LIMESTONE BANCORP, INC. - Quarter Report: 2010 September (Form 10-Q)

Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

For the Quarterly Period Ended September 30, 2010

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

For the transition period from to

Commission file number: 001-33033

PORTER BANCORP, INC.

(Exact name of registrant as specified in its charter)


Kentucky		61-1142247
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

2500 Eastpoint Parkway, Louisville, Kentucky		40223
(Address of principal executive offices)		(Zip Code)

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

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


Large accelerated filer ¨		Accelerated filer ¨
Non-accelerated filer x		Smaller reporting company ¨

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

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

11,281,625 shares of Common Stock, no par value, were outstanding at October 31, 2010.

INDEX


		Page

PART I –	FINANCIAL INFORMATION

ITEM 1.	FINANCIAL STATEMENTS		1

ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS		21

ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK		34

ITEM 4.	CONTROLS AND PROCEDURES		35

PART II –	OTHER INFORMATION

ITEM 1.	LEGAL PROCEEDINGS		36

ITEM 1A.	RISK FACTORS		36

ITEM 2.	UNREGISTERED SALES ON EQUITY SECURITIES AND USE OF PROCEEDS		37

ITEM 3.	DEFAULTS UPON SENIOR SECURITIES		37

ITEM 4.	SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS		37

ITEM 5.	OTHER INFORMATION		37

ITEM 6.	EXHIBITS		38

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 September 30, 2010 and December 31, 2009

Unaudited Consolidated Statements of Income for the three and nine months ended September 30, 2010 and 2009

Unaudited Consolidated Statement of Changes in Stockholders’ Equity for the nine months ended September 30, 2010

Unaudited Consolidated Statements of Cash Flows for the nine months ended September 30, 2010 and 2009

Notes to Unaudited Consolidated Financial Statements

PORTER BANCORP, INC. AND SUBSIDIARY

Unaudited Consolidated Balance Sheets

(dollars in thousands except share data)


	September 30, 2010		December 31, 2009
Assets
Cash and due from financial institutions	$	166,077	$	169,328
Federal funds sold		793		2,845

Cash and cash equivalents		166,870		172,173
Securities available for sale		150,569		168,721
Mortgage loans held for sale		484		334
Loans, net of allowance of $29,392 and $26,392, respectively		1,298,819		1,386,526
Premises and equipment		22,708		23,610
Other real estate owned		73,645		14,548
Goodwill		23,794		23,794
Accrued interest receivable and other assets		43,290		45,384

Total assets	$	1,780,179	$	1,835,090

Liabilities and Stockholders’ Equity
Deposits
Non-interest bearing	$	103,424	$	97,263
Interest bearing		1,286,639		1,432,833

Total deposits		1,390,063		1,530,096
Federal funds purchased and repurchase agreements		34,083		11,517
Federal Home Loan Bank advances		110,763		82,980
Accrued interest payable and other liabilities		8,922		7,163
Subordinated capital note		8,775		9,000
Junior subordinated debentures		25,000		25,000

Total liabilities		1,577,606		1,665,756
Stockholders’ equity
Preferred stock, no par, 1,000,000 shares authorized Series A – 35,000 issued and outstanding Liquidation preference of $35 million at September 30, 2010		34,439		34,307
Series C – 317,042 issued and outstanding Liquidation preference of $3.6 million at September 30, 2010		3,283		—
Common stock, no par, 19,000,000 shares authorized, 11,281,691 and 8,756,440 shares issued and outstanding, respectively		107,212		83,104
Additional paid-in capital		18,468		14,959
Retained earnings		33,228		34,811
Accumulated other comprehensive income		5,943		2,153

Total stockholders’ equity		202,573		169,334

Total liabilities and stockholders’ equity	$	1,780,179	$	1,835,090

See accompanying notes to unaudited consolidated financial statements.

PORTER BANCORP, INC. AND SUBSIDIARY

Unaudited Consolidated Statements of Income

(dollars in thousands, except per share data)


	Three Months Ended September 30,				Nine Months Ended September 30,
	2010		2009		2010			2009
Interest income
Loans, including fees	$	19,293	$	20,961	$	58,937		$	63,333
Taxable securities		1,689		2,469		6,023			6,483
Tax exempt securities		212		218		643			662
Fed funds sold and other		146		154		489			471

		21,340		23,802		66,092			70,949


Interest expense
Deposits		5,890		8,190		19,816			27,576
Federal Home Loan Bank advances		498		858		1,718			2,944
Subordinated capital note		83		84		235			284
Junior subordinated debentures		170		176		481			636
Federal funds purchased and other		123		120		362			355

		6,764		9,428		22,612			31,795


Net interest income		14,576		14,374		43,480			39,154
Provision for loan losses		5,000		2,000		14,600			5,200

Net interest income after provision for loan losses		9,576		12,374		28,880			33,954

Non-interest income
Service charges on deposit accounts		757		843		2,270			2,319
Income from fiduciary activities		226		227		751			645
Secondary market brokerage fees		83		49		273			180
Title insurance commissions		38		33		114			97
Net gain on sales of loans originated for sale		135		82		410			323
Net gain on sales of securities		2,175		321		2,256			322
Other than temporary impairment on securities		—		—		(465	)		—
Other		517		481		1,511			1,531

		3,931		2,036		7,120			5,417


Non-interest expense
Salaries and employee benefits		3,849		3,799		11,727			11,490
Occupancy and equipment		1,070		993		3,107			2,972
Other real estate owned expense		2,163		353		6,395			706
FDIC Insurance		855		626		2,266			1,588
FDIC special assessment		—		—		—			781
State franchise tax		543		450		1,629			1,350
Professional fees		239		175		797			606
Postage and delivery		183		193		569			561
Communications		179		183		538			568
Advertising		104		121		277			404
Other		764		691		2,206			2,062

		9,949		7,584		29,511			23,088

Income before income taxes		3,558		6,826		6,489			16,283
Income tax expense		1,137		2,290		1,943			5,441

Net income		2,421		4,536		4,546			10,842
Less:
Dividends on preferred stock		498		437		1,373			1,312
Accretion on Series A preferred stock		44		44		132			132
Earnings allocated to participating securities		88		—		81			—

Net income available to common shareholders	$	1,791	$	4,055	$	2,960		$	9,398

Basic earnings per common share	$	0.17	$	0.46	$	0.32		$	1.08

Diluted earnings per common share	$	0.16	$	0.46	$	0.31		$	1.08

See accompanying notes to unaudited consolidated financial statements.

PORTER BANCORP, INC. AND SUBSIDIARY

Unaudited Consolidated Statement of Changes in Stockholders’ Equity

For Nine Months Ended September 30, 2010

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


	Shares											Amount										Additional					Accumulated Other
	Common			Series A Preferred		Series B Preferred			Series C Preferred			Common		Series A Preferred		Series B Preferred			Series C Preferred			Paid-In Capital		Retained Earnings			Comprehensive Income		Total
Balances, January 1, 2010		8,756,440			35,000		—			—		$	83,104	$	34,307	$	—		$	—		$	14,959	$	34,811		$	2,153	$	169,334
Issuance of stock and warrants in private placement		1,820,531			—		597,000			365,080			17,429		—		6,182			3,780			3,149		—			—		30,540
Conversion of Series B preferred to common		597,000			—		(597,000	)		—			6,182		—		(6,182	)		—			—		—			—		—
Conversion of Series C preferred to common		48,038			—		—			(48,038	)		497		—		—			(497	)		—		—			—		—
Issuance of unvested stock		69,182			—		—			—			—		—		—			—			—		—			—		—
Forfeited unvested stock		(9,500	)		—		—			—			—		—		—			—			—		—			—		—
Stock-based compensation expense		—			—		—			—			—		—		—			—			360		—			—		360
Comprehensive income:
Net income		—			—		—			—			—		—		—			—			—		4,546			—		4,546
Changes in accumulated other comprehensive income, net of taxes		—			—		—			—			—		—		—			—			—		—			3,790		3,790

Total comprehensive income		—			—		—			—			—		—		—			—			—		—			—		8,336

Dividends 5% on Series A preferred stock		—			—		—			—			—		—		—			—			—		(1,313	)		—		(1,313	)
Dividends on Series B & C preferred stock ($0.10 per share)		—			—		—			—			—		—		—			—			—		(96	)		—		(96	)
Amortization of Series A preferred stock discount		—			—		—			—			—		132		—			—			—		(132	)		—		—
Cash dividends declared on common stock ($0.50 per share)		—			—		—			—			—		—		—			—			—		(4,588	)		—		(4,588	)

Balances, September 30, 2010		11,281,691			35,000		—			317,042		$	107,212	$	34,439	$	—		$	3,283		$	18,468	$	33,228		$	5,943	$	202,573

See accompanying notes to unaudited consolidated financial statements.

PORTER BANCORP, INC. AND SUBSIDIARY

Unaudited Consolidated Statements of Cash Flows

For Nine Months Ended September 30, 2010 and 2009

(dollars in thousands)


	2010			2009
Cash flows from operating activities
Net income	$	4,546		$	10,842
Adjustments to reconcile net income to net cash from operating activities
Depreciation and amortization		2,289			2,699
Provision for loan losses		14,600			5,200
Net amortization (accretion) on securities		(161	)		(198	)
Stock-based compensation expense		348			282
Net gain on loans originated for sale		(410	)		(323	)
Loans originated for sale		(20,580	)		(15,615	)
Proceeds from sales of loans originated for sale		20,641			15,414
Net gain on sales of investment securities		(1,791	)		(322	)
Net loss on sales of other real estate owned		302			73
Net write-down of other real estate owned		4,805			350
Earnings on bank owned life insurance		(220	)		(212	)
Net change in accrued interest receivable and other assets		2,067			1,318
Net change in accrued interest payable and other liabilities		(282	)		(1,112	)

Net cash from operating activities		26,154			18,396

Cash flows from investing activities
Purchases of available-for-sale securities		(26,792	)		(36,957	)
Sales and calls of available-for-sale securities		32,914			13,675
Maturities and prepayments of available-for-sale securities		19,813			25,316
Proceeds from sale of other real estate owned		20,565			9,107
Improvements to other real estate owned		(1,792	)		(108	)
Loan originations and payments, net		(10,510	)		(55,606	)
Purchases of premises and equipment, net		(289	)		(2,428	)

Net cash from investing activities		33,909			(47,001	)

Cash flows from financing activities
Net change in deposits		(140,033	)		90,107
Net change in federal funds purchased and repurchase agreements		22,566			1,212
Repayment of Federal Home Loan Bank advances		(212,217	)		(212,492	)
Advances from Federal Home Loan Bank		240,000			195,000
Repayment of subordinated capital note		(225	)		—
Issuance of preferred stock and warrants		11,064			—
Issuance of common stock and warrants		19,476			—
Cash dividends paid on preferred stock		(1,409	)		(1,283	)
Cash dividends paid on common stock		(4,588	)		(5,243	)

Net cash from financing activities		(65,366	)		67,301

Net change in cash and cash equivalents		(5,303	)		38,696
Beginning cash and cash equivalents		172,173			52,546

Ending cash and cash equivalents	$	166,870		$	91,242

Supplemental cash flow information:
Interest paid	$	23,198		$	25,271
Income taxes paid		3,850			6,150
Supplemental non-cash disclosure:
Transfer from loans to other real estate	$	82,977		$	14,724
Sale and financing of other real estate owned	$	3,309			—

See accompanying notes to unaudited consolidated financial statements.

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. (Company or PBI) and its wholly-owned subsidiary, PBI Bank (Bank). All significant inter-company transactions and accounts have been eliminated in consolidation.

The accompanying unaudited 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 nine months ended September 30, 2010 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, 2009 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, fair values of financial instruments, goodwill and other intangibles, and fair values of other real estate owned 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 January 2010, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2010-06, “Fair Value Measurements and Disclosures – Improving Disclosures about Fair Value Measurements.” The update requires new disclosures including significant transfers in and out of Level 1 and Level 2 fair value measurements. Also, the ASU provides an update on the reconciliation for fair value measurements using significant unobservable inputs (Level 3). The new guidance is effective for interim and annual periods beginning after December 15, 2009, except for the update on the reconciliation of Level 3 fair value measurements, which is effective for fiscal years beginning after December 15, 2010. The portion that is currently effective did not have an impact on the Company’s consolidated financial statements. The portion that is not yet effective is not expected to have an impact on the Company’s financial statements.

In July 2010, the FASB issued ASU No. 2010-20, “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses,” which requires significant new disclosures about the allowance for credit losses and the credit quality of financing receivables, which for the Company includes loans and standby letters of credit. The requirements are intended to enhance transparency regarding credit losses and the credit quality of loan and lease receivables. Under this statement, allowance for loan losses is to be disclosed by portfolio segment, while credit quality information, impaired loans and nonaccrual status are to be presented by class. Disclosure of the nature and extent, the financial impact and segment information of troubled debt restructurings will also be required. The disclosures are to be presented at the level of disaggregation that management uses when assessing and monitoring the portfolio’s risk and performance. This ASU is effective for interim and annual reporting periods after December 15, 2010. The adoption of ASU 2010-20 is expected to result in additional quarterly and annual disclosures beginning in the fourth quarter of 2010.

Legislative Developments

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Act”) was signed into law on July 21, 2010. Generally, the Act is effective the day after it was signed into law, but different effective dates apply to specific sections of the law. Uncertainty remains as to the ultimate impact of the Act, which could have an adverse impact on the financial services industry as a whole and on the Company’s business, results of operations, and financial condition.

Note 2 – Stock Plans and Stock Based Compensation

On February 23, 2006, the Company adopted the Porter Bancorp, Inc. 2006 Stock Incentive Plan. 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 September 30, 2010, the Company had granted outstanding options to purchase 39,601 shares. The Company also had granted 146,909 unvested shares net of forfeitures and vesting. The Company has 171,924 shares remaining available for issue under the 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. On May 22, 2008, shareholders voted to amend the plan to change the form of incentive award from stock options to unvested shares. Under the terms of the plan, 100,000 shares are reserved for issuance to non-employee directors upon the exercise of stock options or upon the grant of unvested stock awards granted under the plan. Prior to the amendment, options were granted automatically under the plan at fair market value on the date of grant. The options vest over a three-year period and have a five year term. Unvested shares are granted automatically under the plan at fair market value on the date of grant and vest semi-annually on the anniversary date of the grant over three years. To date, the Company has granted options to purchase 43,001 shares and issued 4,644 unvested shares to non-employee directors. At September 30, 2010, 49,812 shares remain available for issue under this plan.

All stock options have an exercise price that is equal to or greater than 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 have a life of five years.

The following table summarizes stock option activity:


	Nine Months Ended September 30, 2010					Twelve Months Ended December 31, 2009
	Options			Weighted Average Exercise Price		Options			Weighted Average Exercise Price
Outstanding, beginning		297,258		$	22.89		297,810		$	22.89
Forfeited		(15,659	)		22.62		(552	)		23.13
Expired		(198,997	)		23.38		—			—

Outstanding, ending		82,602		$	21.76		297,258		$	22.89

The following table details stock options outstanding:


	September 30, 2010
Stock options vested and currently exercisable:		82,578
Weighted average exercise price	$	21.76
Aggregate intrinsic value	$	0
Weighted average remaining life (in years)		1.1
Total Options Outstanding:		82,602
Aggregate intrinsic value	$	0
Weighted average remaining life (in years)		1.1

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. The intrinsic value of the vested and expected to vest stock options is $0 at September 30, 2010. There were no options exercised during the first nine months of 2010. The Company recorded $2,000 of stock option compensation during the nine months ended September 30, 2010 to salaries and employee benefits. A deferred tax benefit of $1,000 was recognized related to this expense. No options were modified during the period. As of September 30, 2010, no stock options issued by the Company have been exercised.

From time-to-time the Company issues unvested shares to employees and non-employee directors. The shares vest either semi-annually or annually over three to ten years on the anniversary date of the issuance date provided the employee or director continues in such capacity at the vesting date. The fair value of the 2010 unvested shares issued to certain employees was $11.60 per share. The fair value of shares issued to non-employee directors was $13.45 per share. The Company recorded $346,000 of stock-based compensation during the first nine months of 2010 to salaries and employee benefits. A deferred tax benefit of $121,000 was recognized related to this expense.

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


	Nine Months Ended September 30, 2010					Twelve Months Ended December 31, 2009
	Shares			Weighted Average Grant Price		Shares			Weighted Average Grant Price
Outstanding, beginning		113,817		$	15.66		72,441		$	19.83
Granted		69,182			11.66		54,268			10.97
Vested		(21,946	)		15.15		(12,351	)		19.19
Forfeited		(9,500	)		13.35		(541	)		23.13

Outstanding, ending		151,553		$	14.05		113,817		$	15.66

Unrecognized stock based compensation expense related to stock options and unvested shares for the remainder of 2010 and beyond is estimated as follows (in thousands):


October 2010 – December 2010	$	120
2011		488
2012		477
2013		389
2014 & thereafter		448

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:


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(in thousands)
September 30, 2010
U.S. Government and federal agency	$	10,343	$	1,023	$	—		$	11,366
State and municipal		24,038		1,851		—			25,889
Agency mortgage-backed: residential		90,633		4,792		—			95,425
Corporate bonds		14,308		1,431		(5	)		15,734
Other debt securities		704		—		(87	)		617

Total debt securities		140,026		9,097		(92	)		149,031
Equity		1,400		150		(12	)		1,538

Total	$	141,426	$	9,247	$	(104	)	$	150,569

December 31, 2009
U.S. Government and federal agency	$	586	$	33	$	—		$	619
State and municipal		24,537		955		(37	)		25,455
Agency mortgage-backed: residential		91,127		4,028		—			95,155
Private label mortgage-backed: residential		33,516		279		(2,156	)		31,639
Corporate bonds		13,054		760		(49	)		13,765
Other		704		—		(175	)		529

Total debt securities		163,524		6,055		(2,417	)		167,162
Equity		1,885		75		(401	)		1,559

Total	$	165,409	$	6,130	$	(2,818	)	$	168,721

Sales and calls of available for sale securities were as follows:


	Three Months Ended September 30,					Nine Months Ended September 30,
	2010			2009		2010			2009
	(in thousands)
Proceeds	$	24,500		$	12,913	$	32,914		$	13,675
Gross gains		2,872			321		3,152			322
Gross losses		(697	)		—		(896	)		—

The amortized cost and fair value of the debt investment securities portfolio are shown by expected maturity. Expected maturities may differ from contractual maturities if issuers have the right to call or prepay obligations with or without call or prepayment penalties.


	September 30, 2010
	Amortized Cost		Fair Value
	(in thousands)
Maturity
Available-for-sale
Within one year	$	25,592	$	26,239
One to five years		80,000		85,279
Five to ten years		32,695		35,746
Beyond ten years		1,739		1,767

Total	$	140,026	$	149,031

Securities pledged at September 30, 2010 and December 31, 2009 had carrying values of approximately $70.4 million and $67.3 million, respectively, and were pledged to secure public deposits, repurchase agreements, and Federal Home Loan Bank advances.

The Company evaluates securities for OTTI 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. Management currently intends to hold all securities with unrealized losses until recovery, which for fixed income securities may be at maturity.

At September 30, 2010, the Company held 43 equity securities. Management monitors the underlying financial condition of the issuers and current market pricing for these equity securities monthly. Based upon the relevant market information and stock price trends in July and early August 2010, we determined that we could not objectively assert that our basis in 21 equity securities that have been in an unrealized loss position for more than 12 months is recoverable in the near term. As such during the second quarter, we recorded an other than temporary impairment charge totaling $465,000 for equity securities held in our portfolio with an original cost of $1.6 million. The market prices of the stocks had been below our initial investment for more than twelve months and after consideration of the issuers’ financial conditions and the likelihood the market value would recover to our cost basis in the reasonable period of time, the investment was written down to fair value. As of September 30, 2010, management does not believe any securities in our portfolio with unrealized losses should be classified as other than temporarily impaired at this time.

Securities with unrealized losses at September 30, 2010 and December 31, 2009, 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
	(in thousands)
September 30, 2010
Corporate bonds	$	1,022	$	(5	)	$	—	$	—		$	1,022	$	(5	)
Other debt securities		—		—			617		(87	)		617		(87	)
Equity		53		(3	)		316		(9	)		369		(12	)

Total temporarily impaired	$	1,075	$	(8	)	$	933	$	(96	)	$	2,008	$	(104	)


December 31, 2009
State and municipal	$	867	$	(5	)	$	1,033	$	(32	)	$	1,900	$	(37	)
Agency mortgage-backed: residential		8		—			—		—			8		—
Private label mortgage-backed: residential		23,731		(1,977	)		4,091		(179	)		27,822		(2,156	)
Corporate bonds		—		—			1,997		(49	)		1,997		(49	)
Other		529		(175	)		—		—			529		(175	)
Equity		46		(12	)		701		(389	)		747		(401	)

Total temporarily impaired	$	25,181	$	(2,169	)	$	7,822	$	(649	)	$	33,003	$	(2,818	)

Note 4 – Loans

Loans were as follows:


	September 30, 2010			December 31, 2009
	(in thousands)
Commercial	$	81,527		$	89,903
Real estate		1,188,096			1,259,474
Agriculture		24,437			25,064
Consumer		33,062			36,989
Other		1,089			1,488

Subtotal		1,328,211			1,412,918
Less: Allowance for loan losses		(29,392	)		(26,392	)

Loans, net	$	1,298,819		$	1,386,526

Activity in the allowance for loan losses was as follows:


	For the Nine Months Ended
	September 30, 2010			September 30, 2009
	(in thousands)
Beginning balance	$	26,392		$	19,652
Provision for loan losses		14,600			5,200
Loans charged-off		(11,823	)		(3,112	)
Loan recoveries		223			218

Ending balance	$	29,392		$	21,958

Impaired loans were as follows:


	September 30, 2010		December 31, 2009
	(in thousands)
Loans with no allocated allowance for loan losses	$	13,449	$	21,373
Loans with allocated allowance for loan losses		35,305		84,766

Total	$	48,754	$	106,139

Amount of the allowance for loan losses allocated	$	5,526	$	5,453


	Nine Months Ended September 30, 2010		Year Ended December 31, 2009
Average of impaired loans during the period	$	68,527	$	44,041
Interest income recognized during impairment		1,012		1,094
Cash basis interest income recognized		87		987

Impaired loans include restructured loans and commercial, construction, agriculture, and commercial real estate loans on non-accrual or classified as doubtful, whereby collection of the total amount is improbable, or loss, whereby all or a portion of the loan has been written off or a specific allowance for loss had been provided.

Nonperforming loans were as follows:


	September 30, 2010		December 31, 2009
	(in thousands)
Loans past due 90 days or more still on accrual	$	7,048	$	5,968
Non-accrual loans		38,784		78,888

Nonperforming loans include impaired loans and smaller balance homogeneous loans, such as residential mortgage and consumer loans, that are collectively evaluated for impairment. At September 30, 2010, and December 31, 2009, we had restructured loans totaling $22.0 million and $25.2 million, respectively, with borrowers who experienced deterioration in financial condition. These loans are secured by 1-4 residential properties, commercial real estate properties, equipment or inventory. Management believes these loans are well secured and the borrowers have the ability to repay the loans in accordance with the renegotiated terms. These restructured loans were on accrual status at each period end as payments were being made according to the restructured loan terms.

Note 5 – Other Real Estate Owned

Other real estate owned (OREO) is real estate acquired as a result of foreclosure or by deed in lieu of foreclosure. It is classified as real estate owned until such time as it is sold. When property is acquired as a result of foreclosure or by deed in lieu of foreclosure, it is recorded at its fair market value less cost to sell. Any write-down of the property at the time of acquisition is charged to the allowance for loan losses. Subsequent reductions in fair value are recorded as non-interest expense. To determine the fair value of OREO for smaller dollar single family homes, we consult with internal real estate sales staff and external realtors, investors, and appraisers. If the internally evaluated market price is below our underlying investment in the property, appropriate write-downs are taken. For larger dollar commercial real estate properties, we obtain a new appraisal of the subject property in connection with the transfer to other real estate owned. In some of these circumstances, an appraisal is in process at quarter end and we must make our best estimate of the fair value of the underlying collateral based on our internal evaluation of the property, review of the most recent appraisal, and discussions with the currently engaged appraiser. We do not obtain updated appraisals on a quarterly basis after the receipt of the initial appraisal. Rather, we internally review the fair value of the other real estate owned in our portfolio on a quarterly basis to determine if a new appraisal is warranted based on the specific circumstances of each property. The following table presents the major categories of OREO:


	September 30, 2010		December 31, 2009
	(in thousands)
Construction, land development, and land	$	57,274	$	7,526
Farmland		1,946		442
1-4 Family residential		10,179		4,642
Multi-family residential		614		—
Commercial real estate		3,632		1,938

Total	$	73,645	$	14,548

Net activity relating to other real estate owned during the nine months ended September 30, 2010 is as follows:


OREO Activity (in thousands)
OREO as of January 1, 2010	$	14,548
Real estate acquired		82,977
Valuation adjustments		(4,805	)
Improvements		1,792
Properties sold		(20,867	)

OREO as of September 30, 2010	$	73,645

Expenses related to other real estate owned include:


	Three Months Ended				Nine Months Ended
	September 30, 2010		September 30, 2009		September 30, 2010		September 30, 2009
	(in thousands)
Net loss on sales	$	212	$	13	$	302	$	73
Impairment write-downs		926		150		4,805		350
Operating expenses		1,025		190		1,288		283

Total	$	2,163	$	353	$	6,395	$	706

Note 6 – Advances from the Federal Home Loan Bank

Advances from the Federal Home Loan Bank were as follows:


	September 30, 2010		December 31, 2009
	(in thousands)
Single maturity advances with fixed rates from 0.15% to 4.82% maturing from 2010 through 2012, averaging 1.66% for 2010	$	100,000	$	70,000
Monthly amortizing advances with fixed rates from 0.00% to 8.28% and maturities ranging from 2011 through 2035, averaging 3.62% for 2010
		10,763		12,980

Total	$	110,763	$	82,980

Each advance is payable per terms on agreement, with a prepayment penalty. The advances were collateralized by first mortgage residential loans, under a blanket lien arrangement. At September 30, 2010, the Bank had unused borrowing capacity of $261,000 with the FHLB.

Note 7 – Fair Values Measurement

The FASB issued guidance that defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The guidance also establishes a fair value hierarchy about the assumptions used to measure fair value and describes three levels of inputs that may be used to measure fair value:

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

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 securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges, if available. This valuation method is classified as Level 1 in the fair value hierarchy. For securities where quoted prices are not available, fair values are calculated on market prices of similar securities, 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. For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators. These calculations utilize appropriate market variable inputs that include estimates and assumptions such as discount rates, prepayment speeds, default rates, and loss severities on a security by security basis. This valuation method is classified as Level 3 in the fair value hierarchy.

Impaired Loans: An impaired loan is evaluated at the time the loan is identified as impaired and is recorded at the lower of cost or fair value. Fair value is measured based on the value of the collateral securing the loan 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. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach.

Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. These routine adjustments are made to adjust the value of a specific property relative to comparable properties for variations in qualities such as location, size, and income production capacity relative to the subject property of the appraisal. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value.

We routinely apply an internal discount to the value of appraisals used in the fair value evaluation of our impaired loans. The deductions to the appraisal take into account changing business factors and market conditions, as well as potential value impairment in cases where our appraisal date predates a likely change in market conditions. These deductions range from 10% for routine real estate collateral to 25% for real estate that is determined (1) to have a thin trading market or (2) to be specialized collateral. This is in addition to estimated discounts for cost to sell of six percent.

Impaired loans are evaluated quarterly for additional impairment. We obtain updated appraisals on properties securing our loans when circumstances are warranted such as at the time of renewal or when market conditions have significantly changed. This determination is made on a property-by-property

basis in light of circumstances in the broader economic climate and our assessment of deterioration of real estate values in the market in which the property is located. The first stage of our assessment involves management’s inspection of the property in question. Management also engages in conversations with local real estate professionals, investors, and market makers to determine the likely marketing time and value range for the property. The second stage involves an assessment of current trends in the regional market. After thorough consideration of these factors, management will either internally evaluate fair value or order a new appraisal.

Other Real Estate Owned: OREO is evaluated at the time of acquisition and recorded at fair value as determined by independent appraisal or internal market evaluation less cost to sell. Our quarterly evaluations of OREO for impairment are driven by property type. For smaller dollar single family homes, we consult with internal real estate sales staff and external realtors, investors, and appraisers. Based on these consultations, we determine asking prices for OREO properties we are marketing for sale. If the internally evaluated fair value is below our underlying investment in the property, appropriate write-downs are taken.

For larger dollar commercial real estate properties, we obtain a new appraisal of the subject property in connection with the transfer to other real estate owned. In some of these circumstances, an appraisal is in process at quarter end, and we must make our best estimate of the fair value of the underlying collateral based on our internal evaluation of the property, review of the most recent appraisal, and discussions with the currently engaged appraiser. We do not obtain updated appraisals on a quarterly basis after the receipt of the initial appraisal. Rather, we internally review the fair value of the other real estate owned in our portfolio on a quarterly basis to determine if a new appraisal is warranted based on the specific circumstances of each property.

Financial assets measured at fair value on a recurring basis at September 30, 2010 are summarized below:


			Fair Value Measurements at September 30, 2010 Using
	(in thousands)
Description	September 30, 2010		Quoted Prices In Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Available-for-sale securities
U.S. Government and federal agency	$	11,366	$	—	$	11,366	$	—
State and municipal		25,889		—		25,889		—
Agency mortgage-backed		95,425		—		95,425		—
Corporate bonds		15,734		—		15,734		—
Other debt securities		617		—		—		617
Equity securities		1,538		1,538		—		—
Total	$	150,569	$	1,538	$	148,414	$	617

Roll-forward of activity for our Significant Unobservable Inputs (Level 3) follows:


Available-for-sale securities	Nine Months Ended September 30, 2010
Balance, January 1, 2010	$	32,168
Purchases		—
Sales		(7,769	)
Net accretion (amortization)		606
Principal paydowns		(3,475	)
Transfers to Level 2		(22,878	)
Net change in unrealized gain/loss		1,965
Balance, September 30, 2010	$	617

Financial assets measured at fair value on a non-recurring basis at September 30, 2010 are summarized below:


			Fair Value Measurements at September 30, 2010 Using
			(in thousands)
Description	September 30, 2010		Quoted Prices In Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired loans	$	29,779	$	—	$	—	$	29,779
Other real estate owned, net		73,645		—		—		73,645

Impaired loans, which are measured for impairment using the fair value of collateral for collateral dependent loans, had a carrying amount of $35.3 million and a valuation allowance of $5.5 million, resulting in an additional provision for loan losses of $3.0 million for the first nine months of 2010. Additional provision for loan losses of $194,000 was recorded during the first nine months of 2009 related to impaired loans.

Other real estate owned which is measured at the lower of carrying or fair value less costs to sell, had a net carrying amount of $73.6 million. Write-downs of $4.8 million and $350,000 were recorded on other real estate owned during the first nine months of 2010 and 2009, respectively.

Financial assets measured at fair value on a recurring basis at December 31, 2009 are summarized below:


			Fair Value Measurements at December 31, 2009 Using
			(in thousands)
Description	December 31, 2009		Quoted Prices In Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Available-for-sale securities
U.S. Government and federal agency	$	619	$	—	$	619	$	—
State and municipal		25,455		—		25,455		—
Agency mortgage-backed		95,155		—		95,155		—
Private label mortgage-backed		31,639		—		—		31,639
Corporate bonds		13,765		—		13,765		—
Other debt securities		529		—		—		529
Equity securities		1,559		1,559		—		—

Total	$	168,721	$	1,559	$	134,994	$	32,168

Financial assets measured at fair value on a non-recurring basis at December 31, 2009 are summarized below:


			Fair Value Measurements at December 31, 2009 Using
			(in thousands)
Description	December 31, 2009		Quoted Prices In Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired loans	$	79,313	$	—	$	—	$	79,313
Other real estate owned		14,548		—		—		14,548

Impaired loans, which are measured for impairment using the fair value of collateral for collateral dependent loans, had a carrying amount of $84.8 million and a valuation allowance of $5.5 million.

Other real estate owned which is measured at the lower of carrying or fair value less costs to sell, had a net carrying amount of $14.5 million.

Carrying amount and estimated fair values of financial instruments were as follows for the periods indicated:


	September 30, 2010				December 31, 2009
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
	(in thousands)
Financial assets
Cash and cash equivalents	$	166,870	$	166,870	$	172,173	$	172,173
Securities available for sale		150,569		150,569		168,721		168,721
Federal Home Loan Bank stock		10,072		N/A		10,072		N/A
Loans, net		1,298,819		1,303,775		1,386,526		1,396,465
Accrued interest receivable		8,153		8,153		9,329		9,329
Financial liabilities
Deposits	$	1,390,063	$	1,397,299	$	1,530,096	$	1,526,508
Federal funds purchased and securities sold under agreements to repurchase		34,083		34,083		11,517		11,517
Federal Home Loan Bank advances		110,763		111,046		82,980		83,217
Subordinated capital notes		8,775		8,079		9,000		7,323
Junior subordinated debentures		25,000		21,722		25,000		18,250
Accrued interest payable		2,119		2,119		2,705		2,705

The methods and assumptions used to estimate fair value are described as follows:

Carrying amount is the estimated fair value for cash and cash equivalents, interest-bearing deposits with financial institutions, repurchase agreements, accrued interest receivable and payable, demand deposits, short-term borrowings, and variable rate loans or deposits that reprice frequently and fully. The fair value of loans is estimated in accordance with paragraph 55-3 of ASC 825, “Disclosures about Fair Value of Financial Instruments,” by discounting expected future cash flows using market rates on like maturity. For fixed rate loans

or deposits and for variable rate loans or deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. Fair value of subordinated capital notes and junior subordinated debentures are based on current rates for similar types of financing. The carrying amount is the estimated fair value for variable and subordinated debentures that reprice frequently. The fair value of off-balance-sheet items is based on the current fees or cost that would be charged to enter into or terminate such arrangements, which is not material.

Note 8 – Earnings per Share

The factors used in the basic and diluted earnings per share computations follow:


	Three Months Ended September 30,				Nine Months Ended September 30,
	2010		2009		2010		2009
	(in thousands, except share and per share data)
Net income	$	2,421	$	4,536	$	4,546	$	10,842
Less:
Preferred stock dividends		498		437		1,373		1,312
Accretion of Series A preferred stock discount		44		44		132		132
Earnings allocated to unvested shares		27		—		42		—
Earnings allocated to Series C preferred		61		—		39		—

Net income allocated to common shareholders, basic and diluted	$	1,791	$	4,055	$	2,960	$	9,398


Basic
Weighted average common shares including unvested common shares outstanding		11,013,063		8,756,289		9,552,646		8,740,314
Less: Weighted average unvested common shares		155,865		—		132,685		—
Less: Weighted average Series C preferred		360,381		—		122,608		—

Weighted average common shares outstanding		10,496,817		8,756,289		9,297,353		8,740,314


Basic earnings per common share	$	0.17	$	0.46	$	0.32	$	1.08


Diluted
Add: Weighted average Series B preferred issued and outstanding		532,108		—		181,506		—
Add: Dilutive effects of assumed exercises of common and Preferred Series B & C stock warrants		—		—		27,427		—

Weighted average common shares and potential common shares		11,028,925		8,756,289		9,506,286		8,740,314

Diluted earnings per common share	$	0.16	$	0.46	$	0.31	$	1.08

Stock options for 82,602 shares of common stock for 2010 and 297,258 shares of common stock for 2009 were not considered in computing diluted earnings per common share because they were anti-dilutive. Additionally, a warrant for the purchase of 314,821 shares of the Company’s common stock at an exercise price of $16.68 was outstanding at September 30, 2010 and 2009 but was not included in the diluted EPS computation as inclusion would have been anti-dilutive. Finally, warrants for the purchase of 1,380,437 shares of non-voting common stock at an exercise price of $11.50 per share were outstanding at September 30, 2010, but were not included in the diluted EPS computation for the three months ended September 30, 2010, as inclusion would have been anti-dilutive.

Note 9 – Other Comprehensive Income (Loss)

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


	Three Months Ended September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009
	(in thousands)
Unrealized holding gains on available-for-sale securities	$	2,772		$	4,186		$	7,622		$	3,919
Less: Reclassification adjustment for net gains and other temporary impairment realized in income		2,175			321			1,791			322

Net unrealized gains		597			3,865			5,831			3,597
Tax effect		(209	)		(1,353	)		(2,041	)		(1,259	)

Net-of-tax amount	$	388		$	2,512		$	3,790		$	2,338

Note 10 – Capital

On June 30, 2010, we completed a $27.0 million stock offering to a group of accredited investors in a private placement transaction exempt from the registration requirements of the federal and state securities laws. In connection with the private placement transaction, we issued (i) 1,755,747 shares of common stock at a price of $11.50 per share; (ii) 227,000 shares of Series B preferred stock at a price of $11.50 per share, which was automatically convertible into an aggregate of 227,000 shares of common stock upon receipt of shareholder approval, as discussed below; and (iii) 365,080 shares of Series C preferred stock at price of $11.50 per share. We also issued warrants to purchase 1,163,045 shares of non-voting common stock at a price of $11.50 per share.

On July 23, 2010, we completed a $4,255,000 stock offering to another accredited investor in a supplemental private placement transaction exempt from the registration requirements of the federal and state securities laws. In connection with the supplemental private placement transaction, we issued (i) 370,000 shares of Series B preferred stock at $11.50 per share and (ii) a warrant to purchase 185,000 shares of non-voting common stock at a purchase price of $11.50 per share. We also granted the accredited investor an option to purchase 64,784 shares of common stock and a warrant to purchase 32,392 shares of non-voting common stock at a purchase price of $11.50 per share. The option exercise price is $745,016, increasing the total potential gross proceeds to be received from the accredited investor to $5,000,000. The option was exercisable during the five business days following receipt of shareholder approval for purposes of NASDAQ Rule 5635.

The Company held a special meeting of shareholders on September 16, 2010. The shareholders approved the proposal for the issuance of common shares to allow for the conversion or exercise of 597,000 shares of the Series B preferred stock; 365,080 shares of our Series C preferred stock; 1,380,437 shares of non-voting common stock; and an option to purchase 64,784 shares of common stock at $11.50 per share. The shareholders also approved the proposal to authorize the new class of non-voting common stock, which will be issuable upon the exercise of the stock purchase warrants at a purchase price of $11.50 per share.

As a result of the shareholder approval, on September 21, 2010, 597,000 shares of Series B preferred stock were automatically converted into 597,000 shares of common stock. On September 27, 2010, the Company issued an additional 64,784 shares of common stock and granted a warrant to purchase 32,392 shares of non-voting common stock, in connection with the exercise of the option granted in the supplemental private placement transaction. This issuance of the additional shares of common stock resulted in the conversion of 48,038 shares of Series C preferred stock into shares of common stock in accordance with the terms of the Series C preferred stock described below.

The Series C preferred stock is a non-voting class of stock substantially similar in priority to the common stock, except for a liquidation preference over shares of our common stock. The Series C preferred stock will automatically convert into common stock on a one share for one share basis at such time as, after giving effect to the automatic conversion, the holder of such Series C preferred stock (and its affiliates or any other persons with which it is acting in concert or whose holdings would otherwise be required to be aggregated for purposes of federal banking law) beneficially holds, directly or indirectly, less than 9.9% of the number of shares of common stock then issued and outstanding.

The non-voting common stock is a non-voting class of stock substantially similar in rights and priority to our common stock, except that the non-voting common stock has no voting rights. The warrants become exercisable upon receipt of shareholder approval and expire September 16, 2015. To the extent issued upon exercise of the warrants, the non-voting common stock will automatically convert into common stock on a one share for one share basis at such time as, after giving effect to the automatic conversion, the holder of such non-voting common stock (and its affiliates or any other persons with which it is acting in concert or whose holdings would otherwise be required to be aggregated for purposes of federal banking law) holds, directly or indirectly, beneficially less than 9.9% of the number of shares of common stock then issued and outstanding.

Each of the federal bank regulatory agencies has established minimum leverage capital requirements for banking organizations. Banking organizations must maintain a minimum ratio of Tier 1 capital to adjusted average quarterly assets equal to 3% to 5% subject to federal bank regulatory evaluation of an organization’s overall safety and soundness. PBI Bank has agreed with its primary regulators to maintain a ratio of total capital to total risk-weighted assets of at least 12.0% and a ratio of Tier 1 capital to total risk-weighted assets of 9.0%.

The following table shows the ratios of Tier 1 capital and total capital to risk-adjusted assets and the leverage ratios for Porter Bancorp, Inc. and PBI Bank at the dates indicated:


							September 30, 2010						December 31, 2009
	Regulatory Minimums			Well-Capitalized Minimums			Porter Bancorp			PBI Bank			Porter Bancorp			PBI Bank
Tier I capital		4.0	%		6.0	%		14.44	%		12.48	%		11.93	%		10.65	%
Total risk-based capital		8.0			10.0			16.35			14.39			13.83			12.56
Tier I leverage ratio		4.0			5.0			11.71			10.11			9.59			8.57

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. It 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, 2009 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 18 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 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 and nine months ended September 30, 2010, respectively, the Company reported net income of $2.4 million and $4.5 million. This compares with net income of $4.5 million and $10.8 million, respectively, for the same periods of 2009. Net income available to common shareholders for the three and nine months ended September 30, 2010 was $1.8 million and $3.0 million, respectively. Fully diluted earnings per common share were $0.16 and $0.31 for the three and nine months ended September 30, 2010, respectively, compared with $0.46 and $1.08 for the same periods of 2009.

Significant developments during the quarter and nine months ended September 30, 2010 consist of the following:

•

Net interest margin increased 14 basis points to 3.73% in the third quarter of 2010 compared with 3.59% in the third quarter of 2009. For the first nine months of 2010, net interest margin increased to 3.58% compared with 3.25% for the same period of 2009. The increase in margin since last year benefited from a lower average cost of funds.

•

Net interest income increased 1.4% to $14.6 million for the three months ended September 30, 2010, and 11.0% to $43.5 million for the nine months ended September 30, 2010, compared with the same quarter and nine months of 2009, respectively. Net interest income benefited from a lower average cost of funds.

•

The Company recorded net income of $2.4 million and $4.5 million for the three and nine months ended September 30, 2010, respectively, compared with net income of $4.5 million and $10.8 million for the same periods of 2009, respectively. The decrease in net income between the comparable periods was due primarily to increased provision for loan losses expense and other real estate owned expense.

•

Net loans decreased 4.8% to $1.30 billion compared with $1.37 billion at September 30, 2009.

•

Deposits increased 0.8% to $1.39 billion compared with $1.38 billion at September 30, 2009.

•

Total assets increased 3.0% to $1.78 billion compared with $1.73 billion at September 30, 2009.

•

Efficiency ratio was 60.5% for the first nine months of 2010, compared with 52.2% for the first nine of 2009. Our efficiency ratio increased from 47.1% in the 2009 third quarter to 60.9% in the third quarter of 2010 due primarily to increased other real estate owned expense.

•

Non-performing loans decreased $2.9 million, or 5.9%, during the third quarter to $45.8 million at September 30, 2010, compared with $48.7 million at June 30, 2010. The decrease was primarily attributable to non-performing loans moving through the collection, foreclosure and disposition process.

•

Non-performing assets increased $2.3 million, or 2.0%, during the third quarter to $119.5 million at September 30, 2010. The increase was primarily attributable to non-performing loans moving through the collection, foreclosure and disposition process.

•

Shareholders’ equity rose to $202.6 million at the end of the third quarter and benefited from a stock offering that raised $27 million in gross proceeds at June 30, 2010 and an additional $5 million in gross proceeds during the third quarter. The proceeds from the offering and third quarter net income resulted in improved capital ratios, including 11.71% tier 1 leverage ratio and 14.44% tier 1 risk-based capital ratio as of September 30, 2010.

The banking industry continues to experience very difficult times. Porter Bancorp is not immune from these difficulties. Real estate lending remains a core business for the Company, and we expect continued weakening in that sector in 2010. We have set up a real estate department with a dedicated real estate sales expert that has been successful in selling OREO properties and assisting in the sale of properties securing non-performing loans.

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 September 30, 2010 compared with the same period of 2009:


	For the Three Months Ended September 30,				Change from Prior Period
	2010		2009		Amount			Percent
	(dollars in thousands)
Gross interest income	$	21,340	$	23,802	$	(2,462	)		(10.3	)%
Gross interest expense		6,764		9,428		(2,664	)		(28.3	)
Net interest income		14,576		14,374		202			1.4
Provision for credit losses		5,000		2,000		3,000			150.0
Non-interest income		3,931		2,036		1,895			93.1
Non-interest expense		9,949		7,584		2,365			31.2
Net income before taxes		3,558		6,826		(3,268	)		(47.9	)
Income tax expense		1,137		2,290		(1,153	)		(50.3	)
Net income		2,421		4,536		(2,115	)		(46.6	)

Net income of $2,421,000 for the three months ended September 30, 2010 decreased $2.1 million, or 46.6%, from net income of $4,536,000 for the comparable period of 2009. This decrease in earnings was primarily attributable to increased provision for loan losses expense and other real estate owned expense. Net interest income benefited from decreased cost of funds to 1.93% in the 2010 third quarter from 2.67% in the prior year third quarter. The increase in non-interest income was due to increased net gains on sales of securities. The increase in non-interest expense was attributable to increased other real estate owned expense, FDIC insurance fees and state franchise tax. Other real estate owned (OREO) expense increased to $2.2 million in the third quarter of 2010 compared with $353,000 in the third quarter of 2009 due to increased losses on sales of OREO, valuation write-downs to account for lower valuations on the underlying real estate collateral, and increased OREO operating costs. FDIC insurance fees increased to $855,000 for the third quarter of 2010 compared with $626,000 in the third quarter of 2009. State franchise tax expense increased to $543,000 in the 2010 third quarter compared with $450,000 in the prior year third quarter.

The following table summarizes components of income and expense and the change in those components for the nine months ended September 30, 2010 compared with the same period of 2009:


	For the Nine Months Ended September 30,				Change from Prior Period
	2010		2009		Amount			Percent
	(dollars in thousands)
Gross interest income	$	66,092	$	70,949	$	(4,857	)		(6.8	)%
Gross interest expense		22,612		31,795		(9,183	)		(28.9	)
Net interest income		43,480		39,154		4,326			11.0
Provision for credit losses		14,600		5,200		9,400			180.8
Non-interest income		7,120		5,417		1,703			31.4
Non-interest expense		29,511		23,088		6,423			27.8
Net income before taxes		6,489		16,283		(9,794	)		(60.1	)
Income tax expense		1,943		5,441		(3,498	)		(64.3	)
Net income		4,546		10,842		(6,296	)		(58.1	)

Net income of $4,546,000 for the nine months ended September 30, 2010 decreased $6.3 million, or 58.1%, from $10,842,000 for the comparable period of 2009. This decrease in earnings was primarily attributable to increased provision for loan losses expense, and other real estate owned expense. Net interest income benefited from decreased cost of funds to 2.06% in the first nine months of 2010 from 2.98% in the same period of 2009. The increase in non-interest income was due primarily to increased net gains on sales of securities, partially offset by an other than temporary impairment charge on securities of $465,000. Non-interest income also benefited from increased income from fiduciary activities, secondary market brokerage fees, and gains on sales of loans originated for sale. The increase in non-interest expense was due to an increase of $4.5 million in other real estate owned valuation write-downs, a $1.0 million increase in other real estate owned operating costs, increased salary and benefits expense, and franchise tax expense. These increases were partially offset by lower advertising expense and FDIC fees. Total FDIC fees were $2.3 million in the first nine months of 2010 compared with $2.4 million in the first nine months of 2009. The 2009 FDIC fees included a special assessment of $781,000.

Net Interest Income – Our net interest income was $14,576,000 for the three months ended September 30, 2010, an increase of $202,000, or 1.4%, compared with $14,374,000 for the same period in 2009. Net interest spread and margin were 3.51% and 3.73%, respectively, for the third quarter of 2010, compared with 3.26% and 3.59%, respectively, for the third quarter of 2009. Net interest income was $43,480,000 for the nine months ended September 30, 2010, an increase of $4.3 million, or 11.0%, compared with $39,154,000 for the same period of 2009. Net interest spread and margin were 3.37% and 3.58%, respectively, for the first nine months of 2010, compared with 2.88% and 3.25%, respectively, for the first nine months of 2009. Net interest margin for the first nine months of 2010 increased 33 basis points from our margin of 3.25% in the first nine months of 2009 due primarily to increased average earning assets coupled with lower cost of funds.

Our yield on earning assets decreased to 5.44% for the third quarter of 2010 compared to 5.93% for the third quarter of 2009. Our cost of funds also decreased to 1.93% for the third quarter of 2010 compared to 2.67% for the third quarter of 2009. Our yield on earning assets declined 43 basis points from 5.86% during the first nine months of 2009 and our cost of funds decreased 92 basis points from 2.98%.

Our average interest-earning assets were $1.64 billion for the nine months ended September 30, 2010, compared with $1.63 billion for the nine months ended September 30, 2009, a 0.6% increase primarily attributable to growth in loans. Average loans were $1.37 billion for the nine months ended September 30, 2010, compared with $1.36 billion for the nine months ended September 30, 2009, a 0.2% increase. Our total interest income decreased by 6.8% to $66.1 million for the nine months ended September 30, 2010, compared with $70.9 million for the same period in 2009. The change was due to lower yield on interest-earning assets resulting from increased non-accrual loans.

Our average interest-bearing liabilities also increased by 2.8%, to $1.47 billion for the nine months ended September 30, 2010, compared with $1.43 billion for the nine months ended September 30, 2009. Our total interest expense decreased by 28.9% to $22.6 million for the nine months ended September 30, 2010, compared with $31.8 million during the same period in 2009, primarily due to continued repricing of certificates of deposit at maturity at lower interest rates. Our average volume of certificates of deposit increased by 9.2% to $1.17 billion for the nine months ended September 30, 2010, compared with $1.07 billion for the nine months ended September 30, 2009. The average interest rate paid on certificates of deposits decreased to 2.10% for the nine months ended September 30, 2010, compared with 3.23% for the nine months ended September 30, 2009. The certificate of deposit volume increase reflected organic growth from promotional efforts throughout the period.

Average Balance Sheets

The following table presents the average balance sheets for the three month periods ending September 30, 2010 and 2009, along with the related calculations of tax-equivalent net interest income, net interest margin and net interest spread for the related periods.


	Three Months Ended September 30,
	2010								2009
	Average Balance			Interest Earned/Paid		Average Yield/Cost			Average Balance			Interest Earned/Paid		Average Yield/Cost
	(dollars in thousands)
ASSETS
Interest-earning assets:
Loan receivables (1)(2)	$	1,335,357		$	19,293		5.73	%	$	1,368,970		$	20,961		6.07	%
Securities
Taxable		132,624			1,676		5.01			152,231			2,457		6.40
Tax-exempt (3)		21,233			212		6.09			21,640			218		6.15
FHLB stock		10,072			113		4.45			10,072			125		4.92
Other equity securities		1,445			13		3.57			1,901			12		2.50
Federal funds sold and other		62,868			33		0.21			45,129			29		0.25

Total interest-earning assets		1,563,599			21,340		5.44	%		1,599,943			23,802		5.93	%

Less: Allowance for loan losses		(27,730	)							(21,283	)
Non-interest earning assets		168,174								96,043

Total assets	$	1,704,043							$	1,674,703

LIABILITIES AND STOCKHOLDERS’ EQUITY
Interest-bearing liabilities:
Certificates of deposit and other time deposits	$	1,095,128		$	5,381		1.95	%	$	1,082,457		$	7,654		2.81	%
NOW and money market deposits		168,910			444		1.04			161,327			461		1.13
Savings accounts		35,841			65		0.72			34,250			75		0.87
Federal funds purchased and repurchase agreements		12,105			123		4.03			11,332			120		4.20
FHLB advances		47,447			498		4.16			78,425			858		4.34
Junior subordinated debentures		33,994			253		2.95			34,000			260		3.03

Total interest-bearing liabilities		1,393,425			6,764		1.93	%		1,401,791			9,428		2.67	%

Non-interest-bearing liabilities:
Non-interest-bearing deposits		102,963								95,592
Other liabilities		6,529								8,759

Total liabilities		1,502,917								1,506,142
Stockholders’ equity		201,126								168,561


Total liabilities and stockholders’ equity	$	1,704,043							$	1,674,703

Net interest income				$	14,576							$	14,374

Net interest spread							3.51	%							3.26	%

Net interest margin							3.73	%							3.59	%

(1)	Includes loan fees in both interest income and the calculation of yield on loans.

(2)	Calculations include non-accruing loans in average loan amounts outstanding.

(3)	Taxable equivalent yields are calculated assuming a 35% federal income tax rate.

Average Balance Sheets

The following table presents the average balance sheets for the nine month periods ending September 30, 2010 and 2009, along with the related calculations of tax-equivalent net interest income, net interest margin and net interest spread for the related periods.


	Nine Months Ended September 30,
	2010								2009
	Average Balance			Interest Earned/Paid		Average Yield/Cost			Average Balance			Interest Earned/Paid		Average Yield/Cost
	(dollars in thousands)
ASSETS
Interest-earning assets:
Loan receivables (1)(2)	$	1,365,322		$	58,937		5.77	%	$	1,363,150		$	63,333		6.21	%
Securities
Taxable		145,961			5,987		5.48			151,550			6,442		5.68
Tax-exempt (3)		21,402			643		6.18			21,858			662		6.23
FHLB stock		10,072			339		4.50			10,072			351		4.66
Other equity securities		1,689			36		2.85			1,901			41		2.88
Federal funds sold and other		92,393			150		0.22			78,356			120		0.20

Total interest-earning assets		1,636,839			66,092		5.43	%		1,626,887			70,949		5.86	%

Less: Allowance for loan losses		(27,376	)							(20,634	)
Non-interest earning assets		148,705								95,714

Total assets	$	1,758,168							$	1,701,967

LIABILITIES AND STOCKHOLDERS’ EQUITY
Interest-bearing liabilities:
Certificates of deposit and other time deposits	$	1,167,040		$	18,329		2.10	%	$	1,069,167		$	25,839		3.23	%
NOW and money market deposits		163,157			1,288		1.06			163,674			1,498		1.22
Savings accounts		35,587			199		0.75			34,860			239		0.92
Federal funds purchased and repurchase agreements		11,769			362		4.11			10,881			355		4.36
FHLB advances		54,785			1,718		4.19			114,393			2,944		3.44
Junior subordinated debentures		33,998			716		2.82			34,000			920		3.62

Total interest-bearing liabilities		1,466,336			22,612		2.06	%		1,426,975			31,795		2.98	%

Non-interest-bearing liabilities:
Non-interest-bearing deposits		101,722								99,523
Other liabilities		6,632								8,297

Total liabilities		1,574,690								1,534,795
Stockholders’ equity		183,478								167,172

Total liabilities and stockholders’ equity	$	1,758,168							$	1,701,967

Net interest income				$	43,480							$	39,154

Net interest spread							3.37	%							2.88	%

Net interest margin							3.58	%							3.25	%

(1)	Includes loan fees in both interest income and the calculation of yield on loans.

(2)	Calculations include non-accruing loans in average loan amounts outstanding.

(3)	Taxable equivalent yields are calculated assuming a 35% federal income tax rate.

Rate/Volume Analysis

The table below sets forth certain information regarding changes in interest income and interest expense for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in rate (changes in rate multiplied by old volume); (2) changes in volume (changes in volume multiplied by old rate); and (3) changes in rate-volume (change in rate multiplied by change in volume). Changes in rate-volume are proportionately allocated between rate and volume variance.


	Three Months Ended September 30, 2010 vs. 2009									Nine Months Ended September 30, 2010 vs. 2009
	Increase (decrease) due to change in						Net Change			Increase (decrease) due to change in						Net Change
	Rate			Volume			Net Change			Rate			Volume			Net Change
	(in thousands)
Interest-earning assets:
Loan receivables	$	(1,131	)	$	(537	)	$	(1,668	)	$	(4,497	)	$	101		$	(4,396	)
Securities		(501	)		(286	)		(787	)		(231	)		(243	)		(474	)
FHLB stock		(12	)		—			(12	)		(12	)		—			(12	)
Other equity securities		4			(3	)		1			—			(5	)		(5	)
Federal funds sold and other		(6	)		10			4			8			22			30

Total decrease in interest income		(1,646	)		(816	)		(2,462	)		(4,732	)		(125	)		(4,857	)

Interest-bearing liabilities:
Certificates of deposit and other time deposits		(2,362	)		89			(2,273	)		(9,703	)		2,193			(7,510	)
NOW and money market accounts		(42	)		25			(17	)		(205	)		(5	)		(210	)
Savings accounts		(13	)		3			(10	)		(45	)		5			(40	)
Federal funds purchased and repurchased agreements		(5	)		8			3			(21	)		28			7
FHLB advances		(34	)		(326	)		(360	)		544			(1,770	)		(1,226	)
Junior subordinated debentures		(7	)		—			(7	)		(204	)		—			(204	)

Total increase (decrease) in interest expense		(2,463	)		(201	)		(2,664	)		(9,634	)		451			(9,183	)

Increase (decrease) in net interest income	$	817		$	(615	)	$	202		$	4,902		$	(576	)	$	4,326

Non-Interest Income – The following table presents the major categories of non-interest income for the three and nine months ended September 30, 2010 and 2009:


	Three Months Ended September 30,				Nine Months Ended September 30,
	2010		2009		2010			2009
	(in thousands)
Service charges on deposit accounts	$	757	$	843	$	2,270		$	2,319
Income from fiduciary activities		226		227		751			645
Secondary market brokerage fees		83		49		273			180
Title insurance commissions		38		33		114			97
Gains on sales of loans originated for sale		135		82		410			323
Gains on sales of investment securities, net		2,175		321		2,256			322
Other than temporary impairment on securities		—		—		(465	)		—
Other		517		481		1,511			1,531

Total non-interest income	$	3,931	$	2,036	$	7,120		$	5,417

Non-interest income for the third quarter ended September 30, 2010 increased $1.9 million, or 93.1%, compared with the third quarter of 2009. For the nine months ended September 30, 2010 non-interest income increased by $1.7 million to $7.1 million compared with $5.4 million for same period of 2009. The increase in non-interest income for the third quarter ended September 30, 2010 was primarily due to higher net gains on sales of investment securities and loans originated for sale. These increases were partially offset by decreased income from service charges on deposit accounts. The increase in non-interest income for the nine months ended September 30, 2010 was due to higher net gains on sales of investments, partially offset by an other than temporary impairment charge on securities, and increased income from fiduciary activities from new business development, secondary market brokerage fees from increased volume of secondary market loan originations, and net gains on sales of loans originated for sale.

Non-interest Expense – The following table presents the major categories of non-interest expense for the three and nine months ended September 30, 2010 and 2009:


	Three Months Ended September 30,				Nine Months Ended September 30,
	2010		2009		2010		2009
	(in thousands)
Salary and employee benefits	$	3,849	$	3,799	$	11,727	$	11,490
Occupancy and equipment		1,070		993		3,107		2,972
Other real estate owned expense		2,163		353		6,395		706
FDIC insurance		855		626		2,266		1,588
FDIC special insurance assessment		—		—		—		781
State franchise tax		543		450		1,629		1,350
Professional fees		239		175		797		606
Postage and delivery		183		193		569		561
Communications		179		183		538		568
Office supplies		113		109		302		327
Advertising		104		121		277		404
Other		651		582		1,904		1,735

Total non-interest expense	$	9,949	$	7,584	$	29,511	$	23,088

Non-interest expense for the third quarter ended September 30, 2010 increased $2.4 million, or 31.2%, compared with the third quarter of 2009. For the nine months ended September 30, 2010, non-interest expense increased $6.4 million, or 27.8%, to $29.5 million compared with $23.1 million for the first nine months of 2009. The increase in non-interest expense was primarily attributable to increased other real estate owned expense. OREO expense increased $1.8 million over the prior year third quarter, and $5.7 million over the nine

months ended September 30, 2009, due to increased losses on sales of OREO, valuation write-downs to account for lower valuations on the underlying real estate collateral, and increased OREO operating costs. In addition, salary and benefits expense for the 2010 third quarter increased $50,000, or 1.3%, over the prior year third quarter, and increased $237,000, or 2.1%, for the nine months ended September 30, 2010, over the same period of 2009, due to additions to staff. State franchise tax for the 2010 third quarter increased $93,000, or 20.7%, over the prior year third quarter, and increased $279,000, or 20.7%, for the nine months ended September 30, 2010, over the same period of 2009. Professional fees expense for the 2010 third quarter increased $64,000, or 36.6%, over the prior year third quarter, and increased $191,000, or 31.5%, for the nine months ended September 30, 2010, over the same period of 2009, due to higher legal and accounting services fees. These increases were partially offset by lower FDIC fees and advertising costs. FDIC fees were $2.3 million in the first nine months of 2010 compared with $2.4 million in the first nine months of 2009. The 2009 FDIC fees included a special assessment of $781,000. Advertising expense for the three months ended September 30, 2010 decreased $17,000, or 14.0%, over the prior year third quarter, and decreased $127,000, or 31.4%, for the nine months ended September 30, 2010, over the same period of 2009, due to the decision to replace certain media advertising with customer relationship focused marketing.

Income Tax Expense – Income tax expense was $1.1 million, or 32.0% of pre-tax income, for the third quarter ended September 30, 2010, and $1.9 million, or 29.9% of pre-tax income, for the first nine months of 2010, compared with $2.3 million, or 33.5% of pre-tax income, for the third quarter of 2009, and $5.4 million, or 33.4% of pre-tax income, for the first nine months of 2009.

Effective tax rates differ from the federal statutory rate of 35% applied to income before income taxes due to the following:


	Three Months Ended September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009
	(dollars in thousands)
Federal statutory rate times financial statement income	$	1,245		$	2,389		$	2,271		$	5,699
Effect of:
Tax-exempt income		(74	)		(75	)		(226	)		(228	)
Non taxable life insurance income		(27	)		(24	)		(77	)		(74	)
Federal tax credits		(11	)		(11	)		(34	)		(34	)
Other, net		4			11			9			78

Total	$	1,137		$	2,290		$	1,943		$	5,441

Analysis of Financial Condition

Total assets decreased $54.9 million, or 3.0%, to $1.78 billion at September 30, 2010 from $1.84 billion at December 31, 2009. This decrease was primarily attributable to a decrease of $87.7 million in net loans due to efforts to move troubled loans through the collection, foreclosure, and disposition process, which contributed to the increase of $59.1 million in other real estate owned. Total assets at September 30, 2010 increased $51.4 million from $1.7 billion at September 30, 2009, representing a 3.0% increase.

Loans Receivable – Loans receivable decreased $84.7 million, or 6.0%, during the nine months ended September 30, 2010 to $1.3 billion. Our commercial, commercial real estate and real estate construction portfolios decreased by an aggregate of $78.9 million, or 8.5%, during the nine months and comprised 64.1% of the total loan portfolio at September 30, 2010.

Loan Portfolio Composition – The following table presents a summary of the loan portfolio at the dates indicated, net of deferred loan fees, by type. There are no foreign loans in our portfolio. Except for commercial real estate, construction real estate and residential real estate, there is no concentration of loans in any industry exceeding 10% of total loans.


	As of September 30, 2010					As of December 31, 2009
	Amount		Percent			Amount		Percent
	(dollars in thousands)
Type of Loan:
Real estate:
Commercial	$	553,576		41.68	%	$	535,843		37.93	%
Construction		215,946		16.26			304,230		21.53
Residential		387,626		29.18			387,017		27.39
Home equity		30,948		2.33			32,384		2.29
Commercial		81,527		6.14			89,903		6.36
Consumer		33,062		2.49			36,989		2.62
Agriculture		24,437		1.84			25,064		1.77
Other		1.089		0.08			1,488		0.11

Total loans	$	1,328,211		100.00	%	$	1,412,918		100.00	%

Non-Performing Assets – Non-performing assets consist of loans past due 90 days or more still on accrual, loans on which interest is no longer accrued, real estate acquired through foreclosure and repossessed assets.

The following table sets forth information with respect to non-performing assets as of September 30, 2010 and December 31, 2009.


	September 30, 2010			December 31, 2009
	(dollars in thousands)
Loans past due 90 days or more still on accrual	$	7,048		$	5,968
Non-accrual loans		38,784			78,888

Total non-performing loans		45,832			84,856
Real estate acquired through foreclosure		73,645			14,548
Other repossessed assets		53			80

Total non-performing assets	$	119,530		$	99,484

Non-performing loans to total loans		3.45	%		6.00	%

Non-performing assets to total assets		6.71	%		5.42	%

Allowance for non-performing loans	$	7,311		$	7,266

Allowance for non-performing loans to non-performing loans		16.0	%		8.6	%

Nonperforming loans at September 30, 2010 were $45.8 million, or 3.5% of total loans, compared with $26.3 million, or 1.9% of total loans, at September 30, 2009, and $84.9 million, or 6.0% of total loans at December 31, 2009. The decrease of $39.0 million in non-performing loans from December 31, 2009 to September 30, 2010 is primarily attributable to efforts to move troubled loans through collection, foreclosure, and disposition process.

We do not have a formal loan modification program. Rather, we work with individual customers on a case-by-case basis to facilitate the orderly collection of our principal and interest before a loan becomes a non-performing loan. If a customer is unable to make contractual payments, we review the particular circumstances of that customer’s situation and negotiate a revised payment stream. In other words, we identify performing customers experiencing financial difficulties, and through negotiations, we lower their interest rate, most

typically on a short-term basis for three to six months. Our goal when restructuring a credit is to afford the customer a reasonable period of time to remedy the issue causing cash flow constraints within their business so that they can return to performing status over time.

Our loan modifications have taken the form of reduction in interest rate and/or curtailment of scheduled principal payments for a short-term period, usually three to six months, but in some cases until maturity of the loan. Our restructured loans are all collateral secured loans. If a customer fails to perform under the modified terms, we place the loan on non-accrual status and begin the process of working with the customer to liquidate the underlying collateral to satisfy the debt.

At September 30, 2010, we had 31 restructured loans totaling $22.0 million with borrowers who experienced deterioration in financial condition compared with 21 loans totaling $25.2 million at December 31, 2009. All of these loans were granted interest rate reductions to provide cash flow relief to customers experiencing cash flow difficulties. Of these loans, 20 loans totaling approximately $6.7 million were also granted principal payment deferrals until maturity. There were no concessions made to forgive principal relative to these loans. These loans are secured by first liens on 1-4 residential or commercial real estate properties. We do not hold a second or junior lien position on these restructured loans. Management believes these loans are well secured and the borrowers have the ability to repay the loans in accordance with the renegotiated terms. As such, these restructured loans were on accrual status at the balance sheet date as payments were being made according to the restructured loan terms. These loans have not had a partial charge-off. In accordance with ASC 310-50-2, we continue to report restructured loans as restructured until such time as the loan has developed a reasonable repayment history, the borrower displays the financial capacity to repay, and the loan terms return to the terms in place prior to the restructure. If the customer fails to perform, we place the loan on non-accrual status and seek to liquidate the underlying collateral for these loans. Our non-accrual policy for restructured loans is identical to our non-accrual policy for all loans. Our policy calls for a loan to be reported as non-accrual if it is maintained on a cash basis because of deterioration in the financial condition of the borrower, payment in full of principal and interest is not expected, or principal or interest has been in default for a period of 90 days or more unless the assets are both well secured and in the process of collection. Changes in value for impairment, including the amount attributed to the passage of time, are recorded entirely within the provision for loan losses.

We consider any loan that is restructured for a borrower experiencing financial difficulties due to a borrower’s potential inability to pay in accordance with contractual terms of the loan a troubled debt restructure. Specifically, we consider a concession involving a modification of the loan terms, such as (i) a reduction of the stated interest rate, (ii) reduction or deferral of principal, or (iii) reduction or deferral of accrued interest at a stated interest rate lower than the current market rate for new debt with similar risk all to be troubled debt restructurings. When a modification of terms is made for a competitive reason, we do not consider that to be a troubled debt restructuring. The primary example of a competitive modification would be an interest rate reduction for a performing customer to a market rate as the result of a market decline in rates.

Foreclosed properties at September 30, 2010 were $73.6 million compared with $12.9 million at September 30, 2009 and $14.5 million at December 31, 2009. See Footnote 5, “Other Real Estate Owned”, to the financial statements. The majority of the increase was due to loans on two multi-unit residential condominiums and patio home developments that were valued at approximately $41.7 million. The bank acquired deeds in lieu of foreclosure on these properties in the first and second quarters of 2010. In addition, the increase in foreclosed properties from year-end 2009 reflects the normal progression of troubled loans through workout, collateral repossession and ultimate disposition. We value foreclosed properties at fair value less costs to sell when acquired and expect to liquidate these properties to recover our investment in the due course of business. Net loss on sales, write-downs, and operating expenses for other real estate owned totaled $2.2 million and $6.4 million, respectively, for the three and nine months ended September 30, 2010, compared with $353,000 and $706,000, respectively, for the same periods of 2009.

Allowance for Loan Losses – The allowance for loan losses is based on management’s continuing review and risk evaluation of individual loans, loss experience, current economic conditions, risk characteristics of various categories of loans and such other factors that, in management’s judgment, require current recognition in estimating loan losses.

Management has established loan grading procedures that result in specific allowance allocations for any estimated inherent risk of loss. For loans not individually graded, a general allowance allocation is computed using factors developed over time based on actual loss experience. The specific and general allocations plus consideration of qualitative factors represent management’s best estimate of probable losses contained in the loan portfolio at the evaluation date. Although the allowance for loan losses is comprised of specific and general allocations, the entire allowance is available to absorb any credit losses.

Our loan loss reserve, as a percentage of total loans at September 30, 2010, increased to 2.21% from 1.58% at September 30, 2009, and 1.87% at December 31, 2009. Provision for loan losses increased by $3.0 million to $5.0 million for the third quarter of 2010 compared with the third quarter of 2009. Provision for loan losses increased by $9.4 million to $14.6 million for the nine months ended September 30, 2010, compared with $5.2 million for the same nine months of 2009. Net loan charge-offs for the third quarter of 2010 were $2.4 million, or 0.18% of average loans, compared with $782,000, or 0.06%, for the third quarter of 2009, and $6.3 million, or 0.46%, for the second quarter of 2010. Net loan charge-offs for the nine months ended September 30, 2010 were $11.6 million, or 0.85% of average loans, compared with $2.9 million or 0.21%, for the first nine months of 2009. Our allowance for loan losses to nonperforming loans increased to 64.13% at September 30, 2010, compared with 31.10% at December 31, 2009, but declined in comparison with 83.60% at September 30, 2009. The change in this metric between periods is attributable to the fluctuation in non-accrual loans. We have assessed these loans for collectability and considered, among other things, the borrower’s ability to repay, the value of the underlying collateral, and other market conditions to ensure the allowance for loan losses is adequate to absorb probable incurred losses.

The majority of our nonperforming loans are secured by real estate collateral. While our nonperforming loans have trended upward since 2008, the underlying collateral coverage for nonperforming loans supports the likelihood of collection of our principal, and therefore, we do not estimate a proportionate upward trending in losses. Our allowance for non-performing loan to non-performing loans was 16.0% at September 30, 2010 compared to 7.7% at September 30, 2009, and 8.6% at December 31, 2009.

An analysis of changes in allowance for loan losses and selected ratios for the three and nine month periods ended September 30, 2010 and 2009 follows:


	Three Months Ended September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009
	(dollars in thousands)
Balance at beginning of period	$	26,836		$	20,740		$	26,392		$	19,652
Provision for loan losses		5,000			2,000			14,600			5,200
Recoveries		70			47			223			218
Charge-offs		(2,514	)		(829	)		(11,823	)		(3,112	)

Balance at end of period	$	29,392		$	21,958		$	29,392		$	21,958

Allowance for loan losses to period-end loans		2.21	%		1.58	%		2.21	%		1.58	%

Net charge-offs to average loans		0.18	%		0.06	%		0.85	%		0.21	%

Allowance for loan losses to non-performing loans		64.13	%		83.60	%		64.13	%		83.60	%

Liabilities – Total liabilities at September 30, 2010 were $1.58 billion compared with $1.67 billion at December 31, 2009, a decrease of $88.2 million, or 5.3%. The decrease was primarily attributable to a decrease in deposits of $140.0 million, or 9.2%, at September 30, 2010 to $1.39 billion from $1.53 billion at December 31, 2009.

Federal Home Loan Bank advances increased $27.8 million, or 33.5%, to $110.8 million from $83.0 million at December 31, 2009. These advances are used from time to time to fund asset growth and manage interest rate risk in accordance with our asset/liability management strategies.

Deposits are our primary source of funds. The following table sets forth the average daily balances and weighted average rates paid for our deposits for the periods indicated:


	For the Nine Months Ended September 30, 2010					For the Year Ended December 31, 2009
	Average Balance		Average Rate			Average Balance		Average Rate
	(dollars in thousands)
Demand	$	101,722		—		$	99,167		—
Interest checking		82,102		0.84	%		75,602		0.84	%
Money market		81,055		1.27			86,619		1.53
Savings		35,587		0.75			34,386		0.90
Certificates of deposit		1,167,040		2.10			1,089,798		3.01

Total deposits	$	1,467,506		1.81	%	$	1,385,572		2.53	%

The following table sets forth the average daily balances and weighted average rates paid for our certificates of deposit for the periods indicated:


	For the Nine Months Ended September 30, 2010					For the Year Ended December 31, 2009


	Average Balance		Average Rate			Average Balance		Average Rate
	Average Balance		Average Rate			Average Balance		Average Rate
	(dollars in thousands)
Less than $100,000	$	587,416		2.07	%	$	611,011		3.03	%
$100,000 or more		579,624		2.13	%		478,787		2.98	%

Total	$	1,167,040		2.10	%	$	1,089,798		3.01	%

The following table shows at September 30, 2010 and December 31, 2009 the amount of our time deposits of $100,000 or more by time remaining until maturity:


Maturity Period	As of September 30, 2010		As of December 31, 2009


	(in thousands)
Three months or less	$	102,356	$	154,365
Three months through six months		88,240		162,828
Six months through twelve months		111,290		131,861
Over twelve months		239,666		167,236

Total	$	541,552	$	616,290

Liquidity

Liquidity risk arises from the possibility we may not be able to satisfy current or future financial commitments, or may become unduly reliant on alternative funding sources. The objective of liquidity risk management is to ensure that the cash flow requirements of depositors and borrowers, as well as our operating cash needs, are met, taking into account all on- and off-balance sheet funding demands. Liquidity risk management also includes ensuring cash flow needs are met at a reasonable cost. We maintain an investment and funds management policy, which identifies the primary sources of liquidity, establishes procedures for monitoring and measuring liquidity and establishes minimum liquidity requirements in compliance with regulatory guidance. The liquidity position is continually monitored and reviewed by our Asset Liability Committee.

Funds are available from a number of sources, including the sale of securities in the available-for-sale portion of the investment portfolio, principal pay-downs on loans and mortgage-backed securities, brokered deposits and other wholesale funding. During 2009 and the first nine months of 2010, PBI Bank utilized brokered and wholesale deposits to supplement its funding strategy. At September 30, 2010, these deposits totaled $92.3 million compared with $114.6 million at December 31, 2009. PBI Bank also secured federal funds borrowing lines from major correspondent banks totaling $44.0 million on an unsecured basis, of which $21.9 million was unused at September 30, 2010, and an additional $25 million on a secured basis.

Traditionally, PBI Bank has utilized borrowings from the FHLB to supplement our funding requirements. At September 30, 2010, the Bank had an unused borrowing capacity with the FHLB of $261,000. Management believes our sources of liquidity are adequate to meet expected cash needs for the foreseeable future.

We use cash to pay dividends on common stock, if and when declared by the board of directors, and to service debt. The main sources of funding include dividends paid by PBI Bank, management fees received from PBI Bank and affiliated banks and financing obtained in the capital markets. PBI Bank must obtain the prior written consent of its primary regulators prior to declaring or paying any future dividends.

Capital

Stockholders’ equity increased $33.2 million to $202.6 million at September 30, 2010 compared with $169.3 million at December 31, 2009. The increase was due to the completion of a stock offering that raised $32.0 million in gross proceeds, net income earned during the first nine months of 2010 reduced by dividends declared on common stock, dividends paid on 5% cumulative preferred stock, dividends paid on participating preferred stock, and increased unrealized net gains on available-for-sale securities. Both the Company and PBI Bank qualified as well capitalized under regulatory guidelines at September 30, 2010.

See Footnote 10 “Capital” for detailed regulatory capital ratios.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

The Company’s interest sensitivity profile was asset sensitive at September 30, 2010, and December 31, 2009. Given an instantaneous 100 basis point decrease in rates that was sustained for 12 months, base net interest income would decrease by an estimated 5.4% at September 30, 2010 compared with a decrease of 4.5% at December 31, 2009. Given a 100 basis point increase in interest rates, base net interest income would increase by an estimated 5.7% at September 30, 2010, compared with an increase of 4.9% at December 31, 2009 and is within the risk tolerance parameters of our risk management policy.

The following table indicates the estimated impact on net interest income under various interest rate scenarios for the twelve months following September 30, 2010, as calculated using the static shock model approach:


	Change in Future Net Interest Income
	Dollar Change		Percentage Change
	(dollars in thousands)
+ 200 basis points	$	6,633		10.95	%
+ 100 basis points		3,442		5.68

We did not run a model simulation for declining interest rates as of September 30, 2010, because the Federal Reserve effectively lowered the federal funds target rate between 0.00% to 0.25% in December 2008. Therefore, no further short-term rate reductions can occur. As we implement strategies to mitigate the risk of rising interest rates in the future, these strategies will lessen our forecasted “base case” net interest income if no interest rate changes occur.

Item 4. Controls and Procedures

As of the end of the period covered by this Quarterly Report on Form 10-Q for the quarter ended September 30, 2010, we carried out an evaluation, under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934). Based on this evaluation, our chief executive officer and chief financial officer concluded that, as of the end of the fiscal quarter covered by this report, these disclosure controls and procedures are effective to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is: (a) recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission, and (b) accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure. Additionally, there was no change in our internal control over financial reporting during the fiscal quarter covered by this report that has materially affected, or is reasonably likely to materially affect, the internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1.

Legal Proceedings

In the normal course of operations, we are defendants in various legal proceedings. In the opinion of management, there is no proceeding pending or, to the knowledge of our management, threatened litigation in which an adverse decision could result in a material adverse change in our business or consolidated financial position.

Item 1A.

Risk Factors

Information regarding risk factors appears in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 under Item 1A – Risk Factors. There have been no material changes from the risk factors previously discussed in our Form 10-K, other than as set forth below.

We continue to hold and acquire a significant amount of OREO properties, which could increase operating expenses and result in future losses to the Company.

During the first nine months of 2010, we have acquired a significant amount of real estate as a result of foreclosure or by deed in lieu of foreclosure (OREO). Large OREO balances have led to increased expenses as we have incurred costs to manage and dispose of these properties and, in certain cases, complete construction of structures prior to sale. We expect that our operating results in 2010 will continue to be negatively affected by expenses associated with OREO, including insurance and taxes, completion and repair costs, and valuation adjustments, as well as by the funding costs associated with assets that are tied up in OREO. In addition, any further decreases in market prices of real estate in our market areas may lead to additional OREO write downs, with a corresponding expense in our income statement. We evaluate OREO property values periodically and write down the carrying value of the properties if the results of our evaluations require it.

The recently enacted Dodd-Frank Act may adversely impact the Corporation’s results of operations, financial condition or liquidity.

On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 was signed into law. The Dodd-Frank Act imposes new restrictions and an expanded framework of regulatory oversight for financial institutions, including depository institutions. Because the Dodd-Frank Act requires various federal agencies to adopt a broad range of regulations with significant discretion, many of the details of the new law and the effects it will have on the Company will not be known for months or even years.

The Dodd-Frank Act represents a comprehensive overhaul of the financial services industry within the United States. There are a number of reform provisions that are likely to significantly impact the ways in which banks and bank holding companies, including the Company, do business. For example, the Dodd-Frank Act changes the assessment base for federal deposit insurance premiums by modifying the deposit insurance assessment base calculation to be based on a depository institution’s consolidated assets less tangible capital instead of deposits, permanently increases the standard maximum amount of deposit insurance per customer to $250,000 and extends the unlimited deposit insurance on non-interest bearing transaction accounts through January 1, 2013. The Dodd-Frank Act also imposes more stringent capital requirements on bank holding companies by, among other things, imposing leverage ratios on bank holding companies and prohibiting new trust preferred issuances from counting as Tier I capital. The Dodd-Frank Act also repeals the federal prohibition on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts. The Act codifies and expands the Federal Reserve’s source of strength doctrine, which

requires that all bank holding companies serve as a source of financial strength for its subsidiary banks. Other provisions of the Dodd-Frank Act include, but are not limited to: (i) the creation of a new financial consumer protection agency that is empowered to promulgate new consumer protection regulations and revise existing regulations in many areas of consumer protection; (ii) enhanced regulation of financial markets, including derivatives and securitization markets; (iii) reform related to the regulation of credit rating agencies; (iv) the elimination of certain trading activities by banks; and (v) new disclosure and other requirements relating to executive compensation and corporate governance.

Many provisions of the Dodd-Frank Act will not be implemented immediately and will require interpretation and rule making by federal regulators. The Company is monitoring all relevant sections of the Dodd-Frank Act to ensure continued compliance with laws and regulations. While the ultimate effect of the Dodd-Frank Act on the Company cannot currently be determined, the law is likely to result in increased compliance costs and fees paid to regulators, along with possible restrictions on the Company’s operations.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

Sale of Equity Securities

On July 23, 2010, the Company completed a supplemental private placement to one additional accredited investor on comparable terms as the June 30, 2010 private placement. The Company received aggregate gross proceeds of $4,255,000 from the new investor in exchange for the sale and issuance of:

•

370,000 shares of Cumulative Mandatory Convertible Perpetual Preferred Stock, Series B (“Series B Preferred Stock”) for $11.50 per share, and

•

warrants to purchase 185,000 shares of convertible non-voting common stock (“Non-Voting Common Stock”) at a purchase price of $11.50 per share (“Warrants”).

The Company also granted the new investor an option (the “Option”) to purchase both 64,784 shares of common stock and a Warrant to purchase 32,392 shares of Non-Voting Common Stock at a purchase price of $11.50 per share. The option exercise price was $745,016, increasing the total potential gross proceeds to be received from the new investor to $5,000,016.

The Company held a special meeting of shareholders on September 16, 2010. The shareholders approved the proposal for the issuance of common shares to allow for the conversion or exercise of the Series B preferred stock; Series C preferred stock; Non-Voting Common Stock; and the Option. The shareholders also approved the proposal to authorize the Non-Voting Common Stock, which will be issuable upon the exercise of the Warrants.

On September 27, 2010, the Company completed the private placement of 64,784 shares of common stock in exchange for aggregate proceeds of $745,016, in connection with the exercise of the Option. Pursuant to the terms of the Option, the Company also granted a Warrant to purchase 32,392 shares of Non-Voting Common Stock at a purchase price of $11.50 per share.

Both the July 23, 2010 and September 27, 2010 private placements were exempt from registration pursuant to section 4(2) of the Securities Act of 1933.

Item 3.

Default Upon Senior Securities

Not applicable.

Item 4.

(Reserved)

Item 5.

Other Information

Not applicable.

Item 6.

Exhibits

(a) Exhibits

The following exhibits are filed or furnished as part of this report:


Exhibit Number		Description of Exhibit
31.1		Certification of Principal Executive Officer, pursuant to Rule 13a – 14(a).

31.2		Certification of Principal Financial Officer, pursuant to Rule 13a – 14(a).

32.1		Certification of Principal Executive Officer, pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2		Certification of Principal Financial Officer, pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

SIGNATURES

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


	PORTER BANCORP, INC.
	(Registrant)

November 12, 2010	By:	/s/ Maria L. Bouvette
		Maria L. Bouvette
		President & Chief Executive Officer

November 12, 2010	By:	/s/ David B. Pierce
		David B. Pierce
		Chief Financial Officer and Chief Accounting Officer