10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2010.

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: 0-24611

CFS Bancorp, Inc.

(Exact name of registrant as specified in its charter)

Indiana	35-2042093
(State or other jurisdiction	(I.R.S. Employer
of incorporation or organization)	Identification No.)
707 Ridge Road, Munster, Indiana	46321
(Address of principal executive offices)	(Zip code)
(219) 836-5500
(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 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 R                      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 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.  (Check one):

Large accelerated filer £	Accelerated filer £
Non-accelerated filer £ (Do not check if a smaller reporting company)	Smaller reporting company R

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES £  NO R

The Registrant had 10,851,724 shares of Common Stock outstanding as of October 27, 2010.

CFS BANCORP, INC.

TABLE OF CONTENTS

		Page
	PART I - FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)
	Condensed Consolidated Statements of Condition	3
	Condensed Consolidated Statements of Income (Loss)	4
	Condensed Consolidated Statements of Changes in Shareholders’ Equity	5
	Condensed Consolidated Statements of Cash Flows	6
	Notes to Condensed Consolidated Financial Statements	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	49
Item 4.	Controls and Procedures	51
	PART II - OTHER INFORMATION
Item 1.	Legal Proceedings	51
Item 1A.	Risk Factors	51
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	53
Item 3.	Defaults Upon Senior Securities	53
Item 4.	(Removed and Reserved)	53
Item 5.	Other Information	53
Item 6.	Exhibits	53
Signature Page		54
Certifications of Principal Executive Officer and Principal Financial Officer		55
	Exhibit 31.1
	Exhibit 31.2
	Exhibit 32.0

2

CFS BANCORP, INC.

Condensed Consolidated Statements of Condition

 (Dollars in thousands)

	September 30, 2010			December 31, 2009
ASSETS	(Unaudited)
Cash and amounts due from depository institutions	$	23,098		$	24,041
Interest bearing deposits		29,120			387
Cash and cash equivalents		52,218			24,428
Investment securities available-for-sale, at fair value		210,717			188,781
Investment securities held-to-maturity, at cost		11,831			5,000
Investment in Federal Home Loan Bank stock, at cost		23,944			23,944
Loans receivable, net of unearned fees		724,137			762,386
Allowance for loan losses		(17,485	)		(19,461	)
Net loans		706,652			742,925
Loans held for sale		4,425			―
Accrued interest receivable		3,315			3,469
Other real estate owned		24,211			9,242
Office properties and equipment		20,611			20,382
Investment in bank-owned life insurance		35,273			34,575
Net deferred tax assets		17,130			18,036
Other assets		9,152			10,733
Total assets	$	1,119,479		$	1,081,515
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits	$	929,856		$	849,758
Borrowed funds		64,199			111,808
Advance payments by borrowers for taxes and insurance		5,952			4,322
Other liabilities		5,592			5,254
Total liabilities		1,005,599			971,142
Commitments and contingencies		―			―
Shareholders’ equity:
Preferred stock, $0.01 par value; 15,000,000 shares authorized		―			―
Common stock, $0.01 par value; 85,000,000 shares authorized; 23,423,306 shares issued; 10,851,724 and 10,771,061 shares outstanding		234			234
Additional paid-in capital		187,075			188,930
Retained earnings		82,783			80,564
Treasury stock, at cost; 12,571,582 and 12,652,245 shares		(155,022	)		(157,041	)
Accumulated other comprehensive loss, net of tax		(1,190	)		(2,314	)
Total shareholders’ equity		113,880			110,373
Total liabilities and shareholders’ equity	$	1,119,479		$	1,081,515

See accompanying notes to the unaudited condensed consolidated financial statements.

3

CFS BANCORP, INC.

Condensed Consolidated Statements of Income (Loss)

(Unaudited)

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

	Three Months Ended September 30,					Nine Months Ended September 30,
	2010		2009			2010		2009
Interest income:
Loans	$	9,199	$	9,648		$	28,503	$	29,400
Investment securities		2,176		2,742			6,552		8,805
Other		90		195			337		575
Total interest income		11,465		12,585			35,392		38,780
Interest expense:
Deposits		2,143		2,431			6,342		8,276
Borrowed funds		436		758			1,392		2,598
Total interest expense		2,579		3,189			7,734		10,874
Net interest income		8,886		9,396			27,658		27,906
Provision for loan losses		525		9,430			3,052		10,767
Net interest income (loss) after provision for loan losses		8,361		(34	)		24,606		17,139
Non-interest income:
Service charges and other fees		1,290		1,479			3,830		4,154
Card-based fees		475		429			1,398		1,249
Commission income		40		56			140		197
Net gain on sale of investment securities		―		321			456		1,041
Net gain (loss) on sale of other assets		2		(15	)		14		(21	)
Income from bank-owned life insurance		217		218			702		552
Other income		112		112			392		504
Total non-interest income		2,136		2,600			6,932		7,676
Non-interest expense:
Compensation and employee benefits		4,709		4,505			13,928		14,758
Net occupancy expense		691		763			2,097		2,410
FDIC insurance premiums and OTS assessments		623		574			1,891		1,540
Professional fees		512		662			1,850		1,433
Furniture and equipment expense		488		526			1,547		1,581
Data processing		443		407			1,316		1,246
Marketing		189		155			519		571
OREO related expense		479		1,343			1,377		1,754
Loan collection expense		156		290			478		818
Severance and early retirement expense		88		―			528		―
FDIC special insurance premium assessment		―		―			―		495
Other general and administrative expenses		1,068		1,023			2,990		3,013
Total non-interest expense		9,446		10,248			28,521		29,619
Income (loss) before income taxes		1,051		(7,682	)		3,017		(4,804	)
Income tax expense (benefit)		188		(3,011	)		475		(2,264	)
Net income (loss)	$	863	$	(4,671	)	$	2,542	$	(2,540	)
Per share data:
Basic earnings (loss) per share	$	.08	$	(.44	)	$	.24	$	(.24	)
Diluted earnings (loss) per share		.08		(.44	)		.24		(.24	)
Cash dividends declared per share		.01		.01			.03		.03
Weighted-average common and common share
equivalents outstanding:
Basic		10,657,719		10,603,828			10,626,890		10,563,814
Diluted		10,707,163		10,695,719			10,701,072		10,674,247

See accompanying notes to the unaudited condensed consolidated financial statements.

4

CFS BANCORP, INC.

Condensed Consolidated Statements of Changes in Shareholders’ Equity

(Unaudited)

(Dollars in thousands, except per share data)

	Common Stock		Additional Paid-In Capital			Retained Earnings			Treasury Stock			Unallocated Common Stock Held By ESOP			Accum- ulated Other Compre-hensive Income (Loss)			Total
Balance at January 1, 2009	$	234	$	189,211		$	81,525		$	(157,466	)	$	(832	)	$	(863	)	$	111,809
Net loss		―		―			(2,540	)		―			―			―			(2,540	)
Other comprehensive loss: Change in unrealized depreciation on investment securities available-for-sale, net of reclassification and tax		―		―			―			―			―			(436	)		(436	)
Total comprehensive loss		―		―			―			―			―			―			(2,976	)
Net purchases of Rabbi Trust shares		―		(414	)		―			958			―			―			544
Shares earned under ESOP		―		(401	)		―			―			832			―			431
Amortization of award under RRP		―		1			―			―			―			―			1
Forfeiture of RRP award		―		906			18			(906	)		―			―			18
Unearned compensation restricted stock awards		―		(373	)		―			373			―			―			―
Dividends declared on common stock ($.03 per share)		―		―			(328	)		―			―			―			(328	)
Balance at September 30, 2009	$	234	$	188,930		$	78,675		$	(157,041	)	$	―		$	(1,299	)	$	109,499
Balance at January 1, 2010	$	234	$	188,930		$	80,564		$	(157,041	)	$	―		$	(2,314	)	$	110,373
Net income		―		―			2,542			―			―			―			2,542
Other comprehensive income: Change in unrealized depreciation on investment securities available-for-sale, net of reclassification and tax		―		―			―			―			―			1,124			1,124
Total comprehensive income		―		―			―			―			―			―			3,666
Net distribution of Rabbi Trust shares		―		(447	)		―			447			―			―			―
Forfeiture of restricted stock awards		―		295			4			(295	)		―			―			4
Vesting of restricted stock awards		―		164			―			―			―			―			164
Unearned compensation restricted stock awards		―		(436	)		―			436			―			―			―
Reclassification of treasury stock issuances of restricted stock at average cost		―		(1,431	)		―			1,431			―			―			―
Dividends declared on common stock ($.03 per share)		―		―			(327	)		―			―			―			(327	)
Balance at September 30, 2010	$	234	$	187,075		$	82,783		$	(155,022	)	$	―		$	(1,190	)	$	113,880

See accompanying notes to the unaudited condensed consolidated financial statements.

5

CFS BANCORP, INC.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(Dollars in thousands)

	Nine Months Ended September 30,
	2010			2009
OPERATING ACTIVITIES:
Net income	$	2,542		$	(2,540	)
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		3,052			10,767
Depreciation and amortization		1,200			1,171
Premium amortization on the early extinguishment of debt		―			157
Net discount accretion on investment securities available-for-sale		(406	)		(1,136	)
Net premium amortization on investment securities held-to-maturity		125			―
Deferred income tax expense (benefit)		386			(1,145	)
Share-based compensation		―			432
Origination of loans held-for-sale		(4,144	)		―
Net gain on sale of investment securities		(456	)		(1,041	)
Net (gain) loss on sale of other assets		(14	)		21
Increase in cash surrender value of bank-owned life insurance		(702	)		(552	)
Decrease in other assets		2,336			1,483
Increase in other liabilities		521			695
Net cash provided by operating activities		4,440			8,312
INVESTING ACTIVITIES:
Investment securities, available-for-sale:
Proceeds from sales		9,603			11,657
Proceeds from maturities and paydowns		61,744			66,550
Purchases		(90,724	)		(31,429	)
Investment securities, held-to-maturity:
Proceeds from maturities and paydowns		1,500			940
Purchases		(8,456	)		―
Net loan repayments (fundings)		16,262			(9,940	)
Proceeds from sale of other real estate owned		1,144			408
Proceeds from bank-owned life insurance		―			496
Purchases of property and equipment		(1,429	)		(1,993	)
Net cash provided by (used for) investing activities		(10,356	)		36,689
FINANCING ACTIVITIES:
Net increase in deposit accounts		80,012			23,007
Proceeds from Federal Home Loan Bank borrowed funds		18,000			119,000
Repayments of Federal Home Loan Bank borrowed funds		(55,242	)		(177,226	)
Decrease in short-term borrowed funds		(10,367	)		(9,511	)
Dividends paid on common stock		(327	)		(649	)
Net increase in advance payments by borrowers for taxes and insurance		1,630			3,029
Net disposition of Rabbi Trust shares		―			544
Net cash provided by (used for) financing activities		33,706			(41,806	)
Increase in cash and cash equivalents		27,790			3,195
Cash and cash equivalents at beginning of period		24,428			19,106
Cash and cash equivalents at end of period	$	52,218		$	22,301

6

CFS BANCORP, INC.

Condensed Consolidated Statements of Cash Flows (continued)

(Unaudited)

(Dollars in thousands)

Supplemental disclosures:
Loans transferred to other real estate owned	$	16,741	$	6,012
Cash paid for interest on deposits		6,344		8,417
Cash paid for interest on borrowed funds		1,425		2,483
Cash paid for taxes		1,075		460

See accompanying notes to the unaudited condensed consolidated financial statements.

7

CFS BANCORP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information or footnotes necessary for a complete presentation of financial condition, results of operations, or cash flows in accordance with U.S. generally accepted accounting principles.  In our opinion, all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation have been included.  The results of operations for the three and nine months ended September 30, 2010 are not necessarily indicative of the results expected for the year ending December 31, 2010.&# 160; The September 30, 2010 condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes for the year ended December 31, 2009 included in the Company’s Annual Report on Form 10-K.

The preparation of the condensed consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates, judgments, or assumptions that could have a material effect on the carrying value of certain assets and liabilities.  These estimates, judgments, and assumptions affect the amounts reported in the condensed consolidated financial statements and the disclosures provided.  The determination of the allowance for loan losses, valuations and impairments of investment securities, and the accounting for income tax expense are highly dependent on management’s estimates, judgments, and assumpt ions where changes in any of these could have a significant impact on the financial statements.

The condensed consolidated financial statements include the accounts of CFS Bancorp, Inc. (the Company), its wholly-owned subsidiary, Citizens Financial Bank (the Bank), and its wholly-owned subsidiary, CFS Holdings, LTD.  All material intercompany balances and transactions have been eliminated in consolidation.

Certain items in the condensed consolidated financial statements of prior periods have been reclassified to conform to the current period’s presentation.  During the second quarter, the Company recorded a reclassification entry between treasury stock and additional paid-in-capital to reflect treasury stock issuances of restricted stock at average cost versus the grant date fair value.  This reclassification had no impact on shareholders’ equity.

2. Earnings Per Share

Amounts reported in earnings per share reflect earnings available to common shareholders for the period divided by the weighted-average number of shares of common stock outstanding during the period, exclusive of unearned Employee Stock Ownership Program (ESOP) shares and unvested restricted stock shares.  Stock options,  restricted stock, and treasury shares held in Rabbi Trust accounts are regarded as common stock equivalents and are considered in the diluted earnings per share calculations to the extent that they would have a dilutive effect if converte d to common stock, computed using the “treasury stock” method.

8

	Three Months Ended September 30,					Nine Months Ended September 30,
	2010		2009			2010		2009
	(Dollars in thousands, except share and per share data)
Net income (loss)	$	863	$	(4,671	)	$	2,542	$	(2,540	)
Weighted-average common shares:
Outstanding		10,657,719		10,603,828			10,626,890		10,563,814
Equivalents		49,444		91,891			74,182		110,433
Total		10,707,163		10,695,719			10,701,072		10,674,247
Earnings (loss) per share:
Basic	$	.08	$	(.44	)	$	.24	$	(.24	)
Diluted		.08		(.44	)		.24		(.24	)
Number of anti-dilutive stock options excluded from the diluted earnings (loss) per share calculation		651,995		778,795			681,336		898,824
Weighted-average exercise price of anti-dilutive option shares	$	13.44	$	13.08		$	13.37	$	12.69

3. Investment Securities

The amortized cost of investment securities available-for-sale and their fair values are as follows for the periods indicated:

	Par Value		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(Dollars in thousands)
At September 30, 2010:
U.S. Treasury securities	$	9,000	$	9,050	$	105	$	―		$	9,155
Government sponsored entity (GSE) securities		38,800		39,490		1,043		―			40,533
Corporate bonds		4,000		3,614		―		(62	)		3,552
Collateralized mortgage obligations		67,423		64,546		2,466		(243	)		66,769
Commercial mortgage-backed securities		68,633		69,290		2,453		―			71,743
Pooled trust preferred securities		29,760		26,764		―		(7,851	)		18,913
GSE preferred stock		5,837		―		52		―			52
	$	223,453	$	212,754	$	6,119	$	(8,156	)	$	210,717

	Par Value		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(Dollars in thousands)
At December 31, 2009:
Government sponsored entity (GSE) securities	$	40,450	$	40,374	$	1,083	$	―		$	41,457
Mortgage-backed securities		9,527		9,426		409		―			9,835
Collateralized mortgage obligations		67,307		66,413		1,336		(981	)		66,768
Commercial mortgage-backed securities		49,722		49,210		1,347		(35	)		50,522
Pooled trust preferred securities		30,223		27,093		―		(7,081	)		20,012
GSE preferred stock		5,837		―		187		―			187
	$	203,066	$	192,516	$	4,362	$	(8,097	)	$	188,781

9

Investment securities available-for-sale with unrealized losses aggregated by investment category and length of time that individual investment securities have been in a continuous unrealized loss position are presented in the following tables for the dates indicated.

	September 30, 2010
	Less than 12 Months					12 Months or More					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
	(Dollars in thousands)
Corporate bonds	$	3,552	$	(62	)	$	―	$	―		$	3,552	$	(62	)
Collateralized mortgage obligations		7,832		(83	)		3,431		(160	)		11,263		(243	)
Pooled trust preferred securities		―		―			18,913		(7,851	)		18,913		(7,851	)
	$	11,384	$	(145	)	$	22,344	$	(8,011	)	$	33,728	$	(8,156	)

	December 31, 2009
	Less than 12 Months					12 Months or More					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
	(Dollars in thousands)
Collateralized mortgage obligations	$	12,461	$	(201	)	$	14,764	$	(780	)	$	27,225	$	(981	)
Commercial mortgage-backed securities		1,598		(35	)		―		―			1,598		(35	)
Pooled trust preferred securities		―		―			20,012		(7,081	)		20,012		(7,081	)
	$	14,059	$	(236	)	$	34,776	$	(7,861	)	$	48,835	$	(8,097	)

We evaluate all investment securities on a quarterly basis, and more frequently when economic conditions warrant additional evaluations, for determining if an other-than-temporary impairment (OTTI) exists pursuant to guidelines established in the Financial Accounting Standards Board Accounting Standards Codification (ASC) 320-10, Investments – Debt and Equity Securities.  Current accounting guidance generally provides that if a marketable security is in an unrealized loss position, whether due to general mar ket conditions or industry or issuer-specific factors, the holder of the investment securities must assess whether the impairment is other-than-temporary.

At September 30, 2010, the Company’s collateralized mortgage obligations consisted of $15.0 million in agency-issued investment securities and $49.5 million in non-agency (private-issued) investment securities.  In management’s belief, the decline in value is primarily attributable to changes in market interest rates and macroeconomic conditions affecting liquidity of these investment securities and not necessarily the expected cash flows of the individual investment securities. The fair value of these investment securities is expected to recover as the investment securities approach their maturity date.

At September 30, 2010, the Company’s pooled trust preferred investment securities consisted of “Super Senior” securities backed by senior securities issued mainly by bank and thrift holding companies.  Due to the structure of the securities, as deferrals and defaults on the underlying collateral increase, cash flows are increasingly diverted from mezzanine and subordinate tranches to pay down principal on the “Super Senior” tranches.  In management’s belief, the decline in value is primarily attributable to macroeconomic conditions affecting liquidity of these securities and not necessarily the expected cash flows of the individual securities. The fair value of these securities is expected to recover as the securities approach their maturity date.

10

Unrealized losses on collateralized mortgage obligations and pooled trust preferred investment securities have not been recognized in income because management does not have the intent to sell these securities and has the ability to hold these securities for a period of time sufficient to allow for any anticipated recovery in fair value.  We may from time to time dispose of an impaired security in response to asset/liability management decisions, future market movements, business plan changes, or if the net proceeds could be reinvested at a rate of return that is expected to recover the loss within a reasonable period of time.  The Company concluded that the unrealized losses that existed at September 30, 2010 did not constitute other-than-temporary impairments.

At September 30, 2010, the Company had asset-backed investment securities with an amortized cost of $7.8 million and state and municipal investment securities with an amortized cost of $4.0 million that were classified as held-to-maturity.  At December 31, 2009, the Company’s held-to-maturity investment securities consisted of state and municipal investment securities with an amortized cost of $5.0 million.  The gross unrealized holding gains on the held-to-maturity investment securities totaled $465,000 and $179,000, respectively, at September 30, 2010 and December 31, 2009.

The amortized cost and fair value of investment securities at September 30, 2010, by contractual maturity, are shown in the tables below.  Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.  Investment securities not due at a single maturity date are shown separately.

	Available-for-Sale
	Amortized Cost		Fair Value
	(Dollars in thousands)
U.S. Treasury securities:
Due after one year through five years	$	9,050	$	9,155
GSE securities:
Due in one year or less		12,499		12,649
Due after one year through five years		26,991		27,884
Corporate bonds:
Due after one year through five years		3,614		3,552
Collateralized mortgage obligations		64,546		66,769
Commercial mortgage-backed securities		69,290		71,743
Pooled trust preferred securities		26,764		18,913
GSE preferred stock		―		52
	$	212,754	$	210,717

	Held-to-Maturity
	Amortized Cost		Fair Value
	(Dollars in thousands)
Asset backed securities:
Due after five years	$	7,831	$	8,181
State and municipal securities:
Due in one year or less		2,000		2,028
Due after one year through five years		2,000		2,087
	$	11,831	$	12,296

The carrying value of investment securities pledged as collateral to secure public deposits and for other purposes at September 30, 2010 and December 31, 2009 was $49.4 million and $58.8 million,

11

respectively.  Other than the U.S. Government, its agencies, and GSEs, there were no other holdings of investment securities of any one issuer in an amount greater than 10% of shareholders’ equity.

4. Fair Value Measurements

The Company measures fair value according to ASC 820-10: Fair Value Measurements and Disclosures.  ASC 820-10 establishes a fair value hierarchy that prioritizes the inputs used in valuation techniques, but not the valuation techniques themselves.  The fair value hierarchy is designed to indicate the relative reliability of the fair value measure.  The highest priority is given to quoted prices in active markets and the lowest to unobservable data such as the Company’s internal information.  ASC 820-10 defines fair value as “ ;the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.”  There are three levels of inputs into the fair value hierarchy (Level 1 being the highest priority and Level 3 being the lowest priority):

Level 1 – Unadjusted quoted prices for identical instruments in active markets;

Level 2 – Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable; and

Level 3 – Instruments whose significant value drivers or assumptions are unobservable and that are significant to the fair value of the assets or liabilities.

A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

The following tables set forth the Company’s financial assets by level within the fair value hierarchy that were measured at fair value on a recurring basis at the dates indicated.

	Fair Value Measurements at September 30, 2010
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(Dollars in thousands)
Investment securities available-for-sale:
U.S. Treasury securities	$	9,155	$	―	$	9,155	$	―
Government sponsored entity (GSE) securities		40,533		―		40,533		―
Corporate bonds		3,552		―		3,552		―
Collateralized mortgage obligations		66,769		―		66,769		―
Commercial mortgage-backed securities		71,743		―		71,743		―
Pooled trust preferred securities		18,913		―		―		18,913
GSE preferred stock		52		52		―		―

12

	Fair Value Measurements at December 31, 2009
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(Dollars in thousands)
Investment securities available-for-sale:
Government sponsored entity (GSE) securities	$	41,457	$	―	$	41,457	$	―
Mortgage-backed securities		9,835		―		9,835		―
Collateralized mortgage obligations		66,768		―		66,768		―
Commercial mortgage-backed securities		50,522		―		50,522		―
Pooled trust preferred securities		20,012		―		―		20,012
GSE preferred stock		187		187		―		―

Investment securities available-for-sale are measured at fair value on a recurring basis.  Level 2 investment securities are valued by a third party pricing service commonly used in the banking industry utilizing observable inputs.  The pricing provider utilizes evaluated pricing models that vary based on asset class.  These models incorporate available market information including quoted prices of investment securities with similar characteristics and, because many fixed-income investment securities do not trade on a daily basis, apply available information through processes such as benchmark yield curves, benchmarking of like investment securities, sector groupings, and matrix pricing.  In addition, model processes, such as an option adjusted spread model, are used to develop prepayment e stimates and interest rate scenarios for investment securities with prepayment features.

Level 3 models are utilized when quoted prices are not available for certain investment securities or in markets where trading activity has slowed or ceased.  When quoted prices are not available and are not provided by third party pricing services, management judgment is necessary to determine fair value.  As such, fair value is determined by using discounted cash flow analysis models, incorporating default rate assumptions, estimations of prepayment characteristics, and implied volatilities.

The Company determined that Level 3 pricing models should be utilized for valuing its pooled trust preferred investment securities.  The markets for these securities and for similar securities at September 30, 2010 were not active.  Given the limited number of observable transactions in the secondary market and the absence of a new issue market, management has determined an income valuation approach (present value technique) that maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs will be more representative of fair value than the market approach valuation technique.

For its Level 3 pricing model, the Company uses externally produced fair values provided by a third party and compares them to other external pricing sources. Other external sources provided similar prices, both higher and lower, than those used by the Company.  The external model uses deferral and default probabilities for underlying issuers, estimated deferral periods, and recovery rates on defaults.

The following is a reconciliation of the beginning and ending balances for the periods indicated of recurring fair value measurements recognized in the accompanying consolidated statements of condition using Level 3 inputs:

13

	Investment Securities Available-for-Sale
	Three Months Ended			Nine Months Ended
	September 30, 2010			September 30, 2010
	(Dollars in thousands)
Balance at beginning of period	$	20,124		$	20,012
Total realized and unrealized losses:
Included in accumulated other comprehensive loss		(1,107	)		(771	)
Purchases, sales, issuances and settlements, net		(104	)		(328	)
Balance at end of period	$	18,913		$	18,913

	Investment Securities Available-for-Sale
	Three Months Ended			Nine Months Ended
	September 30, 2009			September 30, 2009
	(Dollars in thousands)
Balance at beginning of period	$	25,832		$	24,133
Total realized and unrealized losses:
Included in accumulated other comprehensive loss		(4,749	)		(2,700	)
Purchases, sales, issuances and settlements, net		(129	)		(479	)
Balance at end of period	$	20,954		$	20,954

The following tables set forth the Company’s financial and non-financial assets by level within the fair value hierarchy that were measured at fair value on a non-recurring basis at the dates indicated.

	Fair Value Measurements at September 30, 2010
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(Dollars in thousands)
Impaired loans	$	16,314	$	―	$	―	$	16,314
Other real estate owned		13,087		―		―		13,087

	Fair Value Measurements at December 31, 2009
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(Dollars in thousands)
Impaired loans	$	29,411	$	―	$	―	$	29,411
Other real estate owned		1,740		―		―		1,740

Fair value measurements for impaired loans are performed pursuant to ASC 310-10, Receivables, and are measured on a non-recurring basis.  Certain impaired loans were partially charged-off or re-evaluated during the third quarter of 2010.  These impaired loans were carried at estimated fair value using current and prior appraisals, discounting factors, the borrowers’ financial results, estimated cash flows generated from the property, and other factors.  The decrease in the fair value of impaired loans that were valued using Level 3 inputs was approximately $102,000 and $3.7 million for the three and nine months ended September 30, 2010, respectively.  This loss is not recorded direc tly as an adjustment to current earnings or other comprehensive income (loss), but rather as a component in determining the overall adequacy of the allowance for loan losses.  These adjustments to the estimated fair value of impaired loans may result in increases or decreases to the provision for loan losses recorded in future earnings.

14

The fair value of the Company’s other real estate owned is determined by using Level 3 inputs which include current and prior appraisals and estimated costs to sell.  The decrease in fair value of other real estate owned was $210,000 and $642,000 for the three and nine months ended September 30, 2010, respectively, which was recorded directly as an adjustment to current earnings through other real estate owned (OREO) related expenses.

The Company has the option to measure financial instruments and certain other assets and liabilities at fair value on an instrument-by-instrument basis (the Fair Value Option) according to ASC 825-10, Financial Instruments.  The Company is not currently engaged in any hedging activities and, as a result, did not elect to measure any financial instruments at fair value under ASC 825-10.

Disclosure of fair value information about financial instruments, whether or not recognized in the consolidated statement of condition, for which it is practicable to estimate their value, is summarized below.  The aggregate fair value amounts presented do not represent the underlying value of the Company.

The carrying amounts and fair values of financial instruments consist of the following:

	September 30,				December 31,
	2010				2009
	Carrying		Fair		Carrying		Fair
	Amount		Value		Amount		Value
	(Dollars in thousands)
Financial Assets
Cash and cash equivalents	$	52,218	$	52,218	$	24,428	$	24,428
Investment securities, available-for-sale		210,717		210,717		188,781		188,781
Investment securities, held-to-maturity		11,831		12,295		5,000		5,179
Federal Home Loan Bank stock		23,944		23,944		23,944		23,944
Loans receivable, net of allowance for loan losses		706,652		711,516		742,925		745,594
Loans held for sale		4,425		4,610		—		—
Accrued interest receivable		3,315		3,315		3,469		3,469
Total financial assets	$	1,013,102	$	1,018,615	$	988,547	$	991,395
Financial Liabilities
Deposits	$	929,856	$	930,809	$	849,758	$	850,894
Borrowed funds		64,199		67,111		111,808		113,379
Accrued interest payable		110		110		145		145
Total financial liabilities	$	994,165	$	998,030	$	961,711	$	964,418

The carrying amount is the estimated fair value for cash and cash equivalents, Federal Home Loan Bank stock, and accrued interest receivable and payable.  Investment securities fair values are based on quotes received from a third-party pricing source and discounted cash flow analysis models.  The fair values for variable-rate and fixed-rate loans are estimated using discounted cash flow analyses.  Cash flows are adjusted for estimated prepayments where appropriate and are discounted using interest rates currently being offered for loans with similar terms and collateral to borrowers of similar credit quality.  The fair values for loans held for sale are based on secondary market pricing quotes.

The fair value of checking, savings, and money market accounts is the amount payable on demand at the reporting date.  The fair value of fixed-maturity certificates of deposit is estimated by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities.  The fair value of borrowed funds is estimated based on rates currently available to the Company for debt with similar terms and remaining maturities.  The fair value of the Company’s off-

15

balance sheet instruments, including lending commitments, letters of credit, and credit enhancements, approximates their book value and is not included in the above table.

5. Share-Based Compensation

The Company accounts for its stock options in accordance with ASC 718-10, Compensation – Stock Based Compensation.  ASC 718-10 addresses all forms of share-based payment awards, including shares under employee stock purchase plans, stock options, restricted stock, and stock appreciation rights.  ASC 718-10 requires all share-based payments to be recognized as expense, based upon their fair values, in the financial statements over the service period of the awards.

For additional details on the Company’s share-based compensation plans and related disclosures, see Note 9 to the consolidated financial statements as presented in the Company’s 2009 Annual Report on Form 10-K.

Omnibus Equity Incentive Plan

The Company’s 2008 Omnibus Equity Incentive Plan (Equity Incentive Plan) authorized the issuance of 270,000 shares of its common stock.  In addition, there were 64,500 shares that had not yet been issued or were forfeited, cancelled, or unexercised at the end of the option term under the 2003 Stock Option Plan that are available for any type of stock-based awards in the future under the Equity Incentive Plan.  At September 30, 2010, 184,590 shares were available for future grants under the Equity Incentive Plan.

Restricted Stock

The following table presents the activity for restricted stock for the nine months ended September 30, 2010.

			Number of Shares			Weighted-Average Grant- Date Fair Value
Unvested at December 31, 2009				165,664		$	6.04
2010 awards:
Granted	120,392						3.62
Forfeited	(10,132	)					3.49
Net 2010 grant awards				110,260			3.63
Vested				(14,883	)		13.70
Forfeited				(73,014	)		3.56
Unvested at September 30, 2010				188,027		$	4.98

The compensation expense related to restricted stock for the three months ended September 30, 2010 and 2009 totaled $63,000 and $61,000, respectively.  The compensation expense for the nine months ended September 30, 2010 and 2009 totaled $181,000 and $173,000, respectively.  At September 30, 2010, the remaining unamortized cost of the restricted stock awards was reflected as a reduction in additional paid-in capital and totaled $937,000.  This cost is expected to be recognized over a weighted-average period of 3.0 years which is subject to the actual number of shares earned and vested.

16

Stock Options

The Company has stock option plans under which shares of Company common stock were reserved for the grant of both incentive and non-qualified stock options to directors, officers, and employees.  These plans were frozen in conjunction with the approval of the Equity Incentive Plan in 2003 and no new awards will be made under these plans.  The stock option vesting periods and exercise and expiration dates were determined by the Compensation Committee at the time of the grant.  The exercise price of the stock options is equal to the fair market value of the common stock on the grant date.

The following table presents the activity under the Company’s stock option plans for the nine months ended September 30, 2010.

	Number of Shares			Weighted-Average Exercise Price
Options outstanding at December 31, 2009		769,795		$	13.08
Granted		―			―
Exercised		―			―
Forfeited		(3,000	)		13.48
Expired unexercised		(114,800	)		11.00
Options outstanding at September 30, 2010		651,995		$	13.44
Options exercisable at September 30, 2010		651,995		$	13.44

For stock options outstanding at September 30, 2010, the range of exercise prices was $10.44 to $14.76 and the weighted-average remaining contractual term was 2.7 years.  At September 30, 2010, all of the Company’s outstanding stock options were out-of-the-money.  There were no stock options exercised during the nine months ended September 30, 2010 and 2009.  The Company reissues treasury shares to satisfy option exercises.

6. Other Comprehensive Income (Loss)

The related income tax effect and reclassification adjustments to the components of other comprehensive income (loss) for the periods indicated are as follows:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009
	(Dollars in thousands)
Unrealized holding gains (losses) arising during the period:
Unrealized net gains (losses)	$	513		$	(2,221	)	$	2,154		$	247
Related income tax benefit (expense)		(161	)		869			(729	)		(16	)
Net unrealized gains (losses)		352			(1,352	)		1,425			231
Less:  reclassification adjustment for net gains realized during the period:
Realized net gains		―			321			456			1,041
Related income tax expense		―			(109	)		(155	)		(374	)
Net realized gains		―			212			301			667
Change in other comprehensive income (loss)	$	352		$	(1,564	)	$	1,124		$	(436	)

17

7. Recent Accounting Pronouncements

In July 2010, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2010-20, Receivables (Topic 310):  Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.  ASU 2010-20 requires that more information be disclosed about the credit quality of a company’s loans and the allowance for loan losses held against those loans.  A company will need to disaggregate new and existing disclosure based on how it develops its allowance for loan losses and how it manages credit exposures.  Existing disclosures to be presented on a disaggregated basis include a rollforward of the allowance for loan losses, the related recorded investment in such loans, the nonaccrual status of loans, and impaired loans.   Additional disclosure is also required about the credit quality indicators of loans by class at the end of the reporting period, the aging of past due loans, information about troubled debt restructurings, and significant purchases and sales of loans during the reporting period by class.  For public companies, ASU 2010-20 requires certain disclosures as of the end of a reporting period effective for periods ending on or after December 15, 2010.  Other required disclosures about activity that occurs during a reporting period are e ffective for periods beginning on or after December 15, 2010.  The Company anticipates that adoption of these additional disclosures will not have a material effect on its financial position or results of operations.

In February 2010, the FASB issued ASU No. 2010-09, Subsequent Events (Topic 855):  Amendments to Certain Recognition and Disclosure Requirements.  The amendments remove the requirement for an SEC registrant to disclose the date through which subsequent events were evaluated as this requirement would have potentially conflicted with SEC reporting requirements.  Removal of the disclosure requirement did not have an affect on the nature or timing of subsequent events evaluations performed by the Company.  ASU 2010-09 became effective upon issuance.

In January 2010, the FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820):  Improving Disclosures about Fair Value Measurements.  ASU 2010-06 revises two disclosure requirements concerning fair value measurements and clarifies two others.  It requires separate presentation of significant transfers into and out of Levels 1 and 2 of the fair value hierarchy and disclosure of the reasons for such transfers.  It will also require the presentation of purchases, sales, issuances, and settlements within Level 3 on a gross basis rather than a net basis.  The amendments also clarify that disclosures should be disaggregated by class of asset or liability and that disclosures about inputs and valuation techniques should be provided for both recurring and non-recurring fair value measurements.  The Company’s disclosures about fair value measurements are presented in Note 4:  Fair Value Measurements.  These new disclosure requirements were effective for the period ended March 31, 2010, except for the requirement concerning gross presentation of Level 3 activity, which is effective for fiscal years beginning after December 15, 2010.  There was no significant effect to the Company’s financial statement disclosure upon adoption of this ASU.

In June 2009, the FASB issued ASU No. 2009-16, Transfers and Servicing (Topic 860):   Accounting for Transfers of Financial Assets which pertains to securitizations.  ASU 2009-16 requires more information about transfers of financial assets, including securitization transactions, and where entities have continued exposure to the risks related to transferred assets.  The Company adopted this ASU effective January 1, 2010 and adoption did not have a material effect on its financial position or results of operations.

18

In June 2009, the FASB issued ASU No. 2009-17, Consolidations (Topic 810):  Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities.  ASU 2009-17 replaces the quantitative-based risks and rewards calculation for determining which enterprise, if any, has a controlling financial interest in a variable interest entity with a qualitative approach focused on identifying which enterprise has the power to direct the activities of a variable interest entity.  The Company adopted this ASU effective January 1, 2010 and adoption did not have a material effect on its financial position or results of operations since the Company does not have any special purpose entities.

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

Cautionary Statement Regarding Forward Looking Statements

Certain statements contained in this Form 10-Q, in our other filings with the U.S. Securities and Exchange Commission (SEC), and in our press releases or other shareholder communications are forward-looking statements, as that term is defined in U.S. federal securities laws.  Generally, these statements relate to our business plans or strategies, projections involving anticipated revenues, earnings, profitability, or other aspects of operating results, or other future developments in our affairs or the industry in which we conduct business.  Forward-looking statements may be identified by reference to a future period or periods or by t he use of forward-looking terminology such as “anticipate,” “believe,” “expect,” “intend,” “plan,” “estimate,” “would be,” “will,” “intend to,” “project,”  or similar expressions or the negative thereof, as well as statements that include future events, tense or dates, or are not historical or current facts.

We wish to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made.  We also advise readers that various factors, including regional and national economic conditions, changes in levels of market interest rates, credit and other risks which are inherent in our lending and investment activities, legislative changes, changes in the cost of funds, demand for loan products and financial services, changes in accounting principles, ability to realize deferred tax assets, competitive and regulatory factors, and successful execution of our strategy and our Strategic Growth and Diversification Plan could affect our financial performance and could cause actual results for future periods to differ materially from those anticipated or projected.  For further discussion of risks and uncertainties that could cause actual results and events to differ materially from such forward-looking statements see “Part II. Item 1A.  Risk Factors” of this Form 10-Q as well as “Part I. Item 1A.  Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2009.  Such forward-looking statements are not guarantees of future performance.  We do not undertake, and specifically disclaim any obligation, to update any forward-looking statements to reflect occurrences or unanticipated events or circumstances after the date of such statements unless required to do so under the federal securities laws.

Critical Accounting Policies

Our condensed consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (GAAP), which require us to establish various accounting policies.  Certain of these accounting policies require us to make estimates, judgments, or assumptions that could have a material effect on the carrying value of certain assets and liabilities.  The estimates, judgments,

19

and assumptions we use are based on historical experience, projected results, internal cash flow modeling techniques, and other factors which we believe are reasonable under the circumstances.

Significant accounting policies are presented in “Note 1. Summary of Significant Accounting Policies” in the notes to our consolidated financial statements included in “Item 8. Financial Statements and Supplementary Data” of our Annual Report on Form 10-K.  These policies, along with the disclosures presented in other financial statement notes and in this management’s discussion and analysis, provide information on the methodology used for the valuation of significant assets and liabilities in our financial statements.  We view critical accounting policies to be those that are highly dependent on subjective or complex judgments, estimates, and assumptions, and where changes in those estimates and assumptions could have a significant impact on the financial statements.  W e currently view the determination of the allowance for loan losses, valuations and impairments of investment securities, and the accounting for income taxes to be critical accounting policies.

Allowance for loan losses.  We maintain our allowance for loan losses at a level we believe is appropriate to absorb credit losses inherent in our loan portfolio.  The allowance for loan losses represents our estimate of probable incurred losses in our loan portfolio at each statement of condition date and is based on our review of available and relevant information.

The first component of our allowance for loan losses contains allocations for probable incurred losses that we have identified relating to impaired loans pursuant to ASC 310-10, Receivables.  We individually evaluate for impairment all loans over $750,000 and classified substandard.  Loans are considered impaired when, based on current information and events, it is probable that the borrower will not be able to fulfill its obligation according to the contractual terms of the loan agreement.  The impairment loss, if any, is generally measured based on the present value of expected cash flows discounted at the loan’s effective interest rate.  As a practical expedient, impairment may b e measured based on the loan’s observable market price, or the fair value of the collateral, if the loan is collateral-dependent.  A loan is considered collateral-dependent when the repayment of the loan will be provided solely by the underlying collateral and there are no other available and reliable sources of repayment.  If we determine a loan is collateral-dependent, we will charge-off any identified collateral short fall against the allowance for loan losses.

If foreclosure is probable, we are required to measure the impairment based on the fair value of the collateral.  The fair value of the collateral is generally obtained from appraisals or estimated using an appraisal-like methodology.  When current appraisals are not available, management estimates the fair value of the collateral giving consideration to several factors including the price at which individual unit(s) could be sold in the current market, the period of time over which the unit(s) could be sold, the estimated cost to complete the unit(s), the risks associated with completing and selling the unit(s), the required return on the investment a potential acquirer may have, and the current market interest rates.  The analysis of each loan involves a high degree of judgment in estimating the am ount of the loss associated with the loan, including the estimation of the amount and timing of future cash flows and collateral values.

The second component of our allowance for loan losses contains allocations for probable incurred losses within various pools of loans with similar characteristics pursuant to ASC 450-10, Contingencies.  This component is based in part on certain loss factors applied to various stratified loan pools excluding loans evaluated individually for impairment.  In determining the appropriate loss factors

20

for these loan pools, we consider historical charge-offs and recoveries; levels of and trends in delinquencies, impaired loans, and other classified loans; concentrations of credit within the commercial loan portfolios; volume and type of lending; and current and anticipated economic conditions.

Loan losses are charged off against the allowance when the loan balance or a portion of the loan balance is no longer covered by the paying capacity of the borrower based on an evaluation of available cash resources and collateral value, while recoveries of amounts previously charged off are credited to the allowance.  We assess the adequacy of the allowance for loan losses on a quarterly basis and adjust the allowance for loan losses by recording a provision for loan losses in an amount sufficient to maintain the allowance at a level we deem appropriate.  Our evaluation of the adequacy of the allowance for loan losses is inherently subjective as it requires estimates that are susceptible to significant revision as additional information becomes available or as future events occur.  To the extent tha t actual outcomes differ from our estimates, an additional provision for loan losses could be required which could adversely affect earnings or our financial position in future periods.  The Office of Thrift Supervision (OTS) could require us to make additional provisions for loan losses.

Investment Securities.  Under ASC 320-10, Investments – Debt and Equity Securities, investment securities must be classified as held-to-maturity, available-for-sale, or trading.  We determine the appropriate classification at the time of purchase.  The classification of investment securities is significant since it directly impacts the accounting for unrealized gains and losses on investment securities.  Debt investment securities are classified as held-to-maturity and carried at amortized cost when we have the positive i ntent and we have the ability to hold the investment securities to maturity.  Investment securities not classified as held-to-maturity are classified as available-for-sale and are carried at fair value, with the unrealized holding gains and losses, net of tax, reported in other comprehensive income and do not affect earnings until realized.

The fair values of our investment securities are generally determined by reference to quoted prices from reliable independent sources utilizing observable inputs.  Certain of the fair values of investment securities are determined using models whose significant value drivers or assumptions are unobservable and are significant to the fair value of the investment securities.  These models are utilized when quoted prices are not available for certain investment securities or in markets where trading activity has slowed or ceased.  When quoted prices are not available and are not provided by third-party pricing services, our judgment is necessary to determine fair value.  As such, fair value is determined by using discounted cash flow analysis models, incorporating default rates, estimation of prepayment characteristics, and implied volatilities.

We evaluate all investment securities on a quarterly basis, and more frequently when economic conditions warrant additional evaluations, for determining if an other-than-temporary impairment (OTTI) exists pursuant to guidelines established in ASC 320-10, Investments – Debt and Equity Securities.  In evaluating the possible impairment of investment securities, consideration is given to many factors including the length of time and the extent to which the fair value has been less than cost, whether the market decline was affected by macroeconomic conditions, the financial conditions and near-term prospects of th e issuer, and our ability and intent to retain our 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, we may consider whether the investment securities are issued by the federal government or its agencies or government sponsored agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer’s financial condition.  The assessment of

21

whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.

If we determine that an investment experienced an OTTI, we must then determine the amount of the OTTI to be recognized in earnings.  If we do not intend to sell the security and it is more likely than not that we will not be required to sell the security before recovery of its amortized cost basis less any current period loss, the OTTI will be separated into the amount representing the credit loss and the amount related to all other factors.  The amount of the OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings.  The amount of the OTTI related to other factors will be recognized in other comprehensive income, net of applicable taxes.  The previous amortized cost basis less the OTTI recognized in earnin gs will become the new amortized cost basis of the investment.  If we intend to sell the security or it is more likely than not we will be required to sell the security before recovery of its amortized cost basis less any current period credit loss, the OTTI will be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date.  Any recoveries related to the value of these investment securities are recorded as an unrealized gain (as other comprehensive income (loss) in shareholders’ equity) and not recognized in income until the security is ultimately sold.  From time to time we may dispose of an impaired security in response to asset/liability management decisions, future market movements, business plan changes, or if the net proceeds can be reinvested at a rate of return that is expected to recover the loss within a reasonable period of time.

Income Tax Accounting.  We file a consolidated federal income tax return.  The provision for income taxes is based upon income in our consolidated financial statements, rather than amounts reported on our income tax return.  Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.  Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recove red or settled.  The effect of a change in tax rates on our deferred tax assets and liabilities is recognized as income or expense in the period that includes the enactment date.

Under GAAP, a valuation allowance is required to be recognized if it is more likely than not that a deferred tax asset will not be realized.  The determination of the realizability of the deferred tax assets is highly subjective and dependent upon judgment concerning our evaluation of both positive and negative evidence, our forecasts of future income, applicable tax planning strategies, and assessments of current and future economic and business conditions.  Positive evidence includes the existence of taxes paid in available carryback years as well as the probability that taxable income will be generated in future periods, while negative evidence includes any cumulative losses in the current year and prior two years and general business and economic trends.  At September 30, 2010, we conducted an ex tensive analysis to determine if a valuation allowance was required and concluded that a valuation allowance was not necessary, largely based on our projections of future taxable income and available tax planning strategies.  Additional positive evidence considered in our analysis was our long-term history of generating taxable income, including four straight quarters of taxable income at September 30, 2010; the industry in which we operate is cyclical in nature, as a result, recent losses are not expected to have a significant long-term impact on our profitability; the fact that recent losses were partly attributable to syndicated/participation lending which we stopped investing in during 2007; our history of fully realizing net operating losses, most recently a federal net operating loss from a $45.0 million taxable loss in 2004; and the relatively long remaining tax loss carryforward periods (nineteen years for federal

22

income tax purposes, ten years for the state of Indiana, and eight years for the state of Illinois).  We concluded that the aforementioned positive evidence outweighs the negative evidence of cumulative losses over the past three years.  Any reduction in estimated future taxable income may require us to record a valuation allowance against our deferred tax assets.  Any required valuation allowance would result in additional income tax expense in the period and could have a significant impact on our future earnings.

Positions taken in our tax returns may be subject to challenge by the taxing authorities upon examination.  The benefit of an uncertain tax position is initially recognized in the financial statements only when it is more likely than not the position will be sustained upon examination by the tax authorities.  Such tax positions are both initially and subsequently measured as the largest amount of tax benefit that is greater than 50% likely of being realized upon settlement with the tax authority, assuming full knowledge of the position and all relevant facts.  Differences between our position and the position of tax authorities could result in a reduction of a tax benefit or an increase to a tax liability, which could adversely affect our future income tax expense.

We believe our tax policies and practices are critical accounting policies because the determination of our tax provision and current and deferred tax assets and liabilities have a material impact on our net income and the carrying value of our assets.  We believe our tax liabilities and assets are adequate and are properly recorded in the condensed consolidated financial statements at September 30, 2010.

Results of Operations for the Three and Nine Months Ended September 30, 2010 and 2009

Performance Overview

The following table provides selected financial information and performance information for the three months and nine months ended September 30, 2010 and September 30, 2009.

	Three Months Ended September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009
	(Dollars in thousands)
Net income (loss)	$	863		$	(4,671	)	$	2,542		$	(2,540	)
Diluted earnings (loss) per share		.08			(.44	)		.24			(.24	)
Pre-tax, pre-provision earnings from core operations (1)		2,297			3,075			7,982			8,010
Return on average assets (2)		.31	%		(1.70	)%		.31	%		(.31	)%
Return on average equity (2)		3.03			(16.06	)		3.03			(3.00	)
Average interest-earning assets	$	997,279		$	996,382		$	989,290		$	1,013,786
Net interest income		8,886			9,396			27,658			27,906
Net interest margin		3.54	%		3.74	%		3.74	%		3.68	%
Non-interest income	$	2,136		$	2,600		$	6,932		$	7,676
Non-interest expense		9,446			10,248			28,521			29,619
Efficiency ratio (3)		85.72	%		87.66	%		83.59	%		85.70	%
(1) See “Non-GAAP Financial Information” on page 26.
(2) Annualized.
(3) The efficiency ratio is calculated by dividing non-interest expense by the sum of net interest income and non-interest income, excluding net gain on sales of investment securities and other assets.

23

	September 30, 2010			December 31, 2009			September 30, 2009
Book value per share	$	10.49		$	10.25		$	10.16
Shareholders’ equity to total assets		10.17	%		10.21	%		10.15	%
Tangible capital ratio (Bank only)		8.91			8.88			8.63
Core capital ratio (Bank only)		8.91			8.88			8.63
Risk based capital ratio (Bank only)		13.21			12.35			11.91

The following discussion and analysis presents the more significant factors affecting our financial condition as of September 30, 2010 and results of operations for the three and nine months ended September 30, 2010.  This discussion and analysis should be read in conjunction with our condensed consolidated financial statements and notes thereto included in this report.

During the third quarter of 2010, we recorded net income of $863,000, or $.08 per diluted share, which represents our fourth consecutive quarter of positive earnings.  We continue to see progress in our core banking operations as a result of our Strategic Growth and Diversification Plan and we are making progress in our business units in executing our strategy.

Improving credit quality remains our number one priority in 2010.  Our loan portfolio mix is improving as the higher risk, targeted contraction portfolios of commercial construction and land development and non-owner occupied commercial real estate loans continue to decrease as a percentage of the commercial portfolio.  We reduced our participations purchased loan exposure during the quarter by $20.3 million to $26.5 million at September 30, 2010 through paydowns totaling $7.9 million and transfers to other real estate owned of $12.3 million.

Our non-performing loans decreased to $56.1 million at September 30, 2010 from $59.0 million at December 31, 2009.  Non-performing loans during the third quarter were positively affected by the above mentioned paydowns and transfers to other real estate owned.  Offsetting these decreases was the transfer to non-accrual of several loans totaling $16.4 million during the third quarter, including two troubled debt restructurings of non-owner occupied commercial real estate loans aggregating $10.1 million that contained modest concessions and are performing in accordance with their agreements.  We anticipate that credit quality-costs, including the provision for loan losses and other real estate owned related costs, will continue to affect reported earnings as we diligently work to reduce non-performing assets.

Our net interest margin for the third quarter of 2010 decreased 20 basis points to 3.54% from 3.74% for the third quarter of 2009.  The net interest margin for the third quarter of 2010 was negatively impacted by lower yields on loans receivable and investment securities, as well as the Bank having higher levels of liquidity due to a combination of strong deposit growth and loan portfolio shrinkage.  The yield on loans receivable declined due to several large loan payoffs during 2010 along with the reduction in interest income related to new non-accrual loans.  The yield on investment securities declined due to reinvesting proceeds from maturing investment securities and loan payoffs in lower yielding inves tments as market interest rates declined significantly to new lows.  The decrease in earning asset yields was partially offset by a 5 basis point decrease in the cost of interest bearing deposits.

We continue to have success in growing core deposits through many channels including enhancing our brand recognition within our communities, offering attractive deposit products, bringing in new client relationships by meeting all of their banking needs, and holding our experienced sales team accountable for growing deposits and relationships.  We increased our core deposits, excluding

24

municipal core deposits, at September 30, 2010 by $39.1 million, or 8.8%, from December 31, 2009 and by $44.0 million, or 10.0%, from September 30, 2009.  The increase in core deposits has strengthened our balance sheet and enhanced our liquidity by allowing us to pay maturing Federal Home Loan Bank (FHLB) borrowed funds during the year.

Our tangible, core, and risk-based capital ratios exceeded “minimum” and “well capitalized” for regulatory capital requirements.  Our tangible common equity at September 30, 2010 was $113.9 million, or 10.17% of tangible assets compared to $110.4 million, or 10.21% of tangible assets, at December 31, 2009.

Progress on Strategic Growth and Diversification Plan

The Company’s Strategic Growth and Diversification Plan is built around four core objectives: decreasing non-performing loans; ensuring costs are appropriate given the Company’s targeted future asset base; growing while diversifying by targeting small and mid-sized business owners for relationship-based banking opportunities; and expanding and deepening the Company’s relationships with its clients by meeting a higher percentage of their financial service needs.

The Company employs a dual strategy in managing its loan portfolio.  The Company continues to focus its efforts on reducing non-performing loans, seeking to either restructure specific non-performing credits or foreclose, obtain title, and transfer the loan to other real estate owned where we can take control of and liquidate the underlying collateral.  For new loan originations, the Company continues to be conservative in its underwriting criteria, resulting in a higher quality loan origination process.  The Company’s ratio of non-performing loans to total loans remained stable compared to December 31, 2009 with loan paydowns and transfers to other real estate owned being offset with new non-accrual loans.

The Company remains strongly focused on its cost structure.  Non-interest expense for the current quarter compared to the second quarter of 2010 decreased $157,000, or 1.6%, and $802,000, or 7.8%, compared to the prior year quarter.  Non-interest expense for the nine months ended September 30, 2010 compared to the prior year period decreased $1.1 million, or 3.7%.

Efforts to grow while diversifying and to expand and deepen client relationships continue but remain constrained by current economic conditions.  The Company has succeeded in increasing targeted growth segments in its portfolio, including commercial and industrial, commercial real estate – owner occupied, and multifamily, to comprise 49.6% of the commercial loan portfolio at September 30, 2010, up from 46.8%, 39.4%, and 35.6% at December 31, 2009, 2008, and 2007, respectively.  The Company expects to benefit further from this diversification effort once business owners resume borrowing and their line of credit usage moves higher.  The Company’s focus on deepening relationships has emphasized core deposit and relationship-oriented time deposit growth which has resulted in an $80.1 million, or a 9.4%, increase in deposits since December 31, 2009.

Pre-tax, Pre-Provision Earnings from Core Operations

Our pre-tax, pre-provision earnings from core operations totaled $2.3 million for the third quarter of 2010 compared to $3.1 million for the third quarter of 2009.  The current low interest rate environment, relatively flat yield curve, and level of non-performing assets reduced our net interest

25

income during the current quarter.  In addition, lower service charges and other fees due to recent regulatory changes also impacted earnings for the quarter.

For the nine months ended September 30, 2010, pre-tax, pre-provision earnings from core operations was stable at $8.0 million when compared to the nine months ended September 30, 2009.  The current quarter period included lower compensation and employee benefits expense, net occupancy expense, and marketing expense, partially offset by an increase in professional fees related to the proxy contest and moderately lower levels of net interest income and fee related non-interest income.

Non-GAAP Financial Information

The following table reconciles income  (loss) before income taxes in accordance with U.S. generally accepted accounting principles (GAAP) to the non-GAAP measurement of pre-tax, pre-provision earnings from core operations.

	Three Months Ended September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009
	(Dollars in thousands)
Income (loss) before income taxes	$	1,051		$	(7,682	)	$	3,017		$	(4,804	)
Provision for loan losses		525			9,430			3,052			10,767
Pre-tax, pre-provision earnings		1,576			1,748			6,069			5,963
Add back (subtract):
Net gain on sale of investment securities		―			(321	)		(456	)		(1,041	)
Net (gain) loss on sale of other assets		(2	)		15			(14	)		21
OREO related expense		479			1,343			1,377			1,754
Loan collection expense		156			290			478			818
Severance and early retirement expense		88			―			528			―
FDIC special insurance premium assessment		―			―			―			495
Pre-tax, pre-provision earnings from core operations	$	2,297		$	3,075		$	7,982		$	8,010
Pre-tax, pre-provision earnings from core operations to average assets		.82	%		1.12	%		.97	%		.97	%

The Company’s accounting and reporting policies conform to U.S. generally accepted accounting principles (GAAP) and general practice within the banking industry.  Management uses certain non-GAAP financial measures to evaluate the Company’s financial performance and has provided the non-GAAP financial measures of pre-tax, pre-provision earnings from core operations and pre-tax, pre-provision earnings from core operations to average assets.  In these non-GAAP financial measures, the provision for loan losses, OREO related expense, loan collection expense, and certain other items, such as gains and losses on sales of investment securities and other assets, severance and early retirement expense, and FDIC special insurance premium assessment, are excluded from t he determination of core operating results.  Management believes that these measures are useful because they provide a more comparable basis for evaluating financial performance from core operations period to period and allows management and others to assess the Company’s ability to generate earnings to cover credit costs.  Although these non-GAAP financial measures are intended to enhance investors understanding of the Company’s business performance, these should not be considered as an alternative to GAAP.

26

The risks associated with utilizing operating measures (such as the pre-tax, pre-provision earnings from core operations) are that various persons might disagree as to the appropriateness of items included or excluded in these measures and that other companies might calculate these measures differently.  Management compensates for these limitations by providing detailed reconciliations between GAAP information and our pre-tax, pre-provision earnings from core operations as noted above; however, these disclosures should not be considered an alternative to GAAP.

Average Balances/Rates

The following tables reflect the average yield on assets and average cost of liabilities for the periods indicated.  Average balances are derived from average daily balances.

	Three Months Ended September 30,
	2010							2009
	Average Balance		Interest		Average Yield/Cost			Average Balance		Interest		Average Yield/Cost
	(Dollars in thousands)
Interest-earning assets:
Loans receivable (1)	$	744,316	$	9,199		4.90	%	$	747,828	$	9,648		5.12	%
Investment securities (2)		216,393		2,176		3.93			222,025		2,742		4.83
Other interest-earning assets (3)		36,570		90		0.98			26,529		195		2.92
Total interest-earning assets		997,279		11,465		4.56			996,382		12,585		5.01
Non-interest earning assets		114,363							92,728
Total assets	$	1,111,642						$	1,089,110
Interest bearing liabilities:
Deposits:
Checking accounts	$	145,471		120		0.33		$	133,719		74		0.22
Money market accounts		159,445		245		0.61			154,347		263		0.68
Savings accounts		120,486		80		0.26			118,134		98		0.33
Certificates of deposit		404,586		1,698		1.67			364,876		1,996		2.17
Total deposits		829,988		2,143		1.02			771,076		2,431		1.25
Borrowed funds:
Other short-term borrowed funds (4)		14,122		19		0.53			11,969		24		0.80
FHLB borrowed funds		55,572		417		2.94			104,253		734		2.76
Total borrowed funds		69,694		436		2.45			116,222		758		2.55
Total interest bearing liabilities		899,682		2,579		1.14			887,298		3,189		1.43
Non-interest bearing deposits		87,654							69,341
Non-interest bearing other liabilities		11,161							17,060
Total liabilities		998,497							973,699
Shareholders’ equity		113,145							115,411
Total liabilities and shareholders’ equity	$	1,111,642						$	1,089,110
Net interest-earning assets	$	97,597						$	109,084
Net interest income / interest rate spread			$	8,886		3.42	%			$	9,396		3.58	%
Net interest margin						3.54	%						3.74	%
Ratio of average interest-earning assets to average interest bearing liabilities						110.85	%						112.29	%

(1) Loans receivable include non-performing loans, interest on which is recognized on a cash basis.

(2) Investment securities are based on amortized cost.

(3) Includes FHLB stock, money market accounts, federal funds sold, and interest-earning bank deposits.

(4) Includes federal funds purchased, overnight borrowed funds from the Federal Reserve Bank

discount window, and repurchase agreements (Repo Sweeps).

27

	Nine Months Ended September 30,
	2010							2009
	Average Balance		Interest		Average Yield/Cost			Average Balance		Interest		Average Yield/Cost
	(Dollars in thousands)
Interest-earning assets:
Loans receivable (1)	$	754,145	$	28,503		5.05	%	$	750,930	$	29,400		5.23	%
Investment securities (2)		204,392		6,552		4.23			232,953		8,805		4.98
Other interest-earning assets (3)		30,753		337		1.47			29,903		575		2.57
Total interest-earning assets		989,290		35,392		4.78			1,013,786		38,780		5.11
Non-interest earning assets		105,755							87,242
Total assets	$	1,095,045						$	1,101,028
Interest bearing liabilities:
Deposits:
Checking accounts	$	144,661		240		0.22		$	127,032		281		0.30
Money market accounts		149,519		750		0.67			158,125		881		0.74
Savings accounts		118,243		273		0.31			118,216		304		0.34
Certificates of deposit		389,824		5,079		1.74			367,274		6,810		2.48
Total deposits		802,247		6,342		1.06			770,647		8,276		1.44
Borrowed funds:
Other short-term borrowed funds (4)		14,823		56		0.51			13,412		77		0.77
FHLB borrowed funds		65,190		1,336		2.70			122,727		2,521		2.71
Total borrowed funds		80,013		1,392		2.29			136,139		2,598		2.52
Total interest bearing liabilities		882,260		7,734		1.17			906,786		10,874		1.60
Non-interest bearing deposits		90,041							65,919
Non-interest bearing other liabilities		10,683							15,168
Total liabilities		982,984							987,873
Shareholders’ equity		112,061							113,155
Total liabilities and shareholders’ equity	$	1,095,045						$	1,101,028
Net interest-earning assets	$	107,030						$	107,000
Net interest income / interest rate spread			$	27,658		3.61	%			$	27,906		3.51	%
Net interest margin						3.74	%						3.68	%
Ratio of average interest-earning assets to     average interest bearing liabilities						112.13	%						111.80	%

(1) Loans receivable include non-performing loans, interest on which is recognized on a cash basis.

(2) Investment securities are based on amortized cost.

(3) Includes FHLB stock, money market accounts, federal funds sold, and interest-earning bank deposits.

(4) Includes federal funds purchased, overnight borrowed funds from the Federal Reserve Bank

discount window, and Repo Sweeps.

28

Rate / Volume Analysis of Net Interest Income

The following table shows the impact of changes in the volume of interest-earning assets and interest bearing liabilities and changes in interest rates on our interest income and interest expense for the periods indicated.  Changes attributable to the combined impact of rate and volume have been allocated proportional to the changes due to rate and changes due to volume.

	September 30, 2010 compared to September 30, 2009
	Three Months Ended									Nine Months Ended
	Increase (decrease) due to
	Rate			Volume			Total Change			Rate			Volume			Total Change
	(Dollars in thousands)
Interest income:
Loans receivable	$	(404	)	$	(45	)	$	(449	)	$	(1,023	)	$	125		$	(897	)
Investment securities		(498	)		(68	)		(566	)		(1,246	)		(1,007	)		(2,253	)
Other interest-earning assets		(161	)		56			(105	)		(254	)		16			(238	)
Total		(1,063	)		(57	)		(1,120	)		(2,523	)		(866	)		(3,388	)
Interest expense:
Deposits:
Checking accounts		39			7			46			(76	)		35			(41	)
Money market accounts		(27	)		9			(18	)		(85	)		(46	)		(131	)
Savings accounts		(20	)		2			(18	)		(31	)		–			(31	)
Certificates of deposit		(499	)		201			(298	)		(2,128	)		397			(1,731	)
Total deposits		(507	)		219			(288	)		(2,320	)		386			(1,934	)
Borrowed funds:
Other short-term borrowed funds		(9	)		4			(5	)		(28	)		7			(21	)
FHLB borrowed funds		46			(363	)		(317	)		(6	)		(1,179	)		(1,185	)
Total borrowed funds		37			(359	)		(322	)		(34	)		(1,172	)		(1,206	)
Total		(470	)		(140	)		(610	)		(2,354	)		(786	)		(3,140	)
Net change in net interest income	$	(593	)	$	83		$	(510	)	$	(169	)	$	(80	)	$	(248	)

Net Interest Income and Net Interest Margin

Net Interest Margin.Thenet interest margin for the third quarter of 2010 was 3.54% compared to 3.74% for the prior year quarter.  The net interest margin increased six basis points to 3.74% for the year to date period ended September 30, 2010 compared to 3.68% for the prior year period.  Net interest income was $8.9 million for the third quarter of 2010 compared to $9.4 million for the comparable 2009 period.  The net interest margin was negatively impacted d uring 2010 by lower yields on loans receivable and investment securities, as well as the Bank having higher levels of liquidity due to a combination of strong deposit growth and loan portfolio shrinkage.

Interest Income.  Interest income decreased 8.9% to $11.5 million for the third quarter of 2010 compared to $12.6 million for the prior year quarter.  For the year to date period ended September 30, 2010, interest income decreased 8.7% to $35.4 million from $38.8 million for the prior year period.  The decrease was primarily due to lower average balances of investment securities and the current lower interest rate environment which reduced the yields on loans receivable and investment securities.  The yield on loans receivable decreased due to several large payoffs and a reduction in interest income relate d to new non-accrual loans.  The yield on investment securities declined due to reinvesting maturing investment securities and loan payoff proceeds in lower yielding investments as market interest rates declined significantly to new lows.  In addition, the Bank is currently holding higher levels

29

of short-term liquid investments due to the lack of desirable investment alternatives in the current interest rate environment.

Interest Expense.  Interest expense decreased 19.1% to $2.6 million for the third quarter of 2010 compared to $3.2 million for the prior year quarter.  For the year to date period ended September 30, 2010, interest expense decreased 28.9% to $7.7 million from $10.9 million for prior year period.  Interest expense was positively affected by continued lower market interest rates during 2010 and decreases in the average balance of borrowed funds.

Interest expense on deposits decreased 11.8% and 23.4% to $2.1 million and $6.3 million, respectively, for the third quarter and year to date period ended September 30, 2010 from $2.4 million and $8.3 million, respectively, for the prior year periods.  The weighted-average cost of deposits decreased 23 and 38 basis points from the prior year periods, respectively, as a result of disciplined pricing on deposits, the repricing of certificates of deposit at lower interest rates, and increases in the average balance of non-interest bearing deposits, which was partially offset by increases in the average balance of interest bearing deposits.

Interest expense on borrowed funds decreased 42.5% and 46.4% to $436,000 and $1.4 million, respectively, for the third quarter and year to date period ended September 30, 2010 from $758,000 and $2.6 million, respectively, for the prior year periods.  The decrease was primarily due to a reduction in the average balance of borrowed funds of 40.0% and 41.2%, respectively, during the 2010 periods compared to the prior year periods as we continue to strengthen our balance sheet and enhance our liquidity position by replacing this funding source with core deposits.  The weighted-average cost of borrowed funds decreased 10 and 23 basis points for the 2010 periods, respectively, as a result of downward repricing due to lower market interest rates.

Provision for loan losses

The Company’s provision for loan losses was $525,000 for the third quarter of 2010 compared to $9.4 million for the prior year quarter.  The Company’s provision for loan losses was $3.1 million compared to $10.8 million, respectively, for the year to date periods ended September 30, 2010 and 2009.  For more information, see “Changes in Financial Condition – Allowance for Loan Losses” below in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

30

Non-interest income

The following tables identify the changes in non-interest income for the periods presented:

	Three Months Ended September 30,
	2010		2009			$ Change			% Change
	(Dollars in thousands)
Service charges and other fees	$	1,290	$	1,479		$	(189	)		(12.8	)%
Card-based fees		475		429			46			10.7
Commission income		40		56			(16	)		(28.6	)
Subtotal fee based revenues		1,805		1,964			(159	)		(8.1	)
Income from bank-owned life insurance		217		218			(1	)		(0.5	)
Other income		112		112			―			―
Subtotal		2,134		2,294			(160	)		(7.0	)
Net gain on sale of investment securities		―		321			(321	)		(100.0	)
Net gain (loss) on sale of other assets		2		(15	)		17		NM
Total non-interest income	$	2,136	$	2,600		$	(464	)		(17.8	)%

	Nine Months Ended September 30,
	2010		2009			$ Change			% Change
	(Dollars in thousands)
Service charges and other fees	$	3,830	$	4,154		$	(324	)		(7.8	)%
Card-based fees		1,398		1,249			149			11.9
Commission income		140		197			(57	)		(28.9	)
Subtotal fee based revenues		5,368		5,600			(232	)		(4.1	)
Income from bank-owned life insurance		702		552			150			27.2
Other income		392		504			(112	)		(22.2	)
Subtotal		6,462		6,656			(194	)		(2.9	)
Net gain on sale of investment securities		456		1,041			(585	)		(56.2	)
Net gain (loss) on sale of other assets		14		(21	)		35		NM
Total non-interest income	$	6,932	$	7,676		$	(744	)		(9.7	)%

Service charges and other fees decreased during the 2010 periods from the comparable 2009 periods from lower volume of non-sufficient funds transactions which is an industry trend that is expected to continue, if not accelerate, due to the recent regulatory changes affecting deposit account  overdraft activity.  Service charges and other fees were also impacted by lower fee income from letters of credit and credit enhancements related to non-owner occupied commercial real estate lending as we strategically reduce our exposure to these types of credits.  Income from bank-owned life insurance increased during the year to date period as a result of re positioning the underlying investment portfolio in the fourth quarter of 2009 into higher yielding assets and the reduction in the face amount of insurance coverage during the first quarter of 2010.  For information related to net gains on sale of investment securities, see “Changes in Financial Condition – Investment Securities” below in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

31

Non-interest expense

The following tables identify changes in our non-interest expense for the periods presented:

	Three Months Ended September 30,
	2010		2009		$ Change			% Change
	(Dollars in thousands)
Compensation and mandatory benefits	$	4,239	$	3,650	$	589			16.1	%
Retirement and stock related compensation		176		372		(196	)		(52.7	)
Medical and life benefits		285		475		(190	)		(40.0	)
Other employee benefits		9		8		1			12.5
Subtotal compensation and employee benefits		4,709		4,505		204			4.5
Net occupancy expense		691		763		(72	)		(9.4	)
FDIC insurance premiums and OTS assessments		623		574		49			8.5
Professional fees		512		662		(150	)		(22.7	)
Furniture and equipment expense		488		526		(38	)		(7.2	)
Data processing		443		407		36			8.8
Marketing		189		155		34			21.9
OREO related expense		479		1,343		(864	)		(64.3	)
Loan collection expense		156		290		(134	)		(46.2	)
Severance and early retirement expense		88		―		88			N/A
Other general and administrative expense		1,068		1,023		45			4.4
Total non-interest expense	$	9,446	$	10,248	$	(802	)		(7.8	)%

	Nine Months Ended September 30,
	2010		2009		$ Change			% Change
	(Dollars in thousands)
Compensation and mandatory benefits	$	12,414	$	12,288	$	126			1.0	%
Retirement and stock related compensation		565		1,373		(808	)		(58.8	)
Medical and life benefits		910		1,055		(145	)		(13.7	)
Other employee benefits		39		42		(3	)		(7.1	)
Subtotal compensation and employee benefits		13,928		14,758		(830	)		(5.6	)
Net occupancy expense		2,097		2,410		(313	)		(13.0	)
FDIC insurance premiums and OTS assessments		1,891		1,540		351			22.8
Professional fees		1,850		1,433		417			29.1
Furniture and equipment expense		1,547		1,581		(34	)		(2.2	)
Data processing		1,316		1,246		70			5.6
Marketing		519		571		(52	)		(9.1	)
OREO related expense		1,377		1,754		(377	)		(21.5	)
Loan collection expense		478		818		(340	)		(41.6	)
Severance and early retirement expense		528		―		528			N/A
FDIC special insurance premium assessment		―		495		(495	)		N/A
Other general and administrative expense		2,990		3,013		(23	)		(.8	)
Total non-interest expense	$	28,521	$	29,619	$	(1,098	)		(3.7	)%

Compensation and mandatory benefits expense increased $589,000 and $126,000, respectively, for the three and nine month 2010 periods compared to the 2009 periods.  The increase during the third quarter of 2010 was primarily due to a reduction of $600,000 during the third quarter of 2009 in incentive compensation accruals due to the large net loss recorded in the third quarter of 2009.  The increase during the 2010 year to date period was related to the incentive compensation accrual reduction and was partially offset by a decrease in compensation expense of $232,000 from the 2009 period due to the lower number of full-time equivalent employees during 2010 co mpared to 2009.

32

Retirement plan expense was lower for the three and nine month 2010 periods due to reductions of $180,000 and $540,000, respectively, in pension expense as the required annual contribution is being funded by an available carryover balance thus reducing our current expense.  In addition, retirement and stock related compensation expense for the nine month 2010 period decreased due to the absence of $235,000 of expense related to our Employee Stock Ownership Plan (ESOP) expense since the ESOP loan was repaid in full during the first quarter of 2009.

Net occupancy expense decreased $72,000 and $313,000 for the three and nine month 2010 periods due to the relocation of our operations center from a leased facility to existing facilities coupled with decreases in office and building maintenance expense.

Our FDIC insurance premiums and OTS assessments increased $49,000 and $351,000 during the three and nine month 2010 periods due to increases in the average balance of deposits from the 2009 periods and the adoption of the FDIC’s Restoration Plan during 2009 which resulted in industry-wide rate increases effective April 1, 2009.

Professional fees decreased $150,000 for the three month 2010 period due to the absence of fees incurred during the third quarter of 2009 related to a shareholder derivative demand made earlier that year.  Professional fees increased $417,000 for the nine month 2010 period as a result of the SEC’s new proxy statement disclosures effective in 2010, the Board of Directors’ review of strategic alternatives, and costs associated with the current year proxy contest and the annual meeting.

Costs related to other real estate owned properties decreased $864,000 and $377,000, respectively, during the three and nine month 2010 periods primarily due to decreased valuation allowances combined with decreases in required expenses on these properties when compared to the 2009 periods.

Loan collection expense decreased $134,000 and $340,000, respectively, for the three and nine month 2010 periods as our balance of non-accrual loans begins to moderate.  These expenses will fluctuate depending on the activity and costs related to collecting and protecting our interests in our non-performing loans.

The aggregate severance and early retirement expense of $528,000 incurred during the nine months ended September 30, 2010, reflects $437,000 from the second quarter, a substantial portion of which related to the separation of the Company’s former chief financial officer during the second quarter of 2010, and amounts incurred during the third quarter, including amounts payable to the daughter of the Company’s Chairman and Chief Executive Officer, in connection with her agreed separation of employment and agreement to forego certain bonus and equity-based compensation, refrain from certain competitive activities, and release claims.

The efficiency ratio improved for both the three and nine month 2010 periods from the prior year periods primarily due to our successful cost control initiatives which resulted in decreases in almost all operating expense categories including compensation and employee benefits, credit related costs, and the absence of the prior year FDIC special insurance premium assessment.  These expense reductions were partially offset by severance and early retirement costs and higher professional fees during the nine month period related to certain corporate matters including the current year’s proxy contest.

33

Income Tax Expense

Income tax expense totaled $188,000 for the third quarter of 2010 compared to an income tax benefit of $3.0 million for the comparable 2009 period.  Income tax expense for the nine months ended September 30, 2010 was $475,000 compared to an income tax benefit of $2.3 million for the comparable 2009 period.  Our effective income tax rates for the three and nine month periods ended September 30, 2010 were 17.9% and 15.7%, respectively.  Our effective income tax benefit rates for the comparable 2009 periods were 39.2% and 47.1%, respectively.

Changes in Financial Condition

Our total assets at September 30, 2010 increased $38.0 million, or 3.5%, from $1.08 billion at December 31, 2009, primarily in investment securities and cash and cash equivalents as a result of growth in total deposits and a reduction in total loan balances.

	September 30, 2010		December 31, 2009		$ Change			% Change
	(Dollars in thousands)
Assets:
Cash and cash equivalents	$	52,218	$	24,428	$	27,790			113.8	%
Investment securities available-for-sale		210,717		188,781		21,936			11.6
Investment securities held-to-maturity		11,831		5,000		6,831			136.6
Investment in FHLB stock		23,944		23,944		―			―
Loans receivable, net		706,652		742,925		(36,273	)		(4.9	)
Mortgage loans held for sale		4,425		—		4,425		NM
Bank-owned life insurance		35,273		34,575		698			2.0
Other real estate owned		24,211		9,242		14,969			162.0
Other		50,208		52,620		(2,412	)		(4.6	)
Total assets	$	1,119,479	$	1,081,515	$	37,964			3.5	%
Liabilities and Equity:
Deposits	$	929,856	$	849,758	$	80,098			9.4	%
Borrowed funds		64,199		111,808		(47,609	)		(42.6	)
Other liabilities		11,544		9,576		1,968			20.6
Total liabilities		1,005,599		971,142		34,457			3.5
Shareholders’ equity		113,880		110,373		3,507			3.2
Total liabilities and equity	$	1,119,479	$	1,081,515	$	37,964			3.5	%

34

Loans Receivable.  The following table provides the balance and the percentage of loans by category at the dates indicated.

	September 30, 2010					December 31, 2009
	Amount		% of Total			Amount		% of Total			% Change
	(Dollars in thousands)
Commercial loans:
Commercial and industrial	$	71,403		9.9	%	$	78,600		10.3	%		(9.2	)%
Commercial real estate – owner occupied		98,440		13.6			99,559		13.1			(1.1	)
Commercial real estate – non-owner occupied		207,787		28.7			218,329		28.6			(4.8	)
Commercial real estate – multifamily		70,318		9.7			63,008		8.3			11.6
Commercial construction and land        development		35,889		4.9			55,733		7.3			(35.6	)
Total commercial loans		483,837		66.8			515,229		67.6			(6.1	)
Retail loans:
One-to-four family residential		178,769		24.7			185,293		24.3			(3.5	)
Home equity lines of credit		55,840		7.7			56,911		7.5			(1.9	)
Retail construction and land development		4,085		.6			3,401		.4			20.1
Other		1,606		.2			1,552		.2			3.5
Total retail loans		240,300		33.2			247,157		32.4			(2.8	)
Total loans receivable, net of unearned fees	$	724,137		100.0	%	$	762,386		100.0	%		(5.0	)%

At September 30, 2010, the net loan portfolio included $158.8 million of variable-rate loans indexed to the prime lending rate as listed in the Wall Street Journal and $222.1 million of loans tied to other indices that reprice at various intervals over the next five years.

Total loan fundings during 2010 were $46.2 million which were more than offset by loan payoffs and repayments of $58.4 million, gross charge-offs of $5.1 million, and transfers to other real estate owned of $16.7 million.  Through the execution of our Strategic Growth and Development Plan, we continue to diversify our loan portfolio and reduce loans not meeting our current defined risk tolerance.  We have increased our targeted segments of the loan portfolio, including commercial and industrial, commercial real estate – owner occupied, and multifamily, to comprise 49.6% of the commercial loan portfolio at September 30, 2010.  During 2010, the se targeted segments were impacted by loan payoffs including four commercial and industrial payoffs totaling $7.2 million, two commercial real estate – owner occupied loan payoffs totaling $5.1 million, and two commercial real estate – multifamily loan payoffs totaling $5.0 million.  In addition, one performing commercial real estate – multifamily purchased participation loan totaling $5.1 million was repaid during the third quarter.  Since December 31, 2009, we have decreased commercial construction and land development and non-owner occupied commercial real estate loans by $30.4 million, or 11.1%.

Historically we had invested, on a participating basis, in loans originated by other lenders and loan syndications to supplement the direct origination of our commercial and construction loan portfolio.  We stopped investing in these types of credits in the second quarter of 2007 due to marginal pricing, increased credit risk, and decreasing collateral values in this segment.  We have had success during 2010 in reducing our exposure on these types of loans by 49.4% since December 31, 2009 through net paydowns/payoffs totaling $9.0 million, charge-offs totaling $3.1 million, and transfers to other real estate owned totaling $13.8 million.  The transfer to other real estate owned of these participation loans allows the lead lender and participant banks to take control of and liquidate the underlying co llateral.

35

Participations and syndication loans outstanding at September 30, 2010 included $9.0 million of commercial construction and land development loans, $17.2 million of loans secured by commercial real estate, and $236,000 of commercial and industrial loans.  Total participations and syndications by state are presented in the table below for the dates indicated.

	September 30, 2010							December 31, 2009
	Count		Amount		% of Total			Count		Amount		% of Total			% Change
	(Dollars in thousands)
Illinois		6	$	6,197		23.4	%		14	$	21,964		41.9	%		(71.8	)%
Indiana		6		5,950		22.4			5		13,149		25.1			(54.7	)
Other states		5		14,341		54.2			9		17,252		33.0			(16.9	)
Total participations and syndications		17	$	26,488		100.0	%		28	$	52,365		100.0	%		(49.4	)%

Loans Held for Sale. At September 30, 2010, we had $4.4 million of conforming one-to-four family mortgage loans held for sale, of which $4.1 million were originated during the third quarter of 2010.  We intend to sell these loans into the secondary market on a servicing-retained basis in the fourth quarter of 2010.

InvestmentSecurities. We manage our investment securities portfolio to adjust balance sheet interest rate sensitivity to insulate net interest income against the impact of changes in market interest rates, to maximize the return on invested funds within acceptable risk guidelines, and to meet pledging and liquidity requirements.

We adjust the size and composition of our investment securities portfolio according to a number of factors including expected loan and deposit growth, the interest rate environment, and projected liquidity.  The amortized cost of investment securities available-for-sale and their fair values were as follows at the dates indicated:

	Par Value		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(Dollars in thousands)
At September 30, 2010:
U.S. treasury securities	$	9,000	$	9,050	$	105	$	―		$	9,155
Government sponsored entity (GSE) securities		38,800		39,490		1,043		―			40,533
Corporate bonds		4,000		3,614		―		(62	)		3,552
Collateralized mortgage obligations		67,423		64,546		2,466		(243	)		66,769
Commercial mortgage-backed securities		68,633		69,290		2,453		―			71,743
Pooled trust preferred securities		29,760		26,764		―		(7,851	)		18,913
GSE preferred stock		5,837		―		52		―			52
	$	223,453	$	212,754	$	6,119	$	(8,156	)	$	210,717

36

	Par Value		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(Dollars in thousands)
At December 31, 2009:
Government sponsored entity (GSE) securities	$	40,450	$	40,374	$	1,083	$	―		$	41,457
Mortgage-backed securities		9,527		9,426		409		―			9,835
Collateralized mortgage obligations		67,307		66,413		1,336		(981	)		66,768
Commercial mortgage-backed securities		49,722		49,210		1,347		(35	)		50,522
Pooled trust preferred securities		30,223		27,093		―		(7,081	)		20,012
GSE preferred stock		5,837		―		187		―			187
	$	203,066	$	192,516	$	4,362	$	(8,097	)	$	188,781

The fair value of investment securities available-for-sale totaled $210.7 million at September 30, 2010 compared to $188.8 million at December 31, 2009.  Our investment securities increased since December 31, 2009 due to investing the proceeds from deposit inflows and loan paydowns as the demand for loans remain constrained by current economic conditions.

At September 30, 2010, the Company’s collateralized mortgage obligation portfolio totaled $64.5 million at amortized cost with 97% of the portfolio maintaining ratings of of AA-or-better.  The portfolio is mainly backed by conventional residential mortgages with prime loans originated prior to 2005; low historical delinquencies; and weighted-average credit scores in excess of 725.  The composition of this portfolio includes $15.0 million backed by either Ginnie Mae, Fannie Mae, or Freddie Mac.  The $49.5 million portfolio of non-agency collateralized mortgage obligations has underlying collateral with a weighted-average 90-day delinquency ratio of 1.2% and a weighted-average loan-to-value of 46.6% when using valuations from the original appraisals.

The Company’s commercial mortgage-backed investment securities portfolio consists mainly of senior tranches of issues originated prior to 2006 with extensive subordination and limited balloon risk.  All bonds are AAA-rated and none are on watch for downgrade.  Management stress tests all bonds in this sector on a monthly basis.  Of this portfolio, 93% of the bonds can withstand a minimum annual default rate of 50% with recoveries of 50 cents on the dollar and not experience any losses.  The single bond that experiences losses in this scenario has an average life in excess of 3 years.  An annual default rate of 50% would default over 80% of the underlying loans in this scenario.

The Company’s corporate bond portfolio consists of a single AA-rated, floating-rate note purchased at a large discount and maturing in 2016.

At September 30, 2010, the Company’s pooled trust preferred investment securities consisted of “Super Senior” securities backed by senior securities issued mainly by bank and thrift holding companies.  Due to the structure of the securities, as deferrals and defaults on the underlying collateral increase, cash flows are increasingly diverted from mezzanine and subordinate tranches to pay down principal on the “Super Senior” tranches.  In management’s belief, the decline in value is primarily attributable to macroeconomic conditions affecting the liquidity of these securities and not necessarily the expected cash flows of the individual securities. The fair value of these securities is expected to recover as the economy recovers, as interest rates rise, and as the performance of the underlying collateral improves.

37

All of the Company’s holdings were AAA-rated when they were purchased at discounts in excess of 10%.  In 2009, the market for pooled trust preferred investment securities was severely impacted by the credit crisis leading to increased deferral and defaults.  Ratings were negatively affected in 2009 and all of these securities in our portfolio have at least one rating below investment grade.  One tranche with an amortized cost of $7.8 million holds recently updated ratings of both A and CCC-.  The market for pooled trust preferred securities is currently inactive.  As such, management may have to hold these securities for a n extended period of time, which it has the ability and intent to do.  We utilize extensive external and internal analysis on the pooled trust preferred holdings.  Stress tests are performed on all underlying issuers in the pools to project probabilities of deferral or default.  Management’s internal stress testing utilizes immediate defaults for all deferring collateral.  Any collateral that management believes may be at risk for deferring, based upon management’s review of the underlying banks’ and thrift holding companies’ most recent financial and regulatory information, is assumed to default immediately.  Internal stress testing also assumes no recoveries on defaulted collateral.  All external and internal stress testing currently projects no loss of principal or interest on any of our holdings.  

During the third quarter, the level of collateral backing the pools deemed by management to be at risk decreased based upon trends of improving financials, large capital increases, acquisitions, and cures by previously deferring issuers.  Based on the increasing pace of and success of capital raises by and confirmed acquisitions of underlying issuers, management expects the pace of cures may accelerate in the fourth quarter of 2010.  Due to the structure of the securities, as deferrals and defaults on the underlying collateral increase, cash flows are increasingly diverted from mezzanine and subordinate tranches to pay down principal on the “Super Seni or” tranches.  Principal paydown rates increased in the third quarter of 2010 as deferral levels were generally stable and previous paydowns have reduced the size of the “Super Senior” tranches relative to subordinate tranches.  Past defaults on underlying collateral ensure cash flows will continue to be diverted to the Company’s “Super Senior” tranches to pay down principal for several years.

Recent law changes enacted in the Dodd-Frank Wall Street Reform and Consumer Protection Act affect the capital treatment of trust preferred securities.  Offering circulars outline the underlying issuer’s ability to prepay their issues if such a capital treatment event occurs.  While management believes the opportunity exists for underlying issuers to prepay their trust preferred securities, we believe any such activity will be limited.  Of the five issues we own, four are failing certain coverage tests designed to protect the holders of the “Super Senior” tranches.  As such, the proceeds of any early redemptions, success ful tenders or cures, will be used to further pay down principal on these four issues.

38

Deposits.The following table sets forth the dollar amount of deposits and the percentage of total deposits in each category offered at the dates indicated:

	September 30, 2010					December 31, 2009
	Amount		% of Total			Amount		% of Total			% Change
	(Dollars in thousands)
Core deposits:
Non-interest bearing checking accounts	$	94,927		10.2	%	$	89,261		10.5	%		6.3	%
Interest bearing checking accounts		123,381		13.3			106,013		12.5			16.4
Money market accounts		144,610		15.6			136,411		16.0			6.0
Savings accounts		121,732		13.1			113,865		13.4			6.9
Subtotal core deposits		484,650		52.2			445,550		52.4			8.8
Certificates of deposit		399,350		42.9			354,401		41.7			12.7
Non-municipal deposits		884,000		95.1			799,951		94.1			10.5
Municipal core deposits		39,493		4.2			38,993		4.6			1.3
Municipal certificates of deposit		6,363		0.7			10,814		1.3			(41.2	)
Municipal deposits		45,856		4.9			49,807		5.9			(7.9	)
Total deposits	$	929,856		100.0	%	$	849,758		100.0	%		9.4

Our ongoing implementation of high performance sales training; increased community involvement; increased partner calling between our business, cash management, and retail teams; and enhanced brand recognition continues to produce favorable deposit gathering results.  Deposits increased $80.1 million to $929.9 million at September 30, 2010 from $849.8 million at December 31, 2009.  This 9.4% increase includes a $39.6 million increase in total core deposits and an increase of $40.5 million in total certificates of deposit.  The increase in core deposits included increases of $5.7 million, or 6.3%, in non-interest bearing checking accounts and $17.4 million, or 16.4%, in interest bearing checking accounts primarily related to a significant new deposit relationship with a trust company.  The increase in our core deposits strengthened our balance sheet and enhanced our liquidity by allowing us to reduce higher cost FHLB borrowed funds.  As previously mentioned, increased core deposits are reflective of our success in deepening our client relationships, one of our core Strategic Plan objectives.

While we maintain strong relationships with our municipal clients, and municipal deposits continue to comprise an important funding source, we are planning to reduce our reliance on such funds over time in anticipation that the recession’s impact on municipalities and other government-related entities may result in lower municipal deposit levels.

In addition, we offer a repurchase sweep agreement (Repo Sweep) account which allows public entities and other business depositors to earn interest with respect to checking and savings deposit products offered.  The depositor’s excess funds are swept from a deposit account and are used to purchase an interest in investment securities that we own.  The swept funds are not recorded as deposits and instead are classified as other short-term borrowed funds which generally provide a lower-cost funding alternative as compared to FHLB advances.  A t September 30, 2010, we had $13.9 million in Repo Sweeps compared to $15.7 million at December 31, 2009.  The Repo Sweeps are included in the table under “Borrowed Funds” and are treated as financings, and the obligations to repurchase investment securities sold are reflected as short-term borrowed funds.  The investment securities underlying these Repo Sweeps continue to be reflected as assets.

39

Borrowed Funds.  Borrowed funds consisted of the following at the dates indicated:

	September 30, 2010					December 31, 2009
	Weighted- Average Contractual Rate			Amount		Weighted- Average Contractual Rate			Amount
	(Dollars in thousands)
Short-term variable-rate borrowed funds:
Repo Sweep accounts		0.50	%	$	13,931		0.50	%	$	15,659
Federal Reserve Bank discount window		―			―		0.50			8,640
Secured borrowed funds from FHLB – Indianapolis:
Maturing in 2010 – variable-rate		―			―		0.47			6,000
Maturing in 2010 – fixed-rate		0.69			10,000		1.56			41,000
Maturing in 2011 – fixed-rate		3.75			15,000		3.75			15,000
Maturing in 2013 – fixed-rate		2.22			15,000		2.22			15,000
Maturing in 2014 – fixed-rate (1)		6.71			1,097		6.71			1,122
Maturing in 2018 – fixed-rate (1)		5.54			2,582		5.54			2,582
Maturing in 2019 – fixed-rate (1)		6.30			6,589		6.30			6,805
Subtotal FHLB – Indianapolis borrowed funds					50,268					87,509
Total borrowed funds				$	64,199				$	111,808
Weighted-average contractual interest rate		2.59	%				2.09	%

 (1) These advances are amortizing and are listed by their contractual maturity.

At September 30, 2010, we also had a $15.0 million secured federal funds line of credit.  We did not utilize this line of credit during the three months ended September 30, 2010 or borrow from the Federal Reserve Bank discount window during the third quarter of 2010.

Subsequent to September 30, 2010, the Bank received approval for an additional $8.0 million secured federal funds line of credit which would provide another source of liquidity.

Shareholders’ Equity.Shareholders’ equity at September 30, 2010 was $113.9 million compared to $110.4 million at December 31, 2009.  The increase was primarily due to $2.5 million of net income for the year to date period, a decrease in the unrealized loss on investment securities available-for-sale, net of tax of $1.1 million, and vesting of restricted stock awards of $168,000, offset by cash dividends declared of $327,000.

40

Asset Quality and Allowance for Loan Losses

Non-performing Assets.The following table provides information relating to non-performing assets at the dates presented.

	September 30, 2010			June 30, 2010			December 31, 2009
	(Dollars in thousands)
Non-accrual loans:
Commercial loans:
Commercial and industrial	$	868		$	883		$	1,399
Commercial real estate – owner occupied		8,811			4,940			3,627
Commercial real estate – non-owner occupied		27,549			19,826			22,103
Commercial real estate – multifamily		1,089			1,477			623
Commercial construction and land development		14,101			25,745			26,059
Total commercial loans		52,418			52,871			53,811
Retail loans:
One-to-four family residential		2,870			2,937			4,519
Home equity lines of credit		636			365			393
Retail construction and land development		169			298			279
Other		5			11			7
Total retail loans		3,680			3,611			5,198
Total non-accrual loans		56,098			56,482			59,009
Other real estate owned, net:
Commercial real estate – non-owner occupied		5,391			2,781			2,819
Commercial real estate – multifamily		328			—			—
Commercial construction and land development		17,746			8,200			5,940
One-to-four family residential		746			844			483
Total other real estate owned		24,211			11,825			9,242
Total non-performing assets		80,309			68,307			68,251
90 days past due and still accruing interest		3,388			3,272			640
Total non-performing assets plus 90 days past due loans still accruing interest	$	83,697		$	71,579		$	68,891
Non-performing assets to total assets		7.17	%		6.24	%		6.31	%
Non-performing loans to total loans		7.75	%		7.47	%		7.74	%

Total non-performing loans were relatively stable at $56.1 million at September 30, 2010 compared to $56.5 million at June 30, 2010 and decreased from $59.0 million at December 31, 2009.  The ratio of non-performing loans to total loans increased to 7.75% compared to the second quarter of 2010 and was stable when compared to December 31, 2009.  The ratio of non-performing loans to total loans increased due to a decrease in total loans.  During the third quarter of 2010, non-performing loans decreased due to the repayment of a $1.9 million impaired commercial construction and land development purchased participation loan from the sale of the collate ral and a $750,000 principal reduction for a separate impaired commercial construction and land development participation loan.  In addition, four impaired commercial participations with carrying values of $12.7 million were transferred to other real estate owned during the third quarter of 2010.  Offsetting these decreases, was the third quarter transfer to non-accrual of two non-owner occupied commercial real estate loans totaling $10.1 million that were restructured during the quarter, two owner-occupied commercial real estate loans totaling $3.9 million, one commercial construction and land development loan totaling $767,000, and 16 residential real estate loans and HELOCs totaling $1.3 million.

41

Included in the above non-performing loan totals are non-performing syndications and purchased participations as identified by loan category in the following table.

	September 30, 2010			June 30, 2010			December 31, 2009
	(Dollars in thousands)
Commercial real estate – non-owner occupied	$	5,302		$	7,856		$	10,158
Commercial construction and land development		4,827			17,059			16,571
Total non-performing syndications and purchased participations	$	10,129		$	24,915		$	26,729
Percentage of total non-performing loans		18.1	%		44.1	%		45.3	%
Percentage of total syndications and purchased participations		38.2			53.3			51.0

The decrease in non-performing participation loans was primarily the result of the aforementioned paydowns and transfers to other real estate owned.  In addition, a $5.1 million performing commercial real estate - multifamily purchased participation loan was repaid during the quarter.

The following table provides the detail for non-accrual syndications and purchased participations by state as of the dates indicated.

	September 30,  2010		June 30, 2010		December 31, 2009
	(Dollars in thousands)
Illinois	$	2,984	$	10,251	$	10,659
Indiana		5,302		12,767		12,767
Florida		1,843		1,897		3,303
Total non-performing syndications and purchased participations	$	10,129	$	24,915	$	26,729

Potential Problem Assets.Potential problem assets, defined as loans classified substandard pursuant to our internal loan grading system that do not meet the definition of a non-performing loan, totaled $2.7 million at September 30, 2010 and $5.6 million at December 31, 2009.  Potential problem assets decreased since December 31, 2009 as one $2.6 million commercial construction and land development loan moved into non-accrual status, two n on-owner occupied commercial real state loans totaling $587,000 were identified as impaired, and one $246,000 commercial and industrial loan was upgraded to our pass/watch classification.  Partially offsetting these decreases was the classification of a $598,000 commercial real estate – multifamily loan to substandard.

42

Allowance for Loan Losses.The following is a summary of changes in allowance for loan losses for the periods presented:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009
	(Dollars in thousands)
Balance at beginning of period	$	17,608		$	14,934		$	19,461		$	15,558
Loan charge-offs		(690	)		(3,623	)		(5,205	)		(5,677	)
Recoveries of loans previously charged-off		42			58			177			151
Net loan charge-offs		(648	)		(3,565	)		(5,028	)		(5,526	)
Provision for loan losses		525			9,430			3,052			10,767
Balance at end of period	$	17,485		$	20,799		$	17,485		$	20,799

	September 30,  2010			December 31, 2009			September 30, 2009
	(Dollars in thousands)
Allowance for loan losses	$	17,485		$	19,461		$	20,799
Total loans receivable, net of unearned fees		724,137			762,386			748,464
Allowance for loan losses to total loans		2.41	%		2.55	%		2.78	%
Allowance for loan losses to non-performing loans		31.17			32.98			37.15

Net charge-offs during the current quarter included $462,000 related to residential real estate loans and HELOCs, $54,000 related to a $1.2 million impaired commercial construction and land development loan, and $41,000 related to an impaired non-owner occupied commercial real estate loan that was transferred to other real estate owned during the quarter at its net realizable value of $2.8 million.  The decrease in the provision for loan losses in the third quarter of 2010 compared to the prior year quarter is primarily due to $3.6 million of charge-offs and increased impairment reserves of $5.3 million identified during the third quarter of 2009.  Net charg e-offs for the nine months ended September 30, 2010 included a $2.3 million partial charge-off that had previously been identified and recorded as a specific impairment reserve in 2009.

The ratio of allowance for loan losses to total loans decreased to 2.41% at September 30, 2010 compared to 2.55% at December 31, 2009 primarily as a result of a partial charge-off during the second quarter of 2010 of $2.3 million that was a specific reserve in the same amount at December 31, 2009.

When management determines a non-performing collateral dependent loan has a collateral shortfall, management will immediately charge off the collateral shortfall.  As a result, the Company is not required to maintain an allowance for loan losses on these loans as the loan balance has already been written down to its net realizable value (fair value less estimated costs to sell the collateral).  As such, the ratio of the allowance for loan losses to total loans and the ratio of the allowance for loan losses to non-performing loans have been affected by partial charge-offs of $7.3 million recorded on $16.2 million of collateral dependent non-performing loans t hrough September 30, 2010 and impairment reserves totaling $7.5 million on other non-collateral dependent non-performing participation loans at September 30, 2010.

43

The following table identifies impaired loans as of the dates presented.

	September 30, 2010		June 30, 2010		December 31, 2009
	(Dollars in thousands)
Impaired loans:
With a valuation reserve	$	21,599	$	12,928	$	17,200
With no valuation reserve required*		38,000		46,234		42,021
Total impaired loans	$	59,599	$	59,162	$	59,221
Valuation reserves relating to impaired loans	$	7,588	$	7,539	$	9,181
Average outstanding impaired loans		59,164		59,163		48,547
*Net of partial charge-offs on impaired loans with no valuation reserves	$	7,300	$	12,090	$	9,412

At September 30, 2010, we had $10.8 million of loan modifications meeting the definition of a troubled debt restructuring (TDR)that were performing in accordance with their agreements and accruing interest that are included above in our impaired loans with no valuation reserve required.  These modified loans include three non-owner occupied commercial real estate loans totaling $5.1 million, one commercial and industrial loan totaling $4.1 million, and 13 on e-to-four family residential loans totaling $1.6 million.  In addition, we had two new troubled debt restructurings of non-owner occupied commercial real estate loans aggregating $10.1 million that were performing in accordance with their modified terms but on non-accrual status, one of which had an impairment reserve of $51,000.  The loan modifications included short-term extensions of maturity, interest only payments, or payment modifications to better match the timing of cash flows due under the modified terms with the cash flows from the borrowers’ operations.

Liquidity and Capital Resources

Liquidity, represented by cash and cash equivalents, is a product of operating, investing, and financing activities.  Our primary sources of funds have been:

• deposits and Repo Sweeps;

• scheduled payments of amortizing loans and mortgage-backed investment securities; 

• prepayments and maturities of outstanding loans and mortgage-backed investment securities; 

• maturities of investment securities and other short-term investments; 

• funds provided from operations;

• federal funds line of credit; and

• borrowed funds from the FHLB and Federal Reserve Bank.

The Asset Liability Committee is responsible for measuring and monitoring our liquidity profile.  We manage our liquidity to ensure stable, reliable, and cost-effective sources of funds to satisfy demand for credit, deposit withdrawals, and investment opportunities.  Our general approach to managing liquidity involves preparing a monthly “funding gap” report which forecasts cash inflows and cash outflows over various time horizons and rate scenarios to identify potential cash imbalances.  We supplement our funding gap report with the monitoring of several liquidity ratios to assist in identifying any trends that may have an effect on av ailable liquidity in future periods.

44

We maintain a contingency funding plan that outlines the process for addressing a liquidity crisis.  The plan assigns specific roles and responsibilities for effectively managing liquidity through a problem period.

Scheduled payments from the amortization of loans, maturing investment securities, and short-term investments are relatively predictable sources of funds, while deposit flows and loan prepayments are greatly influenced by market interest rates, economic conditions, and competitive rate offerings.

At September 30, 2010, we had cash and cash equivalents of $52.2 million, an increase from $24.4 million at December 31, 2009.  The increase was mainly the result of:

• increases in deposit accounts totaling $80.0 million;

• proceeds from sales, maturities, and paydowns of investment

securities aggregating $72.8 million;

• proceeds from FHLB advances totaling $18.0 million; and

• net loan repayments totaling $16.3 million.

The above cash inflows were partially offset by:

• purchases of investment securities totaling $99.2 million;

• repayment of FHLB advances totaling $55.2 million; and

• repayment of short-term borrowed funds totaling $10.4 million.

We use our sources of funds primarily to meet our ongoing commitments, fund loan commitments, fund maturing certificates of deposit and savings withdrawals, and maintain an investment securities portfolio.  We anticipate that we will continue to have sufficient funds to meet our current commitments.

Our liquidity needs consist primarily of operating expenses and dividend payments to shareholders.  The primary sources of liquidity are cash and cash equivalents and dividends from the Bank.  We are prohibited from repurchasing shares and incurring any debt at the parent company without the prior approval of the OTS under our informal regulatory agreement with them.

We are currently prohibited from paying dividends without the prior approval of the OTS pursuant to our informal regulatory agreement with them.  Absent such restriction, under OTS regulations, without prior approval, the dividends from the Bank are limited to the extent of the Bank’s cumulative earnings for the year plus the net earnings (adjusted by prior distributions) of the prior two calendar years.  During the third quarter of 2010, the Bank did not pay dividends to the parent company.  At September 30, 2010, the parent company had $3.3 million in cash and cash equivalents.  We do not anticipate that these restrictions will ha ve a material adverse impact on our liquidity in the short-term.

45

Contractual Obligations.The following table presents our contractual obligations at September 30, 2010 by contractual maturity:

	Payments Due By Period
	Less Than 1 Year		1 To 3  Years		3 To 5 Years		Over 5 Years		Total
	(Dollars in thousands)
Certificates of deposit	$	310,986	$	71,473	$	22,550	$	704	$	405,713
FHLB borrowed funds (1)		25,329		727		16,767		7,445		50,268
Short-term borrowed funds (2)		13,931		―		―		―		13,931
Service bureau contract		1,548		3,096		3,096		―		7,740
Operating leases		405		505		262		2,031		3,203
Dividends payable on common stock		109		―		―		―		109
	$	352,308	$	75,801	$	42,675	$	10,180	$	480,964

(1) Does not include interest expense at the weighted-average contractual rate of 3.17% for the periods presented.

(2) Does not include interest expense at the weighted-average contractual rate of 0.50% for the periods presented.

Off-Balance Sheet Obligations.We are party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our clients.  These financial instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the statement of condition.  Our exposure to credit loss in the event of non-performance by the third-party to the financial instrument for commitments to extend credit and letters of credit is represented by the contractual notional amount of those instruments.  We use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments.

The following table details the amounts and expected maturities of significant commitments at September 30, 2010:

	Less Than		1 To 3		3 To 5		Over 5
	1 Year		Years		Years		Years		Total
	(Dollars in thousands)
Commitments to extend credit:
Commercial and industrial	$	7,785	$	598	$	―	$	256	$	8,639
Commercial real estate – owner occupied		3,924	―			135	―			4,059
Commercial real estate – non-owner occupied		360	―		―		―			360
Commercial real estate – multifamily		1,226	―		―		―			1,226
Commercial construction and land development		2,462		150	―		―			2,612
Retail		2,917	―		―		―			2,917
Commitments to fund unused:
Construction loans		4,562	―		―			228		4,790
Commercial business lines		33,825		1,174		171	―			35,170
Equity lines of credit		12,497	―		―			42,073		54,570
Commitments to sell one-to-four family mortgage loans		282	―		―		―			282
Letters of credit		3,784		119	―		―			3,903
Credit enhancements		11,275	―		―			13,771		25,046
	$	84,899	$	2,041	$	306	$	56,328	$	143,574

The commitments listed above do not necessarily represent future cash requirements, in that many of these commitments often expire without being drawn upon.  Letters of credit expire at various dates through 2012 and credit enhancements expire at various dates through 2018.

46

We also have commitments to fund community investments through investments in various limited partnerships, which represent future cash outlays for the construction and development of properties for low-income housing, small business real estate, and historic tax credit projects that qualify under the Community Reinvestment Act.  These commitments include $625,000 to be funded over four years.  The timing and amounts of these commitments are projected based upon the financing arrangements provided in each project’s partnership agreement, and could change due to variances in the construction schedule, project revisions, or the cancellation of the projec t.  These commitments are not included in the commitment table above.

Credit enhancements are related to the issuance by municipalities of taxable and nontaxable revenue bonds.  The proceeds from the sale of such bonds are loaned to for-profit and not-for-profit companies for economic development projects.  In order for the bonds to receive AAA ratings, which provide for a lower interest rate, the FHLB issues, in favor of the bond trustee, an Irrevocable Direct Pay Letter of Credit (IDPLOC) for our account.  Since we, in accordance with the terms and conditions of a Reimbursement Agreement between the FHLB, would b e required to reimburse the FHLB for draws against the IDPLOC, these facilities are analyzed, appraised, secured by real estate mortgages, and monitored as if we had funded the project initially.  Our current lending strategy does not include originating new or additional credit enhancements.

Regulatory Capital  

The Bank is subject to regulatory capital requirements under the rules of the Office of Thrift Supervision, or OTS.  Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators, which could have a material impact on the Bank’s financial statements.  Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must maintain capital amounts in excess of specified minimum ratios based on quantitative measures of the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices.

Quantitative measures established by the OTS to ensure capital adequacy require us to maintain minimum amounts and ratios (as set forth in the table below) of three capital requirements: tangible capital (as defined in the regulations) as a percentage of adjusted total assets, core capital (as defined) as a percentage of adjusted total assets, and risk-based capital (as defined) as a percentage of total risk-weighted assets.  At September 30, 2010, the Bank exceeded all minimum regulatory capital ratios to be considered well capitalized.

47

The Bank’s actual capital amounts and ratios, as well as minimum amounts and ratios required for capital adequacy and prompt corrective action provisions are presented in the following table:

	Actual					For Capital Adequacy Purposes				To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio		Amount		Ratio
	(Dollars in thousands)
As of September 30, 2010:
Total capital to risk-weighted assets	$	108,639		13.21	%	$	65,782	>8.00	%	$	82,227	>10.00	%
Tier 1 (core) capital to risk-weighted assets		98,763		12.01			32,891	>4.00			49,336	>6.00
Tier 1 (core) capital to adjusted total assets		98,763		8.91			44,323	>4.00			55,404	>5.00
Tangible capital to adjusted total assets		98,763		8.91			16,621	>1.50			22,161	>2.00
As of December 31, 2009:
Total capital to risk-weighted assets	$	105,323		12.35	%	$	68,200	>8.00	%	$	85,250	>10.00	%
Tier 1 (core) capital to risk-weighted assets		95,078		11.15			34,100	>4.00			51,150	>6.00
Tier 1 (core) capital to adjusted total assets		95,078		8.88			42,838	>4.00			53,548	>5.00
Tangible capital to adjusted total assets		95,078		8.88			16,064	>1.50			21,419	>2.00

The following table reflects the adjustments required to reconcile the Bank’s shareholder’s equity to the Bank’s regulatory capital at September 30, 2010:

	Tangible			Core			Risk-Based
	(Dollars in thousands)
Shareholder’s equity of the Bank	$	111,615		$	111,615		$	111,615
Disallowed deferred tax asset		(13,212	)		(13,212	)		(13,212	)
Adjustment for available-for-sale securities		1,191			1,191			1,191
Other		(831	)		(831	)		(831	)
General allowance for loan losses		―			―			9,876
Regulatory capital of the Bank	$	98,763		$	98,763		$	108,639

At September 30, 2010, the Bank was deemed to be well capitalized and in excess of regulatory requirements set by the OTS.  The increase in the Bank’s capital ratios from December 31, 2009 is primarily a result of the Bank’s net income for the year to date period combined with a shift in the risk categories of the Bank’s assets due to decreases in the level of loans that were risk-weighted 100% and an increase in cash and treasury securities that are in the 0% category.  Determining the amount of deferred tax assets included or excluded in periodic regulatory capital calculations requires significant judgment when assessing a number of fact ors.  In assessing the amount of the disallowed deferred tax asset, we consider a number of relevant factors including the amount of deferred tax assets dependent on future taxable income, the amount of taxes that could be recovered through loss carrybacks, the reversal of temporary book tax differences, projected future taxable income within one year, available tax planning strategies, and OTS limitations.  Using all information available to us at each statement of condition date, these factors are reviewed and vary from period to period.

48

Item 3.     Quantitative and Qualitative Disclosures about Market Risk

We, like other financial institutions, are subject to interest rate risk (IRR).  This risk relates to changes in market interest rates which could adversely affect net interest income or the net portfolio value (NPV) of our assets, liabilities, and off-balance sheet contracts.  IRR is primarily the result of imbalances between the price sensitivity of our assets and liabilities.  These imbalances can be caused by differences in the maturity, re pricing, and coupon characteristics of various assets and liabilities as well as options such as loan prepayment options.

We maintain a written Asset/Liability Management Policy that establishes written guidelines for the asset/liability management function, including the management of net interest margin, IRR, and liquidity.  The Asset/Liability Management Policy falls under the authority of the Board of Directors which in turn assigns its formulation, revision, and administration to the Asset/Liability Committee (ALCO).  ALCO meets monthly and consists of certain senior officers and one outside director.  The results of the monthly meetings are reported to the Boa rd of Directors.  The primary duties of ALCO are to develop reports and establish procedures to measure and monitor IRR, verify compliance with Board approved IRR tolerance limits, take appropriate actions to mitigate those risks, monitor and discuss the status and results of implemented strategies and tactics, monitor our capital position, review the current and prospective liquidity positions, and monitor alternative funding sources.  The policy requires management to measure overall IRR exposure using NPV analysis and earnings-at-risk analysis.

NPV is defined as the net present value of existing assets, liabilities, and off-balance sheet contracts.  NPV analysis measures the sensitivity of NPV under current interest rates and for a range of hypothetical interest rate scenarios.  The hypothetical scenarios are represented by immediate, permanent, parallel movements in interest rates of plus 100, 200, and 300 basis points and minus 100 and 200 basis points.  This rate-shock approach is designed primarily to show the ability of the balance sheet to absorb rate shocks on a “theoretical liquidation value” basis.  The analysis does not take into account non-rate related is sues, which affect equity valuations, such as franchise value or real estate values.  This analysis is static and does not consider potential adjustments of strategies by management on a dynamic basis in a volatile rate environment in order to protect or conserve equity values.  As such, actual results may vary from the modeled results.

The following table presents, as of September 30, 2010 and December 31, 2009, an analysis of IRR as measured by changes in NPV for immediate, permanent, and parallel shifts in the yield curve in 100 basis point increments up to 300 basis points and down 200 basis points in accordance with OTS regulations.

		Net Portfolio Value
		At September 30, 2010								At December 31, 2009
		$ Amount		$ Change			% Change			$ Amount		$ Change			% Change
		(Dollars in thousands)
Assumed Change in Interest Rates (Basis Points)
	+300	$	135,957	$	12,894			10.5	%	$	130,797	$	2,065			1.6	%
	+200		135,000		11,937			9.7			131,109		2,377			1.8
	+100		131,445		8,382			6.8			130,917		2,185			1.7
	0		123,063		―			―			128,732		―			―
	-100		110,069		(12,994	)		(10.6	)		117,387		(11,345	)		(8.8	)
	-200		100,335		(22,728	)		(18.5	)		105,417		(23,315	)		(18.1	)

49

As illustrated in the table, NPV in the base case (zero basis point change) decreased $5.7 million from $128.7 million at December 31, 2009 to $123.1 million at September 30, 2010.  The NPV decrease compared to December 31, 2009 is primarily due to the decline in economic value of the bank’s transaction accounts in the current low interest rate environment.

Earnings-at-risk analysis measures the sensitivity of net interest income over a twelve month period to various interest rate movements.  The interest rate scenarios are used for analytical purposes and do not necessarily represent management’s view of future market movements.  Rather, these scenarios are intended to provide a measure of the degree of volatility interest rate movements may introduce into earnings.

A key assumption we control for use in our earnings-at-risk analysis is the assumed repricing sensitivity of our non-maturing core deposit accounts.  The following assumptions were used for the repricing of non-maturity core deposit accounts.

	Percentage of Deposits Maturing In First Year
	September 30, 2010			December 31, 2009
Deposit Category:
Business checking accounts		20	%		20	%
Interest checking accounts		20			20
High-yield checking accounts		95			95
Savings accounts		30			30
Money market accounts		50			50

The following table presents the projected changes in net interest income over a twelve month period for the various interest rate change (rate shocks) scenarios at September 30, 2010 and December 31, 2009, respectively.

		Percentage Change in Net Interest Income Over a Twelve Month Time Period
		September 30, 2010			December 31, 2009
Assumed Change in Interest Rates  (Basis Points):
	+300		2.5	%		0.1	%
	+200		1.7			0.2
	+100		0.6			0.0
	-100		2.9			3.3
	-200		2.1			1.5

The table above indicates that if interest rates were to move up 300 basis points, net interest income would be expected to rise 2.5% in year one; and if interest rates were to move down 100 basis points, net interest income would be expected to increase 2.9% in year one.  Interest income projections for rates falling 100 basis points are greater than for rates falling 200 basis points as rates on short-term liabilities have limited room to reprice lower while rates on certain assets are at contractual or absolute floors.  Interest income projections for rates rising 200 basis points are greater than for rates rising 100 basis points as short-term liabilitie s may reprice higher while certain assets have interest rate floors that are currently well above their spreads to their respective indexes.  The primary causes for the changes in

50

net interest income over the twelve month period were a result of the changes in the composition of assets and liabilities along with changes in interest rates.

We manage our IRR position by holding assets with various desired IRR characteristics, implementing certain pricing strategies for loans and deposits, and implementing various investment securities portfolio strategies.  On a quarterly basis, the ALCO reviews the calculations of all IRR measures for compliance with the Board approved tolerance limits.  At September 30, 2010, we were in compliance with all of our tolerance limits with the exception of the NPV tolerance limit for a movement in rates down 200 basis points.  Given the current low level of interest rates, we do not believe this exception is material because this interest scenario is not probable.

The above IRR analyses include the assets and liabilities of the Bank only.  Inclusion of Company-only assets and liabilities would not have a material impact on the results presented.

Item 4.      Controls and Procedures

No change in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) or 15d-15(f) under the Securities Exchange Act of 1934, as amended) occurred during the quarter ended September 30, 2010 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

Management evaluated, with the participation of the Chief Executive Officer and Chief Financial Officer, the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) or 15(d)-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report.  Based on such evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures are designed to ensure that information required to be disclosed in the reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and regulations and are operating in an effective manner as of such date.

Part II.      OTHER INFORMATION

Item 1.       Legal Proceedings

           The Company is involved in routine legal proceedings occurring in the ordinary course of business, which, in the aggregate, are believed to be immaterial to the financial condition, results of operations, and cash flows of the Company.

Item 1A.     Risk Factors

In addition to the other information set forth in this report, you should carefully consider the factors discussed in “Item 1A. Risk Factors” contained in our Annual Report on Form 10-K for the year ended December 31, 2009, which could materially affect our business, financial condition, or future results. Other than as set forth below, there have been no material changes from the risk factors as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2009.

51

We operate in a highly regulated industry and may be affected adversely by increased regulatory supervision and scrutiny and changes in laws, rules, and regulations affecting financial institutions.

We are, like other federally-charted savings banks, currently subject to extensive regulation, supervision, and examination by the OTS and by the FDIC, the insurer of its deposits.  CFS Bancorp, like other thrift holding companies, is currently subject to regulation and supervision by the OTS.  This regulation and supervision governs the activities in which we may engage and are intended primarily for the protection of the deposit insurance fund administered by the FDIC and our clients and depositors rather than our shareholders.  Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on our operations, the classification of our assets, determination of the level of our allowance for loan losses, and maintenance of ad equate capital levels.  These bank regulators possess broad authority to prevent or remedy unsafe or unsound practices or violations of law, and given the recent financial crisis in the United States, the trend has been toward increased and more active oversight by regulators.  Recently, pursuant to an agreement among various federal financial institution regulators, the FDIC’s authority to investigate banks was significantly expanded.  Under the terms of this new agreement, the FDIC will have unlimited authority to make a special examination of any insured depository institution as necessary to determine the condition of such depository institution for insurance purposes.  Accordingly, we expect an active supervisory and regulatory environment to continue.

In addition, as a result of ongoing challenges facing the United States economy, new laws and regulations regarding lending and funding practices and liquidity standards have been and may continue to be promulgated, and bank regulatory agencies are expected to be active in responding to concerns and trends identified in examinations, including the issuance of formal or informal enforcement actions or orders.  Accordingly, the regulations applicable to the banking industry continue to change and we cannot predict the effects of these changes on our business and profitability.

On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Act), a sweeping financial reform bill, was signed into law and will result in a number of new regulations that could significantly impact regulatory compliance costs and the operations of community banks.  The Act includes, among other things, provisions establishing a Bureau of Consumer Financial Protection, which will have broad authority to develop and implement rules regarding most consumer financial products; provisions affecting corporate governance and executive compensation at all publicly-traded companies; provisions that would broaden the base for FDIC insurance assessments and permanently increase FDIC deposit insurance to $250,000; and new restrictions on how mortgage brokers and loan originators may be compensated.  The Act also eliminates the OTS, and transfers supervisory authority for all previous OTS-regulated savings banks, like the Bank, to the Office of the Comptroller of the Currency, and for all thrift holding companies, such as CFS Bancorp, to the Federal Reserve.  These provisions, or any other aspects of current proposed regulatory or legislative changes to laws applicable to the financial industry, if enacted or adopted, may impact the profitability of our business activities or change certain of our business practices, including our ability to offer new products, obtain financing, attract deposits, make loans, and achieve satisfactory interest spreads, and could expose us to additional costs, including increased compliance costs.  These changes also may require us to invest significant management attention and resources to make any necessary changes to our operations in order to c omply, and could therefore also materially adversely affect our business, financial condition, and results of operations.

52

Item 2.       Unregistered Sales of Equity Securities and Use of Proceeds

(a)	Not applicable.
(b)	Not applicable.
(c)	We did not repurchase any shares of our common stock during the quarter ended September 30, 2010 or through October 27, 2010.  Under our repurchase plan publicly announced on March 20, 2008 for 530,000 shares, we have 448,612 shares that may yet be purchased.  We are currently prohibited from repurchasing our common stock without prior OTS approval pursuant to an informal regulatory agreement with the OTS.

Item 3.        Defaults Upon Senior Securities

(a)	None.
(b)	Not applicable.

Item 4.       (Removed and Reserved)

Item 5.       Other Information

Item 6.       Exhibits

(a)	List of exhibits (filed herewith unless otherwise noted).
3.1	Articles of Incorporation of CFS Bancorp, Inc. (1)
3.2	Bylaws of CFS Bancorp, Inc. (2)
4.0	Form of Stock Certificate of CFS Bancorp, Inc. (3)
31.1	Rule 13a-14(a) Certification of Chief Executive Officer
31.2	Rule 13a-14(a) Certification of Chief Financial Officer
32.0	Section 1350 Certifications

 ____________

(1) Incorporated herein by Reference to the Company’s Definitive Proxy Statement from the Annual Meeting of Shareholders filed with the SEC on March 25, 2005 (File No. 000-24611).

(2) Incorporated herein by Reference to the Company’s Form 8-K filed with the SEC on July 31, 2009.

(3) Incorporated herein by Reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 2006 filed with the SEC on March 15, 2007.

53

SIGNATURES

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

CFS BANCORP, INC.

Date:  October 28, 2010	By:	/s/ Thomas F. Prisby
		Thomas F. Prisby, Chairman of the Board and
		Chief Executive Officer
Date:  October 28, 2010	By:	/s/ Jerry A. Weberling
		Jerry A. Weberling, Executive Vice President and
		Chief Financial Officer

54

EXHIBIT INDEX

31.1	Rule 13a-14(a) Certification of Cheif Executive Officer
31.2	Rule 13a-14(a) Certification of Cheif Financial Officer
32.0	Section 1350 Certification

55

EX-31.1

Exhibit 31.1

CERTIFICATION

I, Thomas F. Prisby, Chairman of the Board and Chief Executive Officer, certify that:

1. I have reviewed this quarterly report on Form 10-Q of CFS Bancorp, Inc. (Registrant);

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations, and cash flows of the Registrant as of, and for, the periods presented in this report;

4. The Registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the Registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the Registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the Registrant’s internal control over financial reporting that occurred during the Registrant’s most recent fiscal quarter (the Registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the Registrant’s internal control over financial reporting; and

5. The Registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Registrant’s auditors and the audit committee of Registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Registrant’s ability to record, process, summarize, and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant’s internal control over financial reporting.

Date: October 28, 2010	/s/ Thomas F. Prisby
	Thomas F. Prisby
	Chairman of the Board and Chief Executive Officer

EX-31.2

Exhibit 31.2

CERTIFICATION

I, Jerry A. Weberling, Executive Vice President and Chief Financial Officer certify that:

1. I have reviewed this quarterly report on Form 10-Q of CFS Bancorp, Inc. (Registrant);

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations, and cash flows of the Registrant as of, and for, the periods presented in this report;

4. The Registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the Registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the Registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the Registrant’s internal control over financial reporting that occurred during the Registrant’s most recent fiscal quarter (the Registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the Registrant’s internal control over financial reporting; and

5. The Registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Registrant’s auditors and the audit committee of Registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Registrant’s ability to record, process, summarize, and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant’s internal control over financial reporting.

Date: October 28, 2010	/s/ Jerry A. Weberling
	Jerry A. Weberling
	Executive Vice President and Chief Financial Officer

EX-32.0

Exhibit 32.0

SECTION 1350 CERTIFICATIONS

I, Thomas F. Prisby, Chairman of the Board and Chief Executive Officer, and Jerry A. Weberling, Executive Vice President and Chief Financial Officer, of CFS Bancorp, Inc. (Company), hereby certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350, that:

(1) The Quarterly Report on Form 10-Q of the Company for the three months ended September 30, 2010 (Report) fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C 78m(a) or 78o(d)), as amended; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date:	October 28, 2010	By:	/s/ Thomas F. Prisby
			Thomas F. Prisby
			Chairman of the Board and Chief Executive Officer
Date:	October 28, 2010	By:	/s/ Jerry A. Weberling
			Jerry A. Weberling
			Executive Vice President and Chief Financial Officer

A signed original of this written statement required by Section 906 of the Sarbanes-Oxley Act has been provided to CFS Bancorp, Inc. and will be retained by CFS Bancorp, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.