LIMESTONE BANCORP, INC. - Quarter Report: 2008 March (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

For the Quarterly Period Ended March 31, 2008

Or

For the transition period from              to             

Commission file number: 001-33033

PORTER BANCORP, INC.

(Exact name of registrant as specified in its charter)

(502) 499-4800

(Registrant’s telephone number, including area code)

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 shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

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

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

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

7,891,957 shares of Common Stock, no par value, were outstanding at April 30, 2008.

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INDEX

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PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

The following consolidated financial statements of Porter Bancorp Inc. and Subsidiary, PBI Bank, Inc., are submitted:

Unaudited Consolidated Balance Sheets for March 31, 2008 and December 31, 2007

Unaudited Consolidated Statements of Income for the three months ended March 31, 2008 and 2007

Unaudited Consolidated Statement of Changes in Stockholders’ Equity for the three months ended March 31, 2008

Unaudited Consolidated Statements of Cash Flows for the three months ended March 31, 2008 and 2007

Notes to Unaudited Consolidated Financial Statements

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PORTER BANCORP, INC. AND SUBSIDIARY

Unaudited Consolidated Balance Sheets

(dollars in thousands except share data)

See accompanying notes to unaudited consolidated financial statements.

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PORTER BANCORP, INC. AND SUBSIDIARY

Unaudited Consolidated Statements of Income

(dollars in thousands, except per share data)

See accompanying notes to unaudited consolidated financial statements.

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PORTER BANCORP, INC. AND SUBSIDIARY

Unaudited Consolidated Statement of Changes in Stockholders’ Equity

For Three Months Ended March 31, 2008

(dollars in thousands, except share and per share data)

See accompanying notes to unaudited consolidated financial statements.

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PORTER BANCORP, INC. AND SUBSIDIARY

Unaudited Consolidated Statements of Cash Flows

For Three Months Ended March 31, 2008 and 2007

(dollars in thousands)

See accompanying notes to unaudited consolidated financial statements.

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PORTER BANCORP, INC. AND SUBSIDIARY

Notes to Unaudited Consolidated Financial Statements

Note 1 – Basis of Presentation and Summary of Significant Accounting Policies

Basis of Presentation – The consolidated financial statements include Porter Bancorp, Inc. (the “Company”) and its wholly-owned subsidiary, PBI Bank (the “Bank”). All significant inter-company transactions and accounts have been eliminated in consolidation.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, the financial statements do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for three months ended March 31, 2008 are not necessarily indicative of the results that may be expected for the entire year. A description of other significant accounting policies is presented in the notes to the Consolidated Financial Statements for the year ended December 31, 2007 included in the Company’s Annual Report on Form 10-K.

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

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

New Accounting Standards

In September 2006, the FASB issued Statement No. 157, Fair Value Measurements. This Statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. This Statement establishes a fair value hierarchy about the assumptions used to measure fair value and clarifies assumptions about risk and the effect of a restriction on the sale or use of an asset. The standard is effective for fiscal years beginning after November 15, 2007. In February 2008, the FASB issued Staff Position (FSP) 157-2, Effective Date of FASB Statement No. 157. This FSP delays the effective date of FAS 157 for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value on a recurring basis (at least annually) to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. The impact of adoption was not material. See Note 6.

In September 2006, the FASB Emerging Issues Task Force finalized Issue No. 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements. This issue requires that a liability be recorded during the service period when a split-dollar life insurance agreement continues after participants’ employment or retirement. The required accrued liability will be based on either the post-employment benefit cost for the continuing life insurance or based on the future death benefit depending on the contractual terms of the underlying agreement. This issue is effective for fiscal years beginning after December 15, 2007. The adoption of this statement did not have a material impact on our consolidated financial position or results of operations.

In February 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. The standard provides companies with an option to report selected financial assets and liabilities at fair value and establishes presentation and disclosure requirements designed to facilitate

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comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. The new standard is effective for the Company on January 1, 2008. The Company did not elect the fair value option for any financial assets or financial liabilities as of January 1, 2008.

Note 2 – Stock Plans and Stock Based Compensation

At March 31, 2008, the Company has a stock option plan and a stock incentive plan. On December 31, 2005 the Company assumed the 2000 Stock Option Plan of Ascencia Bank, Inc. when the Company acquired the minority interest of Ascencia Bancorp, Inc. On February 23, 2006, the Company adopted the Porter Bancorp, Inc. 2006 Stock Incentive Plan. With regard to the 2000 Option Plan, no additional grants were made subsequent to assumption of the plan and none are expected to be made in the future. The 2006 Plan permits the issuance of up to 400,000 shares of the Company’s common stock upon the exercise of stock options or upon the grant of stock awards. As of March 31, 2008, the Company had granted outstanding options to purchase 192,240 shares under the 2000 option plan and 39,316 shares under the 2006 plan. The Company also had granted under the 2006 plan 37,780 unvested shares net of forfeitures and vesting. The Company has 322,904 shares remaining available for issue under the 2006 Plan. All shares issued under the above mentioned plans came from authorized and unissued shares.

On May 15, 2006, the board of directors approved the Porter Bancorp, Inc. 2006 Non-Employee Directors Stock Ownership Incentive Plan, which was approved by holders of the Company’s voting common stock on June 8, 2006. Under the terms of the plan, 100,000 shares are reserved for issuance to non-employee directors upon the exercise of stock options granted under the plan. Options granted are granted automatically under the plan at fair market value on the date of grant, vest over a three-year period and have a five year term. To date, the Company has granted options to purchase 53,000 shares to non-employee directors. At March 31, 2008, 47,000 shares remain available for issue under this plan.

All stock options have an exercise price that is at least equal to the fair market value of the Company’s stock on the date the options were granted. Options granted generally become fully exercisable at the end of three years of continued employment. Options granted under the 2000 plan have a life of ten years while those granted under the 2006 plan have a life of five years.

The following table summarizes stock option activity:

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The following table details stock options outstanding:

The intrinsic value of stock options is calculated based on the exercise price of the underlying awards and the market price of our common stock as of the reporting date. There were no options exercised during the first three months of 2008. The Company recorded $28,000 of stock option compensation during the three months ended March 31, 2008 to salaries and employee benefits. Since the stock options are non-qualified stock options, a tax benefit of $10,000 was recognized. No options were modified during either period. As of March 31, 2008, no stock options issued by the Company have been exercised.

From time-to-time the Company grants unvested shares which vest over time to employees. The shares vest at a rate of 10% on each one-year anniversary date of the grant date provided the employee is still employed by the Company at that date. The fair value on the date of grant ranged from $22.13 to $25.50 per share. The Company recorded $28,000 of stock-based compensation during the first quarter of 2008 to salaries and employee benefits. A tax benefit of $10,000 was recognized related to this expense.

The following table summarizes unvested share activity as of and for the periods indicated:

Unrecognized stock based compensation expense related to stock options and unvested shares for the remainder of 2008 and beyond is estimated as follows (in thousands):

Note 3 - Securities

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

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Securities pledged at March 31, 2008 and December 31, 2007 had carrying values of approximately $74,543,000 and $83,683,000, respectively, and were pledged to secure public deposits, repurchase agreements, and Federal Home Loan Bank advances.

The Company evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, underlying credit quality of the issuer, and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an issuer’s financial condition, the Company may consider whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, the sector or industry trends and cycles affecting the issuer, and the results of reviews of the issuer’s financial condition.

As of March 31, 2008, the Company owns 62 equity securities. Of these securities, 18 had an unrealized loss of $700,000 and had been in an unrealized loss position for less than 12 months and 16 had an unrealized loss of $366,000 and had been in an unrealized loss position for more than 12 months. Management monitors the credit quality and current market pricing for these equity securities monthly. Management has made a practice of selling equity securities where recovery does not seem likely but does not have the present intent to sell securities with unrealized losses. As of March 31, 2008, management does not believe any equity securities should be classified as other than temporarily impaired.

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Note 4 – Loans

Loans were as follows:

Activity in the allowance for loan losses was as follows:

Impaired loans were as follows:

Nonperforming loans were as follows:

Nonperforming loans include all (or almost all) impaired loans and smaller balance homogeneous loans, such as residential mortgage and consumer loans, that are collectively evaluated for impairment.

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Note 5 – Advance from the Federal Home Loan Bank

Advances from the Federal Home Loan Bank were as follows:

Each advance is payable per terms on agreement, with a prepayment penalty. The advances were collateralized by first mortgage loans, under a blanket lien arrangement. At March 31, 2008, the Bank had unused borrowing capacity of $66.2 million with the FHLB.

Note 6 – Fair Values Measurement

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The statement establishes a fair value hierarchy about the assumptions used to measure fair value and clarifies assumptions about risk and the effect of a restriction on the sale or use of an asset and was effective for us during the first quarter of 2008. In February 2008, the FASB issued FASB Staff Position (FSP) 157-2, “Effective Date of FASB Statement No. 157” (“FSP 157-2”). FSP 157-2 delays the effective date of SFAS No. 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value on a recurring basis (at least annually) to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. We have included the disclosures required by SFAS No. 157 in this document.

SFAS No. 157 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. We use various valuation techniques to determine fair value, including market, income and cost approaches. SFAS No. 157 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. SFAS No. 157 describes three levels of inputs that may be used to measure fair value:

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

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

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

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. When that occurs, we classify the fair value hierarchy on the lowest level of input that is significant to the fair value measurement. We used the following methods and significant assumptions to estimate fair value.

Securities: The fair values of trading securities and securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges or matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities. Matrix pricing relies on the securities’ relationship to similarly traded securities, benchmark curves, and the benchmarking of like securities. Matrix pricing utilizes observable market inputs such as benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, and industry and economic events. In instances where broker quotes are used, these quotes are obtained from market makers or broker-dealers recognized to be market participants. This valuation method is classified as Level 2 in the fair value hierarchy.

Impaired Loans: Impaired loans are evaluated at the time the loan is identified as impaired and are recorded at the lower of cost or market value. Market value is measured based on the value of the collateral securing these loans and is classified as Level 3 in the fair value hierarchy. Fair value is determined using several methods. Generally the fair value of real estate is determined based on appraisals by qualified licensed appraisers. If an appraisal is not available, the fair value of the collateral may be determined by using a cash flow analysis, a broker’s opinion of value, the net present value of future cash flows, or an observable market price from an active market. Fair value on non-real estate collateral loans is determined using similar methods. In addition, business equipment may be valued by using the net book value from the business’ financial statements. Impaired loans are evaluated quarterly for additional impairment.

Assets measured at fair value on a recurring basis are summarized below:

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Assets measured at fair value on a recurring basis are summarized below:

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $486,000 and a valuation allowance of $31,000.

Note 7 – Business Combinations

On February 1, 2008, the Company completed the acquisition of Paramount Bank in Lexington, Kentucky in a $5 million all cash transaction. Operating results of Paramount Bank are included in the consolidated financial statements since the date of the acquisition. As a result of this acquisition, we expect to further solidify our market share in the Lexington market, expand our customer base to enhance deposit fee income, provide an opportunity to market additional products and services to new customers and reduce operating costs through economies of scale.

The acquisition added approximately $73 million in loans and $76 million in deposits. The purchase price resulted in approximately $5.6 million in goodwill, and $1 million in core deposit intangibles. The intangible assets will be amortized over 5-10 years, using an accelerated method. Goodwill will not be amortized but instead evaluated periodically for impairment. Goodwill and intangible assets will be deducted for tax purposes over 15 years using the straight-line method.

The following table summarizes the estimated fair value of assets acquired and liabilities assumed at the date of acquisition. We are in the process of obtaining independent third-party valuations of intangible assets, thus, the purchase price allocation is subject to refinement.

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Note 8 – Earnings per Share

The factors used in the earnings per share computation follow:

Unvested share of common stock of 37,780 for 2008 and 33,930 for 2007; and stock options for 284,556 shares of common stock for 2008 and 251,070 shares of common stock for 2007, were not considered in computing diluted earnings per common share because they were anti-dilutive.

Note 9 – Total Comprehensive Income

Other comprehensive income (loss) components and related tax effects were as follows:

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

and Results of Operations

This item analyzes our financial condition, change in financial condition and results of operations. This section should be read in conjunction with the unaudited condensed consolidated financial statements and accompanying notes presented in Part I, Item 1 of this report.

Cautionary Note Regarding Forward-Looking Statements

This report contains statements about the future expectations, activities and events that constitute forward-looking statements under the Private Securities Litigation Reform Act. Forward-looking statements are based on our beliefs, assumptions and expectations of our future financial and operating performance and growth plans, taking into account information currently available to us. These statements are not statements of historical fact. The words “believe,” “may,” “should,” “anticipate,” “estimate,” “expect,” “intend,” “objective,” “seek,” “plan,” “strive” or similar words, or the negatives of these words, identify forward-looking statements.

Forward-looking statements involve risks and uncertainties that may cause our actual results to differ materially from the expectations of future results we expressed or implied in any forward-looking statements. These risks and uncertainties can be difficult to predict and may be out of our control. Factors that could contribute to differences in our results include, but are not limited to the factors listed in Part 2, Item 1A – Risk Factors in this report and the more detailed risks identified, and the cautionary statements included in our December 31, 2007 Annual Report on Form 10-K.

Forward-looking statements are not guarantees of performance or results. A forward-looking statement may include a statement of the assumptions or bases underlying the forward-looking statement. The Company believes it has chosen these assumptions or bases in good faith and that they are reasonable. We caution you however, that assumptions or bases almost always vary from actual results, and the differences between assumptions or bases and actual results can be material. The forward-looking statements included in this report speak only as of the date of the report. We have no duty, and do not intend to, update these statements unless applicable laws require us to do so.

Overview

Porter Bancorp, Inc. (NASDAQ: PBIB) is a Louisville, Kentucky-based bank holding company which operates 19 full-service banking offices in twelve counties through its wholly-owned subsidiary, PBI Bank. Our markets include metropolitan Louisville in Jefferson County and the surrounding counties of Henry and Bullitt, and extend south along the Interstate 65 corridor to Tennessee. We serve south central Kentucky and southern Kentucky from banking offices in Cumberland, Butler, Green, Hart, Edmonson, Barren, Warren, Ohio and Daviess Counties. We also have an office in Lexington Kentucky, the second largest city in Kentucky. The Bank is both a traditional community bank with a wide range of commercial and personal banking products, including wealth management and trust services, and an innovative online bank which delivers competitive deposit products and services through an online banking division operating under the name of Ascencia.

For the three months ended March 31, 2008, the Company reported net income of $3.6 million. This compares with net income of $3.6 million for the first quarter of 2007. Basic and diluted earnings per share were $0.46 for the three months ended March 31, 2008, compared with $0.47 for the first quarter of 2007.

Highlights for the quarter ended March 31, 2008 consist of the following:

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The following discussion and analysis covers the primary factors affecting our performance and financial condition.

Results of Operations

The following table summarizes components of income and expense and the change in those components for the three months ended March 31, 2008 compared with the same period of 2007:

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Net income of $3,597,000 for the three months ended March 31, 2008 decreased $4,000, or (0.1)%, from $3,601,000 for the comparable period of 2007. This decrease in earnings was primarily attributable to increased non-interest expense. Non-interest expense increased due to costs related to the acquisition of Kentucky Trust Bank and Paramount Bank, increased salaries and benefits for existing employees and occupancy and equipment expense to support the addition of new offices acquired in 2007. Expenses also increased because FDIC insurance premiums rose significantly due to amendments to the FDIC’s risk-based deposit premium assessment system made by the FDIC Reform Act of 2005 that took effect in 2007.

Net Interest Income – Our net interest income was $11,343,000 for the three months ended March 31, 2008, an increase of $1,599,000, or 16.4%, compared with $9,744,000 for the same period in 2007. Net interest spread and margin were 2.76% and 3.21%, respectively, for the first quarter of 2008, compared with 3.29% and 3.92%, respectively, for the first quarter of 2007. Net interest margin for the first quarter of 2008 declined to 3.21% compared with 3.92% for the first quarter of 2007. Net interest margin decreased 33 basis points from our margin of 3.54% in the fourth quarter of 2007. Our spread and margin were adversely impacted during the quarter as the Federal Reserve decreased rates by 200 basis points on top of the effects of a 50 basis points decline during the fourth quarter of 2007. Our balance sheet is asset-sensitive, so our loan yields have responded more rapidly to the Federal Reserve rate cuts than our cost of funds. If the interest rate environment stabilizes, we believe that our funding costs will decrease in the near term as our deposits reprice to match the decline in loan yields. However, future rate cuts would continue to put pressure on our margin since our loans reprice more quickly than our deposits.

Our average interest-earning assets were $1.4 billion for the three months ended March 31, 2008, compared with $1.02 billion for the three months ended March 31, 2007, a 41.0% increase primarily attributable to loan growth. Average loans were $1.3 billion for the three months ended March 31, 2008, compared with $891.6 million for the three months ended March 31, 2007, a 42.4% increase. Our total interest income increased by 28.0% to $25.7 million for the three months ended March 31, 2008, compared with $20.1 million for the same period in 2007. The change was due to growth in our loan portfolio and the Kentucky Trust Bank and Paramount Bank acquisitions.

Our average interest-bearing liabilities also increased, by 46.1%, to $1.3 billion for the three months ended March 31, 2008, compared with $881.8 million for the three months ended March 31, 2007. Our total interest expense increased by 39.0% to $14.3 million for the three months ended March 31, 2008, compared with $10.3 million during the same period in 2007, due primarily to an increase in the volume of certificates of deposit. Our average volume of certificates of deposit increased by 36.2% to $904.3 million for the three months ended March 31, 2008, compared with $664.0 million for the three months ended March 31, 2007. The average interest rate paid on certificates of deposits decreased to 4.91% for the three months ended March 31, 2008, compared with 5.00% for the three months ended March 31, 2007. The decrease in cost of funds was the result of the continued repricing of certificates of deposit at maturity at lower interest rates. The certificate of deposit volume increase reflected organic growth as well as the acquisitions of Kentucky Trust Bank and Paramount Bank.

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Average Balance Sheets

The following table presents the average balance sheets for the three month periods ending March 31, 2008 and 2007, along with the related calculations of tax-equivalent net interest income, net interest margin and net interest spread for the related periods.