| PREMIER FINANCIAL BANCORP INC Item 1A Risk Factors Like all financial companies, the Company’s business and results of operations are subject to a number of risks, many of which are outside of the Company’s control |
| In addition to the other information in this report, readers should carefully consider that the following important factors, among others, could materially impact the Company’s business and future results of operations |
| Changes in Interest Rates Could Negatively Impact the Company’s Results of Operations The earnings of the Company are primarily dependent on net interest income, which is the difference between interest earned on loans and investments, and interest paid on interest-bearing liabilities such as deposits and borrowings |
| Interest rates are highly sensitive to many factors, including government monetary and fiscal policies; domestic and international economic and political conditions; and, in particular, changes in the discount rate by the Board of Governors of the Federal Reserve System |
| Conditions such as inflation, recession, unemployment, money supply, government borrowing and other factors beyond management’s control may also affect interest rates |
| If the Company’s interest-earning assets mature, reprice or prepay more quickly than interest-bearing liabilities in a given period, a decrease in market interest rates could adversely affect net interest income |
| Likewise, if interest-bearing liabilities mature or reprice, or, in the case of deposits, are withdrawn by the accountholder, more quickly than interest-earning assets in a given period, an increase in market interest rates could adversely affect net interest income |
| Given the Company’s current mix of assets and liabilities, a declining interest rate environment would negatively impact the Company’s results of operations |
| Fixed rate loans increase the Company’s exposure to interest rate risk in a rising rate environment because interest-bearing liabilities would be subject to repricing before assets become subject to repricing |
| Adjustable rate loans decrease the risks to a lender associated with changes in interest rates but involve other risks |
| As interest rates rise, the payment by the borrower rises to the extent permitted by the terms of the loan, and the increased payment increases the potential for default |
| At the same time, for secured loans, the marketability of the underlying collateral may be adversely affected by higher interest rates |
| In a declining interest rate environment, there is likely to be an increase in prepayment activity on loans as the borrowers refinance their loans at lower interest rates |
| Under these circumstances, the Company’s results of operations could be negatively impacted |
| Changes in interest rates also can affect the value of loans, investments and other interest-rate sensitive assets and the Company’s ability to realize gains on the sale or resolution of assets |
| This type of income can vary significantly from quarter-to-quarter and year-to-year based on a number of different factors, including the interest rate environment |
| An increase in interest rates that adversely affects the ability of borrowers to pay the principal or interest on 16 _________________________________________________________________ [86]Table of Contents PREMIER FINANCIAL BANCORP, INC FORM 10-K December 31, 2005 loans may lead to an increase in non-performing assets and increased loan loss reserve requirements that could have a material adverse effect on the Company’s results of operations |
| Regional Economic Changes in the Company’s Markets Could Adversely Impact Results From Operations Like all banks, the Company is subject to the effects of any economic downturn, and in particular a significant decline in home values or reduced commercial development in the Company’s markets could have a negative effect on results of operations |
| The Company’s success depends primarily on the general economic conditions in the counties in which the Company conducts business, and in the West Virginia, southern Ohio and northern Kentucky areas in general |
| Unlike larger banks that are more geographically diversified, the Company provides banking and financial services to customers primarily in the West Virginia counties of Barbour, Boone, Harrison, Lewis, Lincoln, Logan, Kanawha and Upshur, as well as the southern Ohio counties of Gallia, Lawrence and Scioto and the northern Kentucky counties of Bracken, Fleming, Greenup, Lewis, Mason, and Robertson |
| The local economic conditions in these market areas have a significant impact on the Company’s ability to originate loans, the ability of the borrowers to repay these loans and the value of the collateral securing these loans |
| A significant decline in the general economic conditions caused by inflation, recession, unemployment or other factors beyond the Company’s control would affect these local economic conditions and could adversely affect the Company’s financial condition and results of operations |
| Additionally, a significant decline in home values would likely lead to increased delinquencies and defaults in both the consumer home equity loan and residential real estate loan portfolios and result in increased losses in these portfolios |
| New or Revised Tax, Accounting and Other Laws, Regulations, Rules and Standards Could Significantly Impact Strategic Initiatives, Results of Operations and Financial Condition The financial services industry is highly regulated and laws and regulations may sometimes impose significant limitations on operations |
| These limitations, and sources of potential liability for the violation of such laws and regulations, are described in Item 1 of Part I of this report under the heading “Business — Regulatory Matters |
| ” These regulations, along with the currently existing tax and accounting laws, regulations, rules and standards, control the methods by which financial institutions conduct business; implement strategic initiatives, as well as past, present, and contemplated tax planning; and govern financial disclosures |
| These laws, regulations, rules, and standards are constantly evolving and may change significantly over time |
| The nature, extent, and timing of the adoption of significant new laws, changes in existing laws, or repeal of existing laws may have a material impact on the Company’s results of operations and financial condition, the effects of which are impossible to predict at this time |
| 17 _________________________________________________________________ [87]Table of Contents PREMIER FINANCIAL BANCORP, INC FORM 10-K December 31, 2005 The Extended Disruption of Vital Infrastructure Could Negatively Impact the Company’s Results of Operations and Financial Condition The Company’s operations depend upon, among other things, its technological and physical infrastructure, including its equipment and facilities |
| While disaster recovery procedures are in place, an extended disruption of its vital infrastructure by fire, power loss, natural disaster, telecommunications failure, computer hacking and viruses, terrorist activity or the domestic and foreign response to such activity, or other events outside of the Company’s control, could have a material adverse impact either on the financial services industry as a whole, or on the Company’s business, results of operations, and financial condition |
| Strong Competition Within the Company’s Market Area May Limit Profitability The Company faces significant competition both in attracting deposits and in the origination of loans, as described under the heading “Business — Competition |
| ” Mortgage bankers, commercial banks, credit unions and other savings institutions, which have offices in the Bank’s market area have historically provided most of the Company’s competition for deposits; however, the Company also competes with financial institutions that operate through Internet banking operations throughout the continental United States |
| In addition, and particularly in times of high interest rates, the Company faces additional and significant competition for funds from money market and mutual funds, securities firms, commercial banks, credit unions and other savings institutions located in the same communities and those that operate through Internet banking operations throughout the continental United States |
| Many competitors have substantially greater financial and other resources than the Company |
| Moreover, credit unions do not pay federal or state income taxes and are subject to fewer regulatory constraints than community banks and as a result, they may enjoy a competitive advantage over the Company |
| The Banks compete for loans principally on the basis of the interest rates and loan fees they charge, the types of loans they originate and the quality of services they provide to borrowers |
| This advantage places significant competitive pressure on the prices of loans and deposits |
| Loss of Large Checking and Money Market Deposit Customers Could Increase Cost of Funds and Have a Negative Effect on Results of Operations The Company has a number of large deposit customers that maintain balances in checking, money market and repurchase agreement accounts at the Affiliate Banks |
| The ability to attract these types of deposits has a positive effect on the Company’s net interest margin as they provide a relatively low cost of funds to the Company compared to certificates of deposits or advances |
| If these depositors were to withdraw these funds and the Affiliate Banks were not able to replace them with similar types of deposits, the cost of funds would increase and the Company’s results of operation would be negatively impacted |
| 18 _________________________________________________________________ [88]Table of Contents PREMIER FINANCIAL BANCORP, INC FORM 10-K December 31, 2005 Extensive Regulation and Supervision The Company, primarily through its Affiliate Banks, is subject to extensive federal and state regulation and supervision |
| Banking regulations are primarily intended to protect depositors’ funds, federal deposit insurance funds and the banking system as a whole, not shareholders |
| These regulations affect Premier’s lending practices, capital structure, investment practices, dividend policy and growth, among other things |
| The Company is also subject to a number of federal laws, which, among other things, require it to lend to various sectors of the economy and population, and establish and maintain comprehensive programs relating to anti-money laundering and customer identification |
| Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes |
| Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect Premier in substantial and unpredictable ways |
| Such changes could subject the Company to additional costs, limit the types of financial services and products it may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things |
| Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, along with corrective action plans required by regulatory agencies, any of which could have a material adverse effect on the Company’s business, financial condition and results of operations |
| Premier is currently and certain of its Affiliate Banks have been in the past, subject to such corrective actions plans and therefore there may be some residual reputation damage within the regulatory agencies |
| While Premier has policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur |
| See the “Regulatory Matters” section in Item 1, “Business” and Notes 3 and 12 to consolidated financial statements included elsewhere in this report |
| Dividend payments by subsidiaries to Premier and by Premier to its shareholders can be restricted |
| The Company’s principal source of funds for dividend payments, distributions on its Trust Preferred Securities and its debt service obligations is dividends received from the subsidiary Banks |
| Banking regulations limit the amount of dividends that may be paid without prior approval of regulatory agencies |
| Under these regula-tions, the amount of dividends that may be paid in any calendar year is limited to the current year’s net profits, as defined, combined with the retained net profits of the preceding two years, subject to the capital requirements and additional restrictions as discussed in Note 20 to the consolidated financial statements |
| During 2006 the Banks could, without prior approval, declare dividends of approximately dlra2dtta5 million plus any 2006 net profits retained to the date of the dividend declaration |
| 19 _________________________________________________________________ [89]Table of Contents PREMIER FINANCIAL BANCORP, INC FORM 10-K December 31, 2005 Allowance for Loan Losses May Be Insufficient Premier, through the Affiliate Banks, maintains an allowance for loan losses based on, among other things, national and regional economic conditions, historical loss experience and delinquency trends |
| Premier believes that its allowance for loan losses is maintained at a level adequate to absorb any probable losses in its loan portfolio give the current information known to Management |
| These determinations are based upon estimates that are inherently subjective, and their accuracy depends on the outcome of future events |
| Therefore, Premier cannot predict loan losses with certainty and ultimate losses may differ from current estimates |
| Depending on changes in economic, operating and other conditions, including changes in interest rates, which are generally beyond its control, Premier’s actual losses could exceed its current allowance estimates |
| Premier can provide no assurance that its allowance is sufficient to cover all charge-offs in future periods |
| If charge-offs exceed Premier’s allowance, its earnings would decrease |
| In addition, regulatory agencies review Premier’s allowance for loan losses and may require additions to the allowance based upon their judgment about information available to them at the time of their examination |
| A required increase in Premier’s allowance for loan losses could reduce its earnings |
| Claims and Litigation Pertaining to Fiduciary Responsibility From time to time, customers make claims and take legal action pertaining to the Company’s and Affiliate Banks’ performance of their fiduciary responsibilities |
| If such claims and legal actions are not resolved in a manner favorable to the Banks they may result in financial liability and/or adversely affect the market perception of the Banks and their products and services as well as impact customer demand for those products and services |
| Any financial liability or reputation damage could have a material adverse effect on the Company’s business, which, in turn, could have a material adverse effect on its financial condition and results of operations Inability to Hire and Retain Qualified Employees The Company’s performance is largely dependent on the talents and efforts of highly skilled individuals and their ability to attract and retain customer relationships in a community bank environment |
| There is intense competition in the financial services industry for qualified employees |
| In addition, the Company faces increasing competition with businesses outside the financial services industry for the most highly skilled individuals |
| The Company’s business could be adversely affected if it were unable to retain and motivate its existing key employees and management team |
| Furthermore, the Company’s success may be impacted if it were unable to recruit replacement management and key employees in a reasonable amount of time |
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