
571
    
714
    
1,801
    
2,323
  
     
4,323
    
4,176
    
12,736
    
13,060
  
Income before income taxes
    
2,219
    
2,006
    
7,287
    
4,205
  
Provision for income taxes
    
744
    
639
    
2,445
    
1,308
  
                           
Net income
  
$
1,475
  
$
1,367
  
$
4,842
  
$
2,897
  
                           
Weighted average shares outstanding:
                          
Basic
    
5,237
    
5,233
    
5,236
    
5,233
  
Diluted
    
5,262
    
5,253
    
5,264
    
5,245
  
                           
Net income per share:
                          
Basic
  
$
0.28
  
$
0.26
  
$
0.92
  
$
0.55
  
Diluted
    
0.28
    
0.26
    
0.92
    
0.55
  
 
(continued)
5
 
PREMIER FINANCIAL BANCORP, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005
(UNAUDITED, DOLLARS IN THOUSANDS)


   
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
  
   
2006
  
2005
  
2006
  
2005
  
Net income
  
$
1,475
  
$
1,367
  
$
4,842
  
$
2,897
  
                           
Other comprehensive income (loss):
                          
Unrealized gains and (losses) arising during the period
    
2,136
    
(894
)
  
597
    
(1,289
)
Reclassification of realized amount
    
-
    
-
    
-
    
-
  
Net change in unrealized gain (loss) on securities
    
2,136
    
(894
)
  
597
    
(1,289
)
Less tax impact
    
726
    
(304
)
  
203
    
(438
)
Other comprehensive income (loss):
    
1,410
    
(590
)
  
394
    
(851
)
                           
Comprehensive income (loss)
  
$
2,885
  
$
777
  
$
5,236
  
$
2,046
  
                           
 
 
 

 
6
PREMIER FINANCIAL BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005
(UNAUDITED, DOLLARS IN THOUSANDS)


   
2006
  
2005
  
Cash flows from operating activities
         
Net income
  
$
4,842
  
$
2,897
  
Adjustments to reconcile net income to net cash from operating activities
              
Depreciation and impairment of real estate
    
666
    
737
  
Provision for loan losses
    
(1,051
)
  
294
  
Amortization, net
    
37
    
193
  
FHLB stock dividends
    
(103
)
  
(81
)
OREO writedowns (gains on sales), net
    
(34
)
  
3
  
Stock compensation expense
    
104
    
-
  
Changes in :
              
Interest receivable
    
(199
)
  
(46
)
Other assets
    
462
    
643
  
Interest payable
    
489
    
(4,814
)
Other liabilities
    
(1,618
)
  
(244
)
Net cash from operating activities
    
3,595
    
(418
)
               
Cash flows from investing activities
              
Purchases of securities available for sale
    
(15,004
)
  
(14,528
)
Proceeds from maturities and calls of securities available for sale
    
23,472
    
24,417
  
Purchase of FHLB stock, net of redemptions
    
(58
)
  
(336
)
Net change in federal funds sold
    
(3,258
)
  
(4,208
)
Net change in loans
   
(17,685
)
  
(9,725
)
Purchases of premises and equipment, net
    
(392
)
  
(726
)
Proceeds from sale of other real estate acquired through foreclosure
    
2,133
    
1,295
  
Net cash from investing activities
    
(10,792
)
  
(3,811
)
               
Cash flows from continuing financing activities
              
Net change in deposits
    
9,977
    
4,857
  
Cash dividends paid
    
(261
)
  
-
  
Repayment of Federal Home Loan Bank advances
    
(702
)
  
(757
)
Repayment of other borrowed funds
    
(413
)
  
(800
)
Proceeds from other borrowings
    
7,000
    
-
  
Early redemption of Trust Preferred Securities
    
(7,000
)
  
-
  
Repayment of subordinated notes
    
(1,402
)
  
-
  
Proceeds from stock option exercises
    
27
    
13
  
Net change in federal funds purchased
    
-
    
(1,838
)
Net change in agreements to repurchase securities
    
157
    
2,113
  
Net cash from financing activities
    
7,383
    
3,588
  
               
Net change in cash and cash equivalents
    
186
    
(641
)
Cash and cash equivalents at beginning of period
    
16,080
    
14,474
  
Cash and cash equivalents at end of period
  
$
16,266
  
$
13,833
  
 
7
 
PREMIER FINANCIAL BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005
(UNAUDITED, DOLLARS IN THOUSANDS)


   
2006
  
2005
  
Supplemental disclosures of cash flow information:
          
Cash paid during period for interest
  
$
7,508
  
$
11,819
  
               
Loans transferred to real estate acquired through foreclosure
    
465
    
1,168
  
               
 

 

 

8
 
PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED, TABLES IN THOUSANDS)


NOTE 1 - BASIS OF PRESENTATION

The consolidated financial statements include the accounts of Premier Financial Bancorp, Inc. (the Company) and its wholly owned subsidiaries:

         
September 30, 2006
   
Year
Total
  
Net Income
Subsidiary
Location
Acquired
Assets
  
Qtr
YTD
Citizens Deposit Bank & Trust
Vanceburg, Kentucky
1991
$117,960
  
$395
$1,532
Farmers Deposit Bank
Eminence, Kentucky
1996
77,586
  
203
1,050
Ohio River Bank
Ironton, Ohio
1998
81,387
  
234
688
First Central Bank, Inc.
Philippi, West Virginia
1998
101,462
  
470
1,383
Boone County Bank, Inc.
Madison, West Virginia
1998
158,264
  
589
1,584
Mt. Vernon Financial Holdings, Inc.
Huntington, West Virginia
1999
1,644
  
(5)
(20)

The Company also has a capital trust subsidiary, PFBI Capital Trust, as discussed in Note 5, and merged its data processing subsidiary, Premier Data Services, Inc. into the parent company on June 30, 2006. In accordance with FASB Interpretation No. 46, the Trust is no longer consolidated with the Company. All other intercompany transactions and balances have been eliminated.

The Company maintains Employee Stock Ownership Incentive Plans (the Plans) whereby certain employees of the Company are eligible to receive incentive stock options. 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 within ten years from the date of grant. The Plans are accounted for in accordance with FASB Statement No. 123 - revised 2004 (SFAS 123R), Share-Based Payment, which was adopted by the Company on January 1, 2006. SFAS 123R replaced Statement of Financial Accounting Standards No. 123 (SFAS 123), “Accounting for Stock-Based Compensation’’ and superseded APB Opinion No. 25 (APB 25), ‘‘Accounting for Stock Issued to Employees” and amended FASB Statement No. 95, “Statement of Cash Flows.’’ SFAS 123R requires the measurement of all employee share-based payments to employees, including grants of employee stock options, using a fair-value based method and the recording of such expense in our consolidated statements of income. See Note 8 below for additional information regarding stock compensation expense.

In June 2005, the FASB issued Statement No. 154 (SFAS 154), “Accounting Changes and Error Corrections”, a replacement of APB No. 20, “Accounting Changes” and FASB Statement No. 3, “Reporting Accounting Changes in Interim Financial Statements”. SFAS 154 applies to all voluntary changes in accounting principle and changes the requirements for accounting for, and reporting of, a change in accounting principle. Previously, most voluntary changes in accounting principles were required to be recognized by way of a cumulative effect adjustment within net income during the period of the change. SFAS 154 requires retrospective application to prior periods’ financial statements, unless it is impracticable to determine either the period specific effects or the cumulative effect of the change. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The implementation of FAS 154 did not have a material impact on Premier’s consolidated financial statements.

(continued)
9
 
PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED, TABLES IN THOUSANDS)


NOTE 1 - BASIS OF PRESENTATION - continued

The FASB also issued FAS 155, Accounting for Certain Hybrid Financial Instruments—an amendment of FASB Statements No. 133 and 140. This Statement changes the accounting for various derivatives and securitized financial assets. This Statement will be effective for all financial instruments acquired, issued, or subject to a remeasurement (new basis) event occurring after the beginning in 2007. Management does not expect the adoption of this standard to have a material impact on the Company’s financial statements.

In March 2006, the FASB issued FAS No. 156, “Accounting for Servicing of Financial Assets - an amendment of FASB Statement No. 140,” which changes the accounting for all loan servicing rights which are recorded as the result of selling a loan where the seller undertakes an obligation to service the loan, usually in exchange for compensation. FAS 156 amends current accounting guidance by permitting the servicing right to be recorded initially at fair value and also permits the subsequent reporting of these assets at fair value. FAS 156 is effective beginning January 1, 2007. Management does not expect the adoption of this standard to have a material impact on the Company’s financial statements.

In July 2006, the FASB released Interpretation No. 48, "Accounting for Uncertainty in Income Taxes." This Interpretation revises the recognition tests for tax saving positions taken in tax returns such that a tax benefit is recorded only when it is more likely than not that the tax position will be allowed upon examination by taxing authorities. The amount of such a tax benefit to record is the largest amount that is more likely than not to be allowed. Although not anticipated, any reduction in deferred tax assets or increase in tax liabilities upon adoption will have a corresponding decrease in retained earnings. The Company has not yet determined the effect of adopting this Interpretation, which will be effective for reporting periods beginning on January 1, 2007.


(continued)
10
 
PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED, TABLES IN THOUSANDS)


NOTE 2 -SECURITIES

Amortized cost and fair value of investment securities, by category, at September 30, 2006 are summarized as follows:
 
   
Amortized Cost
  
Unrealized Gains
  
Unrealized Losses
  
Fair Value
  
Available for sale
                  
U. S. Treasury securities
  
$
6,448
  
$
2
  
$
(46
)
$
6,404
  
U. S. agency securities
    
89,117
    
49
    
(1,269
)
  
87,897
  
Obligations of states and political subdivisions
    
2,068
    
20
    
(3
)
  
2,085
  
Mortgage-backed securities
    
33,858
    
21
    
(780
)
  
33,099
  
Corporate securities
    
25
    
-
    
-
    
25
  
Total available for sale
  
$
131,516
  
$
92
  
$
(2,098
)
$
129,510
  

Amortized cost and fair value of investment securities, by category, at December 31, 2005 are summarized as follows:
 
   
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
  

 
 

 
(continued)
11
 
PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED, TABLES IN THOUSANDS)


NOTE 2-SECURITIES - continued

Securities with unrealized losses at September 30, 2006 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
  
$
3,958
  
$
(26
)
$
966
  
$
(20
)
$
4,924
  
$
(46
)
U.S. agency securities
    
5,955
    
(29
)
  
74,903
    
(1,240
)
  
80,858
    
(1,269
)
Obligations of states and political subdivisions
    
99
    
(1
)
  
248
    
(2
)
  
347
    
(3
)
Mortgage-backed securities
    
1,849
    
(17
)
  
28,280
    
(763
)
  
30,129
    
(780
)
                                       
Total temporarily impaired
  
$
11,861
  
$
(73
)
$
104,397
  
$
(2,025
)
$
116,258
  
$
(2,098
)

Securities with unrealized losses at December 31, 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
)
  
34,296
    
(712
)
                                       
Total temporarily impaired
  
$
45,789
  
$
(691
)
$
85,172
  
$
(1,948
)
$
130,961
  
$
(2,639
)

The investment portfolio is predominately high quality interest-bearing bonds with defined maturity dates backed by the U.S. Government or Government sponsored agencies. The unrealized losses at September 30, 2006 and December 31, 2005 are price changes resulting from changes in the interest rate environment and are not considered to be other than 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.




(continued)
12
 
PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED, TABLES IN THOUSANDS)


NOTE 3 - LOANS 

Major classifications of loans at September 30, 2006 and December 31, 2005 are summarized as follows:
   
2006
  
2005
  
Commercial, secured by real estate
  
$
98,929
  
$
85,989
  
Commercial, other
    
42,293
    
49,362
  
Real estate construction
    
14,803
    
11,070
  
Residential real estate
    
139,806
    
134,570
  
Agricultural
    
2,075
    
1,670
  
Consumer and home equity
    
43,609
    
42,092
  
Other
    
4,522
    
3,964
  
   
$
346,037
  
$
328,717
  


The following table sets forth information with respect to the Company’s impaired loans at September 30, 2006 and December 31, 2005.
   
2006
  
2005
  
Impaired loans at period end with an allowance
  
$
8,231
  
$
7,926
  
Impaired loan at period end with no allowance
    
-
    
291
  
Amount of allowance for loan losses allocated
    
1,790
    
1,921
  

The following table sets forth information with respect to the Company’s nonperforming loans at September 30, 2006 and December 31, 2005.
   
2006
  
2005
  
Non-accrual loans
  
$
5,354
  
$
3,751
  
Accruing loans which are contractually past due 90 days or more
    
887
    
853
  
Restructured loans
    
1,284
    
1,540
  
Total
  
$
7,525
  
$
6,144
  


NOTE 4 - ALLOWANCE FOR LOAN LOSSES

Changes in the allowance for loan losses for the three and nine months ended September 30, 2006 and 2005 are as follows:
   
Three Months Ended
  
Nine Months Ended
  
   
September 30,
  
September 30,
  
   
2006
  
2005
  
2006
  
2005
  
Balance, beginning of period
 
$
7,198
  
$
8,927
  
$
7,892
  
$
9,384
  
Gross charge-offs
    
(370
)
  
(417
)
  
(1,131
)
  
(1,627
)
Recoveries
    
151
    
149
    
1,231
    
468
  
Provision for loan losses
    
(38
)
  
(140
)
  
(1,051
)
  
294
  
Balance, end of period
  
$
6,941
  
$
8,519
  
$
6,941
  
$
8,519
  
 

(continued)
13
 
PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED, TABLES IN THOUSANDS)


NOTE 5 - GUARANTEED JUNIOR SUBORDINATED INTEREST DEBENTURES

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. 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 $29,639,000 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. Debt issuance costs of $1,478,000 have been capitalized by the Trust and are being amortized over the life of the debenture.

The Debentures became redeemable by the Company in whole or in part on June 30, 2002 at 100% of the liquidation amount and are continuously redeemable after that. 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. Since June 30, 2002, the Company has redeemed $3,000,000 (120,000 shares) on March 31, 2003, $4,500,000 (180,000 shares) on October 15, 2004, $1,000,000 (40,000 shares) on December 31, 2004, $5,000,000 (200,000 shares) on December 30, 2005, and an additional $7,000,000 (280,000 shares) on January 31, 2006 (see Note 6 below).

The final $8,250,000 (330,000 shares) was redeemed subsequent to the balance sheet date on November 10, 2006. To fund a portion of this redemption, on November 10, 2006, the Company executed and delivered to the Bankers’ Bank of Kentucky, Inc. of Frankfort, Kentucky a Promissory Note and Business Loan Agreement dated November 10, 2006 for the principal amount of $6,500,000, bearing interest floating daily at the “Wall Street Journal” prime rate minus 1.00% (currently 7.25%) and requiring 83 monthly principal and interest payments of $100,000 and final payment of any balance due at maturity on November 9, 2013. The note is secured by a pledge of Premier’s 100% interest in Citizens Deposit Bank & Trust (a wholly owned subsidiary) and Farmers Deposit Bank (a wholly owned subsidiary) under a Stock Pledge and Security Agreement dated November 10, 2006. In addition to the borrowing, the Company used $1,750,000 of its own cash to complete the redemption. Upon final redemption, the remaining $291,000 of unamortized issuance costs was expensed.
 

 


(continued)
14
 
PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
UNAUDITED, TABLES IN THOUSANDS)


NOTE 6 - NOTES PAYABLE

On January 31, 2006, the Company executed and delivered to First Guaranty Bank of Hammond, Louisiana a Promissory Note and Business Loan Agreement dated January 31, 2006 for the principal amount of $7,000,000, bearing interest floating daily at the “Wall Street Journal” prime rate (currently 8.25%) and requiring monthly principal payments of $50,000 until maturity on September 28, 2017. The note is secured by a pledge of Premier’s 100% interest in Boone County Bank (a wholly owned subsidiary) under Commercial Pledge Agreement dated January 31, 2006. The proceeds of this note were used to redeem $7,000,000 (280,000 shares) of Premier’s 9.75% Trust Preferred Securities as of January 31, 2006.
 
In June the Company fully repaid the $701,000 note payable to Mr. Reynolds, Chairman of the Board, and the $701,000 note payable Mr. Walker, President and CEO of the Company. In an agreement reached with the Federal Reserve Bank of Cleveland, Mr. Reynolds loaned the Company the proceeds to make the June 2002 distribution on the Trust Preferred Securities. Similarly, Mr. Walker loaned the Company the proceeds to make the September 2002 distribution of the Trust Preferred Securities.
 

 

(continued)
15
 
PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED, TABLES IN THOUSANDS)


NOTE 7 - STOCKHOLDERS’ EQUITY AND REGULATORY MATTERS

The Company’s principal source of funds for dividend payments to shareholders is dividends received from the subsidiary Banks. Banking regulations limit the amount of dividends that may be paid without prior approval of regulatory agencies. Under these regulations, the amount of dividends that may be paid in any calendar year is limited to the current year’s net profits, as defined, combined with the retained net profits of the preceding two years, subject to the capital requirements 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 Company and the Banks must meet specific guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices.

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 September 30, 2006, that the Company and the Banks meet all quantitative capital adequacy requirements to which they are subject.

Shown below is a summary of regulatory capital ratios for the Company:
 
Sept 30,
2006
December 31,
2005
Regulatory
Minimum
Requirements
To Be Considered
Well Capitalized
Tier I Capital (to Risk-Weighted Assets)
16.6%
17.8%
4.0%
6.0%
Total Capital (to Risk-Weighted Assets)
17.9%
19.1%
8.0%
10.0%
Tier I Capital (to Average Assets)
10.3%
10.6%
4.0%
5.0%

As of September 30, 2006, the most recent notification from the FRB 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 preceding table. There are no conditions or events since that notification that management believes have changed the Company’s category. As of September 30, 2006, the remaining Preferred Securities issued by the Trust qualify as Tier 1 capital for the Company under the Federal Reserve Board’s regulatory framework. Had the November 10, 2006 redemption of the $8,250,000 remaining securities occurred prior to September 30, 2006, the Company’s Tier I Capital to Risk-Weighted Assets, Total Capital to Risk-Weighted Assets and Tier I Capital to Average Assets ratios would have been 14.1%, 15.3%, and 8.7% respectively.
 

(continued)
16
 
PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED, TABLES IN THOUSANDS)


NOTE 8 - STOCK COMPENSATION EXPENSE

On January 1, 2006, the Company adopted SFAS No. 123R, “Share-Based Payment,” which is a revision of SFAS No. 123, “Accounting for Stock Issued for Employees.” SFAS No. 123R establishes accounting requirements for share-based compensation to employees and carries forward prior guidance on accounting for awards to non-employees. Prior to the adoption of SFAS No. 123R, the Company reported employee compensation expense under stock option plans only if options were granted below market prices at grant date in accordance with the intrinsic value method of Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. In accordance with APB No. 25, the Company reported no compensation expense on options granted as the exercise price of the options granted always equaled the market price of the underlying stock on the date of grant. SFAS No. 123R eliminates the ability to account for stock-based compensation using APB No. 25 and requires that such transactions be recognized as compensation cost in the income statement based on their fair values on the measurement date, which is generally the date of the grant.

The Company transitioned to SFAS No. 123R using the modified prospective application method ("modified prospective application"). As permitted under modified prospective application, as it is applicable to the Company, SFAS No. 123R applies to new awards and to awards modified, repurchased, or cancelled after January 1, 2006. Additionally, compensation cost for non-vested awards that were outstanding as of January 1, 2006 will be recognized as the remaining requisite service is rendered during the period of and/or the periods after the adoption of SFAS No. 123R, adjusted for forfeitures. The recognition of compensation cost for those earlier awards is based on the same method and on the same grant-date fair values previously determined for the pro forma disclosures reported by the Company for periods prior to January 1, 2006.

On February 15, 2006, 35,250 incentive stock options were granted out of the 2002 Plan at an exercise price of $16.00. These options vest in three equal annual installments ending on February 15, 2009. 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 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 Plan at an exercise price of $7.96. These options vested in three equal annual installments and were fully vested on January 15, 2006.
 

 
(continued)
17
 
PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED, TABLES IN THOUSANDS EXCEPT PER SHARE DATA)


NOTE 8 - STOCK COMPENSATION EXPENSE - continued

The fair value of the Company's employee stock options granted is estimated at the date of grant using the Black-Scholes option-pricing model. This model requires the input of highly subjective assumptions, changes to which can materially affect the fair value estimate. Additionally, there may be other factors that would otherwise have a significant effect on the value of employee stock options granted but are not considered by the model. The assumptions used in the Black-Scholes option-pricing model are as follows

   
2006
  
2005
  
2004
  
Risk-free interest rate
    
4.62
%
  
3.70
%
  
3.15
%
Expected option life (yrs)
    
5.00
    
5.00
    
5.00
  
Expected stock price volatility
    
0.26
    
0.25
    
0.25
  
Dividend yield
    
0.00
%
  
0.00
%
  
0.00
%
Weighted average fair value of options granted during the year
  
$
5.21
  
$
3.48
  
$
2.64
  

Compensation expense of $104,000 was recorded for the first nine months of 2006 while $36,000 was recorded for the three months ended September 30, 2006. The after tax impact was to reduce earnings per share by $0.02 for the first nine months of 2006 and less than $0.01 for the three months ended September 30, 2006. Prior to the adoption of SFAS No. 123R, the Company presented all tax benefits of deductions resulting from the exercise of stock options as operating cash flows in the Consolidated Statements of Cash Flows. SFAS No. 123R requires the cash flows from the tax benefits resulting from tax deductions in excess of the compensation expense recognized for those options to be classified as financing cash flows.

Stock-based compensation expense is recognized ratably over the requisite service period for all awards. Unrecognized stock-based compensation expense related to stock options totaled $130,000 at September 30, 2006. This unrecognized expense is expected to be recognized over the next 30 months based on the vesting periods of the options.

The following pro forma information presents net income, earnings per share, and diluted earnings per share for the three and nine months ended September 30, 2005 as if the fair value method of SFAS No. 123 had been used to measure compensation cost for stock-based compensation plans. For purposes of these pro forma disclosures, the estimated fair value of options is amortized to expense over the options’ vesting periods.




(continued)
18
 
PREMIER FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED, TABLES IN THOUSANDS EXCEPT PER SHARE DATA)


NOTE 8 - STOCK COMPENSATION EXPENSE - continued


   
Three Months Ended
  
Nine Months Ended
  
   
Sept. 30, 2005
  
Sept. 30, 2005
  
Net income, as reported
  
$
1,367
  
$
2,897
  
Deduct: Stock-based compensation expense determined under fair value based method, net of tax
    
(15
)
  
(46
)
Pro forma income
 
$
1,352
  
$
2,851
  
               
Basic earnings per share, as reported
  
$
0.26
  
$
0.55
  
Pro forma basic earnings per share
    
0.26
    
0.55
  
               
Diluted earnings per share, as reported
  
$
0.26
  
$
0.55
  
Pro forma diluted earnings per share
    
0.26
    
0.55
  

A summary of the Company’s stock option activity and related information is presented below for the nine months ended September 30:

   
- - - - - - 2006 - - - - - -
  
- - - - - - 2005 - - - - - -
  
       
Weighted
Average
Exercise
      
Weighted
Average
Exercise
  
   
Options
  
Price
  
Options
  
Price
  
Outstanding at beginning of year
    
111,750
  
$
11.05
    
83,650
  
$
10.65
  
Grants
    
35,250
    
16.00
    
35,000
    
11.62
  
Exercises
    
(3,002
)
  
9.02
    
(1,500
)
  
8.41
  
Forfeitures
    
(21,750
)
  
13.10
    
(4,733
)
  
9.06
  
Outstanding at September 30,
   
122,248
  
$
12.26
    
112,417
  
$
11.05
  
                           

Additional information regarding stock options outstanding and exercisable at September 30, 2006, is provided in the following table:

   
- - - - - - - - - - - Outstanding - - - - - - - - - - -
 
- - - - Currently Exercisable - - - -
  
Range of Exercise Prices
  
Number
  
Weighted Average Remaining Contractual Life
  
Weighted Average Exercise Price
  
Aggregate Intrinsic Value
 
Number
  
Weighted Average Exercise Price
  
Aggregate Intrinsic Value
  
                               
$7.50 to $10.00
    
43,249
    
6.9
  
$
8.70
  
$
264
    
34,924
  
$
8.56
  
$
218
  
$10.01 to $12.50
    
33,499
    
8.3
    
11.62
    
106
    
10,508
    
11.62
    
33
  
$15.01 to $17.50
    
45,500
    
7.7
    
16.12
    
0
    
11,000
    
16.50
    
0
  
Outstanding at Sept 30, 2006
    
122,248
    
7.6
    
12.26
  
$
370
    
56,432
    
10.68
  
$
251
  

 
19
PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
SEPTEMBER 30, 2006

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

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, 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. The words “may,” “could,” “should,” “would,” “will,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan,” “project,” “predict,” “continue” and similar expressions are intended to identify forward-looking statements.

A. Results of Operations

A financial institution’s primary sources of revenue are generated by interest income on loans, investments and other 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.

Net income for the nine months ended September 30, 2006 was $4,842,000, or 92 cents per share, compared to net income of $2,897,000, or $0.55 per share, for the nine months ended September 30, 2005. The increase in income reported for 2006 was primarily the result of an 8.6% increase in net interest income (fueled by a 10.3% increase in interest income on loans), negative provisions for loan losses, a 5.1% increase in non-interest income and a 2.5% decline in non-interest expenses. These improvements in profitability more than offset higher interest expense, higher outside data processing costs and the accelerated amortization of issuance costs related to the early redemption of $7.0 million of Premier’s Trust Preferred securities on January 31, 2006. For the three months ended September 30, 2006, net income was $1,475,000, or $0.28 per share, compared to net income of $1,367,000 or $0.26 per share for the three months ended September 30, 2005. The increase in income reported for 2006 was again largely due to 6.4% increase in net interest income (fueled by a 10.6% increase in interest income on loans), and a 14.2% increase in non-interest income. These improvements in profitability more than offset higher interest expense, lower negative provisions for loan losses and higher non-interest expenses, primarily outside data processing.

 
20
PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
SEPTEMBER 30, 2006


Net interest income for the nine months ending September 30, 2006 totaled $15.94 million, up 8.6% from the $14.68 million of net interest income earned in the first nine months of 2005. Interest income in 2006 increased by $2.26 million or 10.4%, $1.79 million due to higher interest rates earned and increases in loans outstanding, and $386,000 due to an increase in yields of federal funds sold. Interest expense increased in total by $990,000 in 2006 compared to 2005, partially offsetting the increase in interest income. Interest savings of $954,000 were realized due to the early redemption of $5.0 million of Premier’s Trust Preferred Securities on December 30, 2005 and another $7.0 million on January 31, 2006. A portion of the savings was offset by the increase in interest expense related to FHLB advances and other borrowings as Premier borrowed the $7.0 million it used to complete the January 2006 redemption. (See Note 6 to the consolidated financial statements). The net interest saving realized was more than offset by a $1.58 million, or 32.5% increase in interest expense on deposits. Due to the rising interest rate environment and actions taken by the Federal Reserve to increase national federal funds rates in 2005 and early 2006, Premier has increased the rates paid to its depositors to remain competitive in its markets. As a result of the increase in interest income, the net interest margin for the nine months ending September 30, 2006 increased to 4.29% compared to 3.93% for the same period in 2005.

Net interest income for the quarter ending September 30, 2006 totaled $5.38 million, up from the $5.06 million of net interest income earned in the third quarter of 2005. Interest income increased by $785,000 in 2006, again due to higher loan income and interest on federal funds sold. Interest income on loans increased by $637,000 or 10.6% as the higher volume of loans was complemented by rising yields on floating rate loans. Interest income on federal funds sold increased by $106,000 due to the higher interest rate environment. Interest expense increased in total by $463,000 in the third quarter of 2006 compared to the same quarter of 2005, partially offsetting the increase in interest income. Interest savings of $297,000 were realized due to the early redemption of $5.0 million Premier’s Trust Preferred Securities on December 30, 2005 and the $7.0 million on January 31, 2006. A portion of the savings was offset by the $131,000 increase in interest expense related to FHLB advances and other borrowings as Premier borrowed the $7.0 million it used to complete the January 2006 redemption. The net interest saving realized was more than offset by a $617,000, or 35.4% increase in interest expense on deposits. As a result of the increase in interest income, the net interest margin for the three months ending September 30, 2006 was approximately 4.30% compared to 4.06% for the same three month period in 2005.

During the first nine months of 2006, the Company reversed $1,051,000 of previously recorded provisions for loan losses (negative provisions) compared to $294,000 of positive provision expense in the first nine months of 2005. During the third quarter of 2006, the Company reversed $38,000 of previously recorded provisions versus a reversal of $140,000 of previously recorded provisions during the same period of 2005. The decrease in the provision was made in accordance with Premier’s policies regarding management’s estimation of probable incurred losses in the loan portfolio and the adequacy of the allowance for loan losses, which are in accordance with accounting principles generally accepted in the United States of America. The negative provisions recorded each consecutive quarter since the third quarter 2005 were the result of continued improvement in the estimated credit risk at banks formerly subject to regulatory agreements, payments on loans previously identified as having significant credit risk at Farmers Deposit Bank and at First Central Bank, and $1,630,000 of recoveries of previously charged-off loans collected since July 1, 2005. Nearly half of the high level of recoveries occurred in the second quarter of 2006 ($772,000) and was attributable to recoveries from a few customers which had significant charged-off loan balances. Future recoveries, if any, are not anticipated to continue to be that sizable. Likewise, 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.

 
21
PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
SEPTEMBER 30, 2006


Non-interest income increased to $3.03 million for the first nine months of 2006 compared to $2.88 million for the first nine months of 2005. Service charges on deposit accounts increased by $74,000 or 3.7% due to increases in fee rates and the volume of deposit customers. Electronic banking income (income from debit/credit cards, ATM fees and internet banking charges) increased $81,000 or 28.4% to $366,000 in 2006 due to increases in Premier’s deposit customer base and their greater propensity to use electronic means to conduct their banking business. Premier’s conversion to a more modern banking software system in 2005 has allowed Premier to offer more electronic banking services and made it easier for customers to conduct their banking electronically. Secondary market mortgage income in the first nine months of 2006 increased $26,000 or 16.6% to $183,000 in 2006 as the Company has expanded its processes to capture more of this business in its local markets. Other non-interest income decreased by $34,000 or 7.9%, largely due to one-time increases in other sources of banking income in 2005, such as revenue from checkbook sales, and recognition of income from certain loan collections. These were partially offset by an increase in late payment fees on consumer loans realized in 2006. For the quarter ending September 30, 2006, non-interest income increased $140,000 to $1,127,000 compared to $987,000 for the third quarter of 2005. The increase is primarily due to a $57,000 or 7.9% increase in service charges on deposit accounts, a $29,000 or 29.0% increase in electronic banking income and a $28,000 or 42.4% increase in secondary market mortgage income. Other income also increased due to increases in consumer loan late fees.

Non-interest expenses for the first nine months of 2006 totaled $12.74 million or 3.14% of average assets on an annualized basis compared to $13.06 million or 3.24% of average assets for the same period of 2005. Non-interest expense in the first nine months of 2005 includes two one-time events that are nearly offsetting. Professional fee expense includes $148,000 of reimbursed legal fees from an insurance settlement in the first quarter of 2005, while other expenses include a $140,000 loss on the disposition of a bond servicing department at one of the Company’s affiliate banks in the first quarter of 2005. Staff costs, occupancy and equipment expense and other operating expenses all decreased partially due to the cessation of operations of Premier’s data processing subsidiary in July 2005. The $425,000 of these savings more than offset the $368,000 increase in outside data processing expenses related to data and item processing. Beginning in late 2004 and continuing through July 2005, Premier’s subsidiary banks were converted to a third-party data processing and item processing provider. Also included in the increase in outside data processing expenses was a $146,000 increase in ATM processing costs. Expenses related to training on the new system and data conversion were expensed as incurred, primarily in the second quarter of 2005, and are included in other expenses. Expenditures for software licenses and new equipment were capitalized and expensed over time in accordance with the Company’s fixed asset policy. 

In addition to the expense savings realized from the cessation of operations of the data processing subsidiary, occupancy and equipment costs decreased by another $75,000 in the first nine months of 2006 compared to same period of 2005, while staff costs increased by $42,000. The increase in staff costs includes $104,000 of stock compensation expense required by FAS 123R in 2006, which was offset by lower benefit and incentive costs. The decrease in occupancy and equipment costs is net of a $55,000 facility writedown in September 2006 as a closed branch building continues to be marketed for sale. Likewise, professional fees decreased $95,000 in 2006 largely due to lower internal audit costs. Taxes not on income increased $165,000 due to tax refunds recognized in 2005 and an increase in shareholders’ equity subject to tax in West Virginia. Conversely, write-downs, expenses and sales of other real estate owned (OREO) decreased in 2006 largely due to gains on the disposition of OREO in 2006. Also, supplies expense decreased $28,000 due to operational changes. The $522,000 decrease in other non-interest expense is partially due to the cessation of data processing operations. In addition to these savings, other one-time expenses (and benefits) are included in other non-interest expense as follows. In 2006, $256,000 of one-time accelerated amortization of trust preferred issuance costs were partially offset by a $140,000 recovery of bad check losses as well as recoveries of expenses incurred to collect delinquent and charged-off loans. In 2005, other non-interest expenses include a $140,000 loss on the disposition of a bond servicing department at one of the Company’s affiliate banks and $437,000 of costs related to the conversion of Premier’s data processing.

 
22
PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
SEPTEMBER 30, 2006


Non-interest expenses for the third quarter of 2006 totaled $4,323,000 or 3.24% of average assets on an annualized basis compared to $4,176,000 or 3.11% of average assets for the same period of 2005. Staff costs increased $73,000 in 2006 largely due to normal salary increases and the addition of $36,000 of stock compensation expense in 2006. Occupancy and equipment costs decreased by $14,000 in 2006 compared to 2005. Decreases in software costs, property insurance and equipment maintenance were only partially offset by a $55,000 facility writedown in September 2006 as a closed branch building continues to be marketed for sale. Outside data processing costs increased $101,000 due to higher ATM processing costs, internet banking charges and an overall increase in data activity. Professional fees increased by $29,000 due to an increase in audit costs while taxes not on income increased $89,000 in the third quarter of 2006 due to tax refunds recognized in 2005 and an increase in shareholders’ equity subject to tax in West Virginia. Other non-interest expenses declined $143,000 in the third quarter of 2006 largely due to $58,000 of conversion costs expensed in the third quarter of 2005 as well as lower loan collection expenses and FDIC insurance costs in the third quarter of 2006.

Income tax expense was $2.45 million for the first nine months of 2006 compared to $1.31 million for the first nine months of 2005. The increase in income tax expense can be primarily attributed to the increase in pre-tax income detailed above. The effective tax rate for the nine months ended September 30, 2006 was 33.6%, compared to the 31.1% effective tax rate for the same period in 2005. Income tax expense for the quarter ending September 30, 2006 was $744,000 (33.5% effective tax rate) compared to $639,000 (31.8% effective tax rate) for the same period of 2005. The increase in the effective rates are largely due to the declining percentage of tax exempt income in relation to total income as the Company’s profits have increased and the completion of a tax credit strategy in 2005.

The annualized returns on shareholders’ equity and on average assets were approximately 11.31% and 1.19% for the nine months ended September 30, 2006 compared to 7.46% and 0.72% for the same period in 2005. For the quarter ended September 30, 2006, annualized returns on shareholders’ equity and on average assets were approximately 10.14% and 1.10%, respectively.

B. Financial Position
 
Total assets at September 30, 2006 increased $11.4 million to $539.7 million from the $528.3 million at December 31, 2005. Earning assets increased to $501.3 million at September 30, 2006 from the $488.6 million at December 31, 2005, an increase of $12.8 million, or 2.6%. The increase was due to a $17.3 million increase total loans and a $3.3 million increase in Federal funds sold which were only partially offset by a $7.9 million decrease in the securities portfolio (see below).

 
23
PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
SEPTEMBER 30, 2006


Cash and due from banks at September 30, 2006 was $16.3 million, relatively unchanged from the $16.1 million at December 31, 2005. Federal funds sold also increased $3.3 million from the $18.8 million reported at December 31, 2005. Changes in these two highly liquid assets are generally in response to demand for deposit withdrawals or the funding of loans and are part of Premier’s management of its liquidity and interest rate risks. With rates earned on Federal funds sold nearly the same as long-term yields on investment grade bonds, the Company has be able to maintain a higher liquidity position to help fund its loan growth without significantly reducing yields.

Securities available for sale totaled $129.5 million at September 30, 2006, a $7.9 million decrease from the $137.4 million at December 31, 2005. The decline was largely due to a lower volume of purchases versus the volume of calls and maturities that occurred during the first nine months slightly offset by a $597,000 increase in the market value of the total portfolio. To provide funding for new loans and anticipated new loans in the short-term future, not all of the funds from maturing investments were renewed. The investment portfolio is predominately high quality interest-bearing bonds with defined maturity dates backed by the U.S. Government or Government sponsored agencies. The unrealized losses at September 30, 2006 and December 31, 2005 are price changes resulting from fluctuations in the interest rate environment and are not considered to be other than 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. Additional details on investment activities can be found in the Consolidated Statements of Cash Flows.

Total loans at September 30, 2006 were $346.0 million compared to $328.7 million at December 31, 2005, an increase of over $17.3 million. This increase is largely due to loan growth in each of Premier’s markets. Over one-half of the increase in loans was from the Company’s West Virginia market, up $11.8 million since December 31, 2005. The increase in loans outstanding was despite the continued loan collections at Farmers Deposit Bank plus the charge-off of $1.1 million of uncollectible loans across the Company.

The following table sets forth information with respect to the Company’s nonperforming assets at September 30, 2006 and December 31, 2005.

   
(In Thousands)
  
   
2006
  
2005
  
Non-accrual loans
  
$
5,354
  
$
3,751
  
Accruing loans which are contractually past due 90 days or more
    
887
    
853
  
Restructured
    
1,284
    
1,540
  
Total non-performing loans
    
7,525
    
6,144
  
Other real estate acquired through foreclosure
    
415
    
2,049
  
Total non-performing assets
  
$
7,940
  
$
8,193
  
               
Non-performing loans as a percentage of total loans
    
2.17
%
  
1.87
%
               
Non-performing assets as a percentage of total assets
    
1.47
%
  
1.55
%
 

 
24
PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
SEPTEMBER 30, 2006

Total non-performing loans have increased since year-end largely due to an increase in non-accrual loans. However, due to sales of OREO properties, total non-performing assets have decreased since year-end. The increase in non-accrual loans is largely due to the past due status of loans of two borrowers, one of which the Company believes is secured with marketable collateral. Management believes the loan balances will be collected upon the liquidation of the collateral. The other borrower is under the protection of the bankruptcy court. As hearings are held, the Company evaluates its collateral position and the likelihood of collecting the loan balances. Any identified deficiencies have either already been charged-off or sufficient allocations of the allowance for loan losses have been made. Non-accrual loans increased by $1,603,000 while loans past due 90 days or more increased $34,000. OREO properties have declined by $1,634,000 due to sales of property during the second and third quarters of 2006. A significant effort has been placed on reviews of loan files, efforts by lenders to bring borrowers current with the terms of their loan agreements and the sale of OREO properties. As in the past, when these plans are executed, Premier may experience increases in non-performing loans and non-performing assets. Furthermore, any resulting increases in loans placed on non-accrual status will have a negative impact on future loan interest income. Also, as these plans are executed, other loans may be identified that would necessitate additional charge-offs and potentially additional provisions for loan losses.

Gross charge-offs totaled $1,131,000 during the first nine months of 2006. Any collections on these loans would be presented in future financial statements as recoveries of the amounts charged against the allowance. Recoveries recorded during the first nine months of 2006 totaled $1,231,000. The allowance for loan losses at September 30, 2006 was 2.01% of total loans as compared to 2.40% at December 31, 2005. The declining percentage of allowance for loan losses to total loans is largely due to the negative provision expense recorded since year-end, to the increase in loans outstanding during 2006 and to the sufficient loan loss reserves allocated to those loans actually charged off during the first nine months of 2006. With the new credit approval standards and procedures employed in 2003, the overall credit quality of the Company’s loan portfolio has steadily improved and thus the ratio of allowance for loan losses to total loans has steadily declined.

Deposits totaled $445.8 million as of September 30, 2006, a $10.0 million increase from the $435.8 million in deposits at December 31, 2005. The increase is largely due to a $10.5 million increase in certificates of deposit over $100,000. Other interest bearing deposits have decreased $1.9 million since December 31, 2005 which has been nearly offset by the $1.5 million increase in non-interest bearing deposits since year-end. Repurchase agreements with corporate and public entity customers increased also, up $157,000 since year-end to $9.5 million as of September 30, 2006.

Federal Home Loan Bank advances declined by $702,000 in the first nine months of 2006 due to regularly scheduled principal payments as well as some penalty-free additional principal payments. Other borrowed funds increased by $6.6 million since December 31, 2005.  On January 31, 2006, the Company executed and delivered to First Guaranty Bank of Hammond, Louisiana a Promissory Note and Business Loan Agreement dated January 31, 2006 for the principal amount of $7,000,000, bearing interest floating daily at the “Wall Street Journal” prime rate (currently 8.25%) and requiring monthly principal payments of $50,000 until maturity on September 28, 2017. The note is secured by a pledge of Premier’s 100% interest in Boone County Bank (a wholly owned subsidiary) under Commercial Pledge Agreement dated January 31, 2006. The proceeds of this note were used to redeem $7,000,000 (280,000 shares) of Premier’s 9.75% Trust Preferred Securities as of January 31, 2006. Premier’s chairman owns approximately 27.6% of the voting stock of First Guaranty Bank. However, Premier’s board of directors determined during its vote to authorize the company to enter into the loan transaction that the terms of the financing, including the interest rate and collateral, were no less favorable than those which could be obtained from other financial institutions. See Notes 5 and 6 to the consolidated financial statements for additional information on the Company’s outstanding bank debt and subordinated debentures.

 
 
25
PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
SEPTEMBER 30, 2006

 
       In June the Company fully repaid the $1.4 million of notes payable to Mr. Reynolds, Chairman of the Board, and Mr. Walker, President and CEO of the Company who loaned the Company the proceeds to make the June and September 2002 distributions on the Trust Preferred Securities.
Accrued interest payable increased by $489,000 since year-end as a result of higher rates paid on deposits and the accrual of the $201,000 third quarter distribution on the Company’s trust preferred securities which was not scheduled to be paid until the first business day in October. Other liabilities declined by $1.6 million since December 31, 2005 largely as a result of the investment purchases that occurred in late December 2005 but were not paid for until January 2006.

C. Critical Accounting Policies

The Company follows financial accounting and reporting policies that are in accordance with generally accepted accounting principles in the United States of America. These policies are presented in Note 1 to the consolidated audited financial statements in the Company's annual report on Form 10-K for the year ended December 31, 2005. Some of these accounting policies, as discussed below, are considered to be critical accounting policies. Critical accounting policies are those policies that require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. The Company has identified three accounting policies that are critical accounting policies, and an understanding of these policies is necessary to understand the financial statements. These policies relate to determining the adequacy of the allowance for loan losses, the impairment of goodwill, and the valuation of deferred tax assets. A detailed description of these accounting policies is contained in the Company’s annual report on Form 10-K for the year ended December 31, 2005. There have been no significant changes in the application of these accounting policies since December 31, 2005.

      Management believes that the judgments, estimates and assumptions used in the preparation of the consolidated financial statements are appropriate given the factual circumstances at the time.

 
D. Liquidity

Liquidity objectives for the Company can be expressed in terms of maintaining sufficient cash flows to meet both existing and unplanned obligations in a cost effective manner. Adequate liquidity allows the Company to meet the demands of both the borrower and the depositor on a timely basis, as well as pursuing other business opportunities as they arise. Thus, liquidity management embodies both an asset and liability aspect while attempting to maximize profitability. In order to provide for funds on a current and long-term basis, the Company’s subsidiary banks rely primarily on the following sources:
 


 
26
PREMIER FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
SEPTEMBER 30, 2006



 
1.
Core deposits consisting of both consumer and commercial deposits and certificates of deposit of $100,000 or more. Management believes that the majority of its $100,000 or more certificates of deposit are no more volatile than its other deposits. This is due to the nature of the markets in which the subsidiaries operate.

 
2.
Cash flow generated by repayment of loans and interest.

 
3.
Arrangements with correspondent banks for purchase of unsecured federal funds.

 
4.
The sale of securities under repurchase agreements and borrowing from the Federal Home Loan Bank.

 
5.
Maintenance of an adequate available-for-sale security portfolio. The Company owns $129.5 million of securities at market value as of September 30, 2006.

      The cash flow statements for the periods presented in the financial statements provide an indication of the Company’s sources and uses of cash as well as an indication of the ability of the Company to maintain an adequate level of liquidity.


E. Capital

At September 30, 2006, total shareholders’ equity of $59.4 million was 11.0% of total assets. This compares to total shareholders’ equity of $54.3 million or 10.3% of total assets on December 31, 2005.

Tier I capital totaled $53.2 million at September 30, 2006, which represents a Tier I leverage ratio of 10.3%. This ratio is down from the 10.6% at December 31, 2005 due to the redemption of $7.0 million of Premier’s Trust Preferred Securities in January 2006, all of which was previously included in Tier I capital. As of September 30, 2006, the remaining Preferred Securities issued by the Trust qualify as Tier 1 capital for the Company under the Federal Reserve Board’s regulatory framework. Had the November 10, 2006 redemption of the $8,250,000 remaining securities occurred prior to September 30, 2006, the Company’s Tier I Capital would be reduced to $44.9 million, which represents a Tier I leverage ratio of 8.7%. The resulting ratio is still well above the minimum ratio established by the FRB to be considered well capitalized. (See Note 7 to the consolidated financial statements). .

Book value per share was $11.34 at September 30, 2006, and $10.37 at December 31, 2005. The increase in book value per share was primarily the result of $5,236,000 of comprehensive net income for the first nine months of 2006 as net income was increased by the $394,000 after tax increase in the market value of investment securities available for sale during the first nine months of 2006.



 
27
PREMIER FINANCIAL BANCORP, INC.
SEPTEMBER 30, 2006


Item 3. Quantitative and Qualitative Disclosures About Market Risk

The Company currently does not engage in any derivative or hedging activity. Refer to the Company’s 2005 10-K for analysis of the interest rate sensitivity. The Company believes there have been no significant changes in the interest rate sensitivity since previously reported on the Company’s 2005 10-K.


Item 4. Controls and Procedures

A. Disclosure Controls & 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 quarterly 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 quarterly 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.

B. Changes in Internal Controls over Financial Reporting

There were no changes in internal controls over financial reporting during the third fiscal quarter that have materially affected or are reasonably likely to materially affect Premier's internal controls over financial reporting.


 
28
PREMIER FINANCIAL BANCORP, INC.
SEPTEMBER 30, 2006


PART II - OTHER INFORMATION

Item 1.  Legal Proceedings  None

Item 1A.  Risk Factors

Please refer to Premier’s Annual Report on Form 10-K for the year ended December 31, 2005 for disclosures with respect to Premier’s risk factors at December 31, 2005. There have been no material changes since year-end 2005 in the specified risk factors disclosed in the Annual Report on Form 10-K.

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds None

Item 3.  Defaults Upon Senior Securities  None

Item 4.  Submission of Matters to a vote of Security Holders None

Item 5. Other Information  None

Item 6. Exhibits

(a) The following exhibits are furnished in accordance with the provisions of Item 601 of Regulation S-K.

31.1 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32  Certification Pursuant to 18 U.S.C §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002


 
29
PREMIER FINANCIAL BANCORP, INC.
SEPTEMBER 30, 2006


SIGNATURES


Pursuant to the requirements of the Securities Exchange Act of 1934, the Corporation has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

PREMIER FINANCIAL BANCORP, INC.



Date: November 13, 2006             /s/ Robert W. Walker             
Robert W. Walker
President & Chief Executive Officer


Date: November 13, 2006             /s/ Brien M. Chase               
Brien M. Chase
Vice President & Chief Financial Officer


 
 
 
30