SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549

FORM 10-Q

[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 30, 2008
   
 
Or
   
[   ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from _____________ to _____________
   

Commission file number 0-11129

COMMUNITY TRUST BANCORP, INC.
(Exact name of registrant as specified in its charter)

Kentucky
61-0979818
(State or other jurisdiction of incorporation or organization)
IRS Employer Identification No.
   
346 North Mayo Trail
Pikeville, Kentucky
(address of principal executive offices)
41501
(Zip Code)

(606) 432-1414
(Registrant's telephone number)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.

Yes  ü
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 definition of “accelerated filer, large accelerated filer, and smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer
Accelerated filer  ü
Non-accelerated filer
Smaller reporting company
   
(Do not check if a 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 ü

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

Common stock –14,999,119 shares outstanding at July 31, 2008
 

 
 
 
 

PART I - FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements
 
The accompanying information has not been audited by independent registered public accountants; however, in the opinion of management such information reflects all adjustments necessary for a fair presentation of the results for the interim period.  All such adjustments are of a normal and recurring nature.
 
The accompanying condensed consolidated financial statements are presented in accordance with the requirements of Form 10-Q and consequently do not include all of the disclosures normally required by accounting principles generally accepted in the United States of America or those normally made in the Registrant's annual report on Form 10-K.  Accordingly, the reader of the Form 10-Q should refer to the Registrant's Form 10-K for the year ended December 31, 2007 for further information in this regard.


 
 
 

Community Trust Bancorp, Inc.
Condensed Consolidated Balance Sheets

(dollars in thousands)
  
(unaudited)
June 30
2008
    
December 31
2007
  
Assets:
            
Cash and due from banks
   $ 88,886     $ 105,209  
Federal funds sold
     4,426       32,041  
Cash and cash equivalents
     93,312       137,250  
                 
Securities available-for-sale at fair value
                
(amortized cost of $309,498 and $325,879, respectively)
     306,869       324,153  
Securities held-to-maturity at amortized cost
                
(fair value of $29,157 and $32,350, respectively)
     29,296       32,959  
Loans held for sale
     1,494       2,334  
                 
Loans
     2,273,646       2,227,897  
Allowance for loan losses
     (29,096 )     (28,054 )
Net loans
     2,244,550       2,199,843  
                 
Premises and equipment, net
     52,448       53,391  
Federal Reserve Bank and Federal Home Loan Bank stock
     28,703       28,060  
Goodwill
     65,059       65,059  
Core deposit intangible (net of accumulated amortization of $5,905 and
                
$5,588, respectively)
     1,599       1,917  
Bank owned life insurance
     23,736       23,285  
Mortgage servicing rights
     3,256       3,258  
Other assets
     28,022       31,175  
Total assets
   $ 2,878,344     $ 2,902,684  
                 
Liabilities and shareholders’ equity:
                
Deposits
                
Noninterest bearing
   $ 447,677     $ 449,861  
Interest bearing
     1,830,446       1,843,303  
Total deposits
     2,278,123       2,293,164  
                 
Repurchase agreements
     142,453       158,980  
Federal funds purchased and other short-term borrowings
     17,880       18,364  
Advances from Federal Home Loan Bank
     40,809       40,906  
Long-term debt
     61,341       61,341  
Other liabilities
     31,587       28,574  
Total liabilities
     2,572,193       2,601,329  
                 
Shareholders’ equity:
                
Preferred stock, 300,000 shares authorized and unissued
     -       -  
Common stock, $5 par value, shares authorized 25,000,000;
                
shares outstanding 2008 – 14,989,038; 2007 – 15,044,124
     74,945       75,221  
Capital surplus
     148,004       149,005  
Retained earnings
     84,911       78,251  
Accumulated other comprehensive income (loss), net of tax
     (1,709 )     (1,122 )
Total shareholders’ equity
     306,151       301,355  
                 
Total liabilities and shareholders’ equity
   $ 2,878,344     $ 2,902,684  


See notes to condensed consolidated financial statements.

 
 
 
 

Community Trust Bancorp, Inc.
Condensed Consolidated Statements of Income and Other Comprehensive Income
(unaudited)
 
   
Three Months Ended
    
Six Months Ended
  
   
June 30
    
June 30
  
(in thousands except per share data)
  
2008
    
2007
    
2008
    
2007
  
                         
Interest income:
                        
Interest and fees on loans, including loans held for sale
   $ 37,308     $ 43,194     $ 77,063     $ 85,381  
Interest and dividends on securities
                                
Taxable
     3,226       4,632       6,638       9,277  
Tax exempt
     471       488       945       989  
Interest and dividends on Federal Reserve and Federal
     285       449       794       887  
Home Loan Bank stock
                                
Other, including interest on federal funds sold
     380       1,322       910       2,730  
Total interest income
     41,670       50,085       86,350       99,264  
                                 
Interest expense:
                                
Interest on deposits
     13,522       19,600       29,049       38,651  
Interest on repurchase agreements and other short-term
                                
Borrowings
     1,090       2,175       2,558       4,333  
Interest on advances from Federal Home Loan Bank
     376       711       753       1,415  
Interest on long-term debt
     1,000       988       2,000       2,364  
Total interest expense
     15,988       23,474       34,360       46,763  
                                 
Net interest income
     25,682       26,611       51,990       52,501  
Provision for loan losses
     2,648       1,846       5,017       2,316  
Net interest income after provision for loan losses
     23,034       24,765       46,973       50,185  
                                 
Noninterest income:
                                
Service charges on deposit accounts
     5,503       5,330       10,602       10,134  
Gains on sales of loans, net
     494       316       1,040       612  
Trust income
     1,298       1,180       2,489       2,379  
Loan related fees
     1,079       867       1,378       1,888  
Bank owned life insurance
     269       240       532       472  
Securities losses
     0       0       (50 )     0  
Other
     1,038       1,041       2,433       1,987  
Total noninterest income
     9,681       8,974       18,424       17,472  
                                 
Noninterest expense:
                                
Salaries and employee benefits
     10,600       11,100       21,311       22,214  
Occupancy, net
     1,708       1,642       3,334       3,402  
Equipment
     1,114       1,233       2,167       2,462  
Data processing
     1,426       1,166       2,807       2,316  
Bank franchise tax
     914       866       1,804       1,732  
Legal and professional fees
     724       814       1,437       1,567  
Other
     3,957       4,117       7,584       9,741  
Total noninterest expense
     20,443       20,938       40,444       43,434  
                                 
Income before income taxes
     12,272       12,801       24,953       24,223  
Income taxes
     3,652       3,943       7,788       7,343  
Net income
     8,620       8,858       17,165       16,880  
                                 
Other comprehensive income, net of tax:
                                
Unrealized holding losses on securities available-for-sale
     (3,618 )     (1,445 )     (587 )     (837 )
Comprehensive income
   $ 5,002     $ 7,413     $ 16,578     $ 16,043  
                                 
Basic earnings per share
   $ 0.58     $ 0.58     $ 1.14     $ 1.11  
Diluted earnings per share
   $ 0.57     $ 0.57     $ 1.13     $ 1.09  
                                 
Weighted average shares outstanding-basic
     14,989       15,216       14,995       15,203  
Weighted average shares outstanding-diluted
     15,152       15,448       15,145       15,421  
                                 
Dividends declared per share
   $ 0.29     $ 0.27     $ 0.58     $ 0.54  

See notes to condensed consolidated financial statements.

 
 
 
 

Community Trust Bancorp, Inc.
Condensed Consolidated Statements of Cash Flows
(unaudited)

   
Six months ended
  
   
June 30
  
(in thousands)
  
2008
    
2007
  
             
Cash flows from operating activities:
            
Net income
   $ 17,165     $ 16,880  
Adjustments to reconcile net income to net cash provided by operating activities:
                
Depreciation and amortization
     2,567       2,917  
Change in net deferred tax liability
     (222 )     (439 )
Stock based compensation
     368       339  
Excess tax benefits of stock-based compensation
     421       560  
Provision for loan and other real estate losses
     5,142       2,581  
Securities losses
     50       0  
Gains on sale of mortgage loans held for sale
     (1,040 )     (612 )
(Gains) losses on sale of assets, net
     (70 )     116  
Proceeds from sale of mortgage loans held for sale
     52,933       34,256  
Funding of mortgage loans held for sale
     (51,053 )     (36,112 )
Amortization of securities premiums, net
     (96 )     330  
Change in cash surrender value of bank owned life insurance
     (451 )     (406 )
Fair value adjustments of mortgage servicing rights
     2       (172 )
Amortization/write-off of debt issuance costs
     0       1,950  
Changes in:
                
Other liabilities
     1,826       6,227  
Other assets
     4,137       (24 )
Net cash provided by operating activities
     31,679       28,391  
                 
Cash flows from investing activities:
                
Securities available-for-sale:
                
Proceeds from sales
     29,950       46,700  
Proceeds from prepayments and maturities
     41,076       22,324  
Purchase of securities
     (54,648 )     (69,800 )
Securities held-to-maturity:
                
Proceeds from prepayments and maturities
     3,684       3,770  
Change in loans, net
     (53,073 )     (51,018 )
Purchase of premises, equipment, and other real estate
     (1,314 )     (1,304 )
Additional investment in equity securities
     (643 )     (11 )
Redemption of investment in unconsolidated subsidiaries
     0       1,841  
Investment in unconsolidated subsidiaries
     0       (1,841 )
Proceeds from sale of other real estate and other repossessed assets
     2,422       1,465  
Additional investment in other real estate owned
     (104 )     (2 )
Additional investment in bank owned life insurance
     0       (1,391 )
Net cash used in investing activities
     (32,650 )     (49,267 )
                 
Cash flows from financing activities:
                
Change in deposits, net
     (15,041 )     23,771  
Change in repurchase agreements and other short-term borrowings, net
     (17,011 )     (7,561 )
Payments on advances from Federal Home Loan Bank
     (97 )     (193 )
Payment for redemption of junior subordinated debentures
     0       (61,341 )
Additional junior subordinated debentures
     0       61,341  
Issuance of common stock
     932       1,514  
Purchase of common stock
     (2,630 )     0  
Excess tax benefits of stock-based compensation
     (421 )     (560 )
Dividends paid
     (8,699 )     (8,198 )
Net cash provided by (used in) financing activities
     (42,967 )     8,773  
Net decrease in cash and cash equivalents
     (43,938 )     (12,103 )
Cash and cash equivalents at beginning of period
     137,250       157,538  
Cash and cash equivalents at end of period
   $ 93,212     $ 145,435  
                 
Supplemental disclosures:
                
Income taxes paid
   $ 9,529     $ 5,717  
Interest paid
     31,430       40,764  
Non-cash activities
                
Loans to facilitate the sale of other real estate and other repossessed assets
     885       106  
Common stock dividends accrued, paid in subsequent quarter
     8,686       8,214  
Real estate acquired in settlement of loans
     4,234       1,326  
 
 
See notes to condensed consolidated financial statements.

 
 
 
 

Community Trust Bancorp, Inc.
Notes to Condensed Consolidated Financial Statements (unaudited)


Note 1 - Summary of Significant Accounting Policies
 
In the opinion of management, the unaudited condensed consolidated financial statements include all adjustments (which consist of normal recurring accruals) necessary, to present fairly the condensed consolidated financial position as of June 30, 2008, the results of operations for the three and six months ended June 30, 2008 and 2007, and the cash flows for the six months ended June 30, 2008 and 2007.  In accordance with accounting principles generally accepted in the United States of America for interim financial information, these statements do not include certain information and footnote disclosures required by accounting principles generally accepted in the United States of America for complete annual financial statements.  The condensed consolidated balance sheet as of December 31, 2007 has been derived from the audited consolidated financial statements of Community Trust Bancorp, Inc. ("CTBI") for that period.  The results of operations for the three and six months ended June 30, 2008 and 2007, and the cash flows for the six months ended June 30, 2008 and 2007, are not necessarily indicative of the results to be expected for the full year.  For further information, refer to the consolidated financial statements and footnotes thereto for the year ended December 31, 2007, included in CTBI's Annual Report on Form 10-K.
 
Principles of Consolidation – The unaudited condensed consolidated financial statements include the accounts of CTBI and its separate and distinct, wholly owned subsidiaries Community Trust Bank, Inc. (the “Bank”) and Community Trust and Investment Company.  All significant intercompany transactions have been eliminated in consolidation.
 
Reclassifications – Certain reclassifications considered to be immaterial have been made in the prior year consolidated financial statements to conform to current year classifications.  These reclassifications had no effect on net income.

New Accounting Standards –

Ø Accounting for Servicing of Financial Assets – Statement of Financial Accounting Standard (“SFAS”) No. 156, Accounting for Servicing of Financial Assets amends SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities – a replacement of SFAS No. 125, by requiring, in certain situations, an entity to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract.  All separately recognized servicing assets and servicing liabilities are required to be initially measured at fair value.  Subsequent measurement methods include the amortization method, whereby servicing assets or servicing liabilities are amortized in proportion to and over the period of estimated net servicing income or net servicing loss or the fair value method, whereby servicing assets or servicing liabilities are measured at fair value at each reporting date and changes in fair value are reported in earnings in the period in which they occur.  If the amortization method is used, an entity must assess servicing assets or servicing liabilities for impairment or increased obligation based on the fair value at each reporting date.  Adoption of SFAS 156 on January 1, 2007 did not have a significant impact on our consolidated financial statements.

Ø Fair Value Measurements – Effective January 1, 2008, CTBI adopted SFAS No. 157, Fair Value Measurements.  SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. SFAS 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value but does not expand the use of fair value in any new circumstances.  In this standard, the FASB clarifies the principle that fair value should be based on the assumptions market participants would use when pricing the asset or liability.  In support of this principle, SFAS 157 establishes a fair value hierarchy that prioritizes the information used to develop those assumptions.  The fair value hierarchy is as follows:

Level 1 Inputs – Unadjusted quoted process in active markets for identical assets or liabilities that the entity has the ability to access at the measurement date.

Level 2 Inputs - Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals.

Level 3 Inputs - Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

Ø  Fair Value Option for Financial Assets and Financial Liabilities – In February 2007, the FASB issued SFAS 159, The Fair Value Option for Financial Assets and Financial Liabilities, which permits entities to choose to measure many financial instruments and certain other items at fair value.  The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. This Statement is expected to expand the use of fair value measurement, which is consistent with the FASB’s long-term measurement objectives for accounting for financial instruments.  SFAS 159 is effective for fiscal years beginning after November 15, 2007. CTBI has not elected the fair value option for any financial assets or liabilities at June 30, 2008.

Ø Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards – On June 14, 2007, the Emerging Issues Task Force (“EITF”) reached a final consensus on Issue No. 06-11, Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards.  This consensus was ratified by FASB on June 27, 2007.  This issue states that tax benefits received on dividends paid to employees associated with their unvested stock compensation awards should be recorded in additional paid-in capital (“APIC”) for awards expected to vest.  Currently, such dividends are accounted for as a permanent tax deduction reducing the annual effective income tax rate.  This issue is to be applied prospectively to dividends declared in fiscal years beginning after December 15, 2007.  Retrospective application of this Issue is prohibited.  Issue No. 06-11 did not have a material effect on our consolidated financial statements.

Ø Business Combinations (Revised 2007) – The FASB recently issued SFAS 141(R), which replaces FAS 141, Business Combinations, and applies to all transactions and other events in which one entity obtains control over one or more other businesses.  SFAS 141R requires an acquirer, upon initially obtaining control of another entity, to recognize the assets, liabilities, and any non-controlling interest in the acquiree at fair value as of the acquisition date.  Contingent consideration is required to be recognized and measured at fair value on the date of acquisition rather than at a later date when the amount of that consideration may be determinable beyond a reasonable doubt.  This fair value approach replaces the cost-allocation process required under SFAS 141 whereby the cost of an acquisition was allocated to the individual assets acquired and liabilities assumed based on their estimated fair value.  SFAS 141R requires acquirers to expense acquisition-related costs as incurred rather than allocating such costs to the assets acquired and liabilities assumed as was previously the case under SFAS 141.  Under SFAS 141R, the requirements of SFAS 146, Accounting for Costs Associated with Exit or Disposal Activities, would have to be met in order to accrue for a restructuring plan in purchase accounting.  Pre-acquisition contingencies are to be recognized at fair value, unless it is a non-contractual contingency that is not likely to materialize, in which case, nothing should be recognized in purchase accounting, and instead, that contingency would be subject to the probable and estimable recognition criteria of SFAS 5, Accounting for Contingencies.  SFAS 141R is expected to have a significant impact on our accounting for business combinations closing on or after January 1, 2009.
 
Ø Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split Dollar Life Insurance Arrangements – EITF Issue No. 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split Dollar Life Insurance Arrangements requires the recognition of a liability and related compensation expense for endorsement split-dollar life insurance policies that provide a benefit to an employee that extends to post-retirement periods.  Under EITF 06-4, life insurance policies purchased for the purpose of providing such benefits do not effectively settle an entity’s obligation to the employee.  Accordingly, the entity must recognize a liability and related compensation expense during the employee’s active service period based on the future cost of insurance to be incurred during the employee’s retirement.  If the entity has agreed to provide the employee with a death benefit, then the liability for the future death benefit should be recognized by following the guidance in SFAS 106, Employer’s Accounting for Postretirement Benefits Other Than Pensions.  CTBI adopted EITF 06-4 as a change in accounting principle through a $1.8 million cumulative-effect adjustment to retained earnings based on the cost of insurance.
 
 
Note 2 – Stock-Based Compensation
 
CTBI’s compensation expense related to stock option grants was $343 thousand and $339 thousand, respectively, for the six months ended June 30, 2008 and 2007, respectively.  Restricted stock expense for the first six months of 2008 was $25 thousand.  There were no restricted stock grants made prior to the first quarter of 2008.  As of June 30, 2008, there was a total of $1.5 million of unrecognized compensation expense related to unvested stock option awards that will be recognized as expense as the awards vest over a weighted average period of 1.5 years.
 
There were no options granted during the three months ended June 30, 2008; however, there were options to purchase 74,776 shares of CTBI common stock and 11,076 shares of restricted stock granted during the six months ended June 30, 2008.  The options were granted pursuant to the terms of the 2006 Stock Ownership Incentive Plan, with an exercise price per share of $28.32 (equal to fair market value on date of grant), a term of 10 years, and vesting in five years.   The restrictions on the restricted stock will lapse at the end of five years.  However, in the event of a change in control of CTBI or the death of the participant, the restrictions will lapse.  In the event of the disability of the participant, the restrictions will lapse on a pro rata basis (with respect to 20% of the participant’s restricted stock for each year since the date of award). The Compensation Committee of the Board of Directors will have discretion to review and revise restrictions applicable to a participant’s restricted stock in the event of the participant’s retirement.  There were options to purchase 109,304 shares of CTBI common stock granted during the six months ended June 30, 2007.
 
The fair values of options granted during the six months ended June 30, 2008 and 2007, were established at the date of grant using a Black-Scholes option pricing model with the weighted average assumptions as follows:

   
Six Months Ended
  
   
June 30
  
   
2008
    
2007
  
Expected dividend yield
     4.10 %     2.77 %
Risk-free interest rate
     3.23 %     4.81 %
Expected volatility
     31.01 %     33.50 %
Expected term (in years)
     7.5       7.5  
Weighted average fair value of options
   $ 6.41     $ 12.74  

Note 3 – Securities
 
Securities are classified into held-to-maturity and available-for-sale categories.  Held-to-maturity securities are those that CTBI has the positive intent and ability to hold to maturity and are reported at amortized cost.  Available-for-sale securities are those that CTBI may decide to sell if needed for liquidity, asset-liability management or other reasons.  Available-for-sale securities are reported at fair value, with unrealized gains or losses included as a separate component of equity, net of tax.

The amortized cost and fair value of securities at June 30, 2008 are summarized as follows:

Available-for-Sale

(in thousands)
  
Amortized
Cost
    
Fair
Value
  
U.S. Treasury and government agencies
   $ 23,315     $ 23,694  
State and political subdivisions
     43,965       44,151  
U.S. government sponsored agencies and mortgage-backed pass through certificates
     207,317       205,323  
Collateralized mortgage obligations
     1       1  
Total debt securities
     274,598       273,169  
Marketable equity securities
     34,900       33,700  
Total available-for-sale securities
   $ 309,498     $ 306,869  

Held-to-Maturity

 (in thousands)
  
Amortized
Cost
    
Fair
Value
  
State and political subdivisions
   $ 1,901     $ 1,912  
U.S. government sponsored agencies and mortgage-backed pass through certificates
     27,395       27,245  
Total held-to-maturity securities
   $ 29,296     $ 29,157  

The amortized cost and fair value of securities as of December 31, 2007 are summarized as follows:

Available-for-Sale

(in thousands)
  
Amortized
Cost
    
Fair
Value
  
U.S. Treasury and government agencies
   $ 20,307     $ 20,736  
State and political subdivisions
     40,472       41,137  
U.S. government sponsored agencies and mortgage-backed pass through certificates
     205,049       202,542  
Collateralized mortgage obligations
     1       1  
Other debt securities
     20,000       19,687  
Total debt securities
     285,829       284,103  
Marketable equity securities
     40,050       40,050  
Total available-for-sale securities
   $ 325,879     $ 324,153  

Held-to-Maturity

(in thousands)
  
Amortized
Cost
    
Fair
Value
  
State and political subdivisions
   $ 1,901     $ 1,914  
U.S. government sponsored agencies and mortgage-backed pass through certificates
     31,058       30,436  
Total held-to-maturity securities
   $ 32,959     $ 32,350  
 
 
 
Note 4 – Loans

Major classifications of loans, net of unearned income and deferred loan origination costs, are summarized as follows:

(in thousands)
  
June 30
2008
    
December 31
2007
  
Commercial construction
   $ 150,356     $ 143,773  
Commercial secured by real estate
     653,830       640,574  
Commercial other
     354,441       333,774  
Real estate construction
     59,956       69,021  
Real estate mortgage
     600,654       599,665  
Consumer
     443,654       435,273  
Equipment lease financing
     10,755       5,817  
Total loans
   $ 2,273,646     $ 2,227,897  

Activity in the allowance for loan and lease losses was as follows:

   
Six Months Ended
  
   
June 30
  
(in thousands)
  
2008
    
2007
  
Allowance balance at January 1
   $ 28,054     $ 27,526  
Additions to allowance charged against operations
     5,017       2,316  
Recoveries credited to allowance
     1,253       1,340  
Losses charged against allowance
     (5,228 )     (3,494 )
Allowance balance at June 30, 2008
   $ 29,096     $ 27,688  

Note 5 – Mortgage Servicing Rights

The following table presents the components of mortgage banking income:

   
Six Months Ended
  
   
June 30
  
(in thousands)
  
2008
    
2007
  
Net gain on sale of loans held for sale
   $ 1,040     $ 612  
Net loan servicing income
                
Servicing fees
     431       436  
Late fees
     31       34  
Ancillary fees
     114       69  
Fair value adjustments
     (245 )     (9 )
Net loan servicing income
     331       530  
Mortgage banking income
   $ 1,371     $ 1,142  
 
Mortgage loans serviced for others are not included in the accompanying balance sheets.  Loans serviced for the benefit of others (primarily FHLMC) increased to $357 million at June 30, 2008 compared to $351 million at December 31, 2007.  Servicing loans for others generally consists of collecting mortgage payments, maintaining escrow accounts, disbursing payments to investors, and processing foreclosures.  Custodial escrow balances maintained in connection with the foregoing loan servicing, and included in demand deposits, were approximately $1.0 million at June 30, 2008 compared to $0.5 million at December 31, 2007.

Activity for capitalized mortgage servicing rights using the fair value method was as follows:

(in thousands)