10-K

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________________
 
FORM 10-K
____________________

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

For the fiscal year ended: December 31, 2007

OR

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

Commission File No.: 0-24611

CFS Bancorp, Inc.
(Exact name of registrant as specified in its charter)

Indiana	35-2042093
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification Number)

707 Ridge Road	46321
Munster, Indiana	(Zip Code)
(Address of Principal Executive Offices)

Registrant’s telephone number, including area code:
(219) 836-5500

Securities registered pursuant to Section 12(b) of the Act:
Not Applicable

Securities registered pursuant to Section 12(g) of the Act:

Common Stock (par value $0.01 per share)
(Title of Class)

     Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes  o  No þ

     Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes  o  No þ

     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  þ  No o

     Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 Large accelerated filer o   Accelerated filer þ  Smaller reporting company o  Non-accelerated filer o 

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

     As of June 30, 2007, the aggregate value of the 10,845,740 shares of Common Stock of the Registrant outstanding on such date, which excludes 445,734 shares held by all directors and executive officers of the Registrant as a group, was approximately $151.3 million. This figure is based on the last known trade price of $14.55 per share of the Registrant’s Common Stock on June 30, 2007.

     Number of shares of Common Stock outstanding as of February 29, 2008: 10,692,806

DOCUMENTS INCORPORATED BY REFERENCE

     Portions of the definitive proxy statement for the Annual Meeting of Stockholders to be held on April 29, 2008 are incorporated by reference into Part III.

CFS BANCORP, INC. AND SUBSIDIARIES

FORM 10-K

INDEX

		Page
	PART I.
Item 1.	Business	3
Item 1A.	Risk Factors	18
Item 1B.	Unresolved Staff Comments	21
Item 2.	Properties	22
Item 3.	Legal Proceedings	24
Item 4.	Submission of Matters to a Vote of Security Holders	24
	PART II.
Item 5.	Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer
	Purchases of Equity Securities	25
Item 6.	Selected Financial Data	27
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	28
Item 7A.	Quantitative and Qualitative Disclosures about Market Risk	52
Item 8.	Financial Statements and Supplementary Data	54
Item 9.	Changes in and Disagreements with Accountants on Accounting and
	Financial Disclosures	86
Item 9A.	Controls and Procedures	86
Item 9B.	Other Information	88
	PART III.
Item 10.	Directors and Executive Officers and Corporate Governance	89
Item 11.	Executive Compensation	89
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related
	Stockholder Matters	89
Item 13.	Certain Relationships and Related Transactions and Director Independence	89
Item 14.	Principal Accounting Fees and Services	89
	PART IV.
Item 15.	Exhibits and Financial Statement Schedules	90
Signature Page		91
Certifications for Principal Executive Officer and Principal Financial Officer		93

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     Certain statements contained in this Annual Report on Form 10-K, in other filings made by the Company with the U.S. Securities and Exchange Commission (SEC), and in the Company’s press releases or other stockholder communications are forward-looking statements, as that term is defined in U.S. federal securities laws. Generally, these statements relate to business plans or strategies, projections involving anticipated revenues, earnings, profitability or other aspects of operating results or other future developments in the Company’s affairs or the industry in which it conducts business. Forward-looking statements may be identified by reference to a future period or periods or by the use of forward-looking terminology such as “anticipate,” “believe,” “expect,” “intend,” “plan,” “estimate,” “would be,” “will,” “intends to,” “project” or similar expressions or the negative thereof.

     The Company wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made. The Company also advises 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 the Company’s lending and investment activities, legislative changes, changes in the cost of funds, demand for loan products and financial services, changes in accounting principles and competitive and regulatory factors, could affect the Company’s financial performance and could cause the Company’s 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 “Item 1A. Risk Factors” of this Annual Report on Form 10-K. Such forward-looking statements are not guarantees of future performance. The Company does not undertake, and specifically disclaims any obligation, to update any forward-looking statements to reflect occurrences or unanticipated events or circumstances after the date of such statements.

PART I.

ITEM 1. BUSINESS

GENERAL

     CFS Bancorp, Inc. (including its consolidated subsidiaries, the Company) is a registered unitary savings and loan holding company incorporated under the laws of the State of Indiana. The Company was formed in March 1998 and operates one wholly-owned subsidiary, Citizens Financial Bank (the Bank), and was formed to facilitate the Bank’s July 1998 conversion from a federally-chartered mutual savings bank to a federally-chartered stock savings bank (the Conversion). In conjunction with the Conversion, the Company completed an initial public offering. The Company and the Bank are subject to oversight and examination by the Office of Thrift Supervision (OTS). See “Regulation – Regulation of Savings and Loan Holding Companies” below in this “Business” section.

The Company employed 303 full-time equivalent employees at December 31, 2007. Management of the Company and the Bank are substantially identical. The Company does not own or lease any property but instead uses the premises, equipment and furniture of the Bank. The Company does not employ any persons other than officers who are also officers of the Bank. In addition, the Company utilizes the support staff of the Bank from time to time. The Company has responsibility for the overall conduct, direction, and performance of the Bank and provides various services, establishes Company-wide policies and procedures, and provides other resources as needed, including capital to the Bank.

     The Bank was originally organized in 1934 and currently conducts its business from its executive offices in Munster, Indiana, as well as 22 banking centers located in Lake and Porter Counties in northwest Indiana and Cook, DuPage and Will Counties in Illinois. The Bank also maintains an Operations Center in Highland, Indiana which is dedicated to its Customer Call Center and other back office operations.

     In recent years, the Bank has transitioned its business model from a traditional savings and loan engaged primarily in one-to-four family residential mortgage lending to a more diversified consumer and business banking model while retaining its emphasis on high-quality personalized customer service.

     The Bank offers a wide variety of checking, savings and other deposit accounts. The Bank also offers investment services and securities brokerage targeted to individuals, families and small- to medium-sized businesses in its primary market areas through a non-affiliated third-party provider. The Bank has increased its business product

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offerings over the past few years to enhance its opportunity to serve the business segment of its customer base. These products include public fund deposits, repurchase sweep accounts, zero balance accounts, remote merchant capture, Business Overdraft Privilege, business on-line banking and lock-box services.

     The Bank’s 22 banking centers are responsible for the delivery of retail and small business loan and deposit products and services in the communities they serve. Banking Center Managers and their staffs utilize a relationship focused, customer centric approach in identifying opportunities, and meeting the needs and exceeding the expectations of their customers. By providing high-quality personalized customer service and solutions, the Banking Centers enhance our ability to improve our market share.

     The Bank’s Commercial Lending Group and Business Resource Center are primarily responsible for developing relationships with businesses that require larger, more sophisticated loan, deposit or cash management services. Specialized professionals analyze lending opportunities to ensure proper assessment of inherent risks and appropriate loan structures to appropriately manage those risks. Cash Management Specialists assist customers in maximizing the utility of cash balances and accelerating delivery of cash though various payment systems.

     The Bank periodically evaluates potential acquisitions and de novo branching opportunities to strengthen its overall market presence. The Bank targets areas that it believes are not yet fully served by other banking organizations, offers an attractive deposit base or potential business growth opportunities, and complements its existing market territory. The Bank opened its newest banking center in Tinley Park, Illinois and relocated its existing Merrillville, Indiana banking center to a free-standing full service banking facility in 2007. The Bank currently has plans to build a new banking center in Bolingbrook, Illinois and to relocate its existing banking centers in Flossmoor and Harvey, Illinois to free-standing full service banking facilities in 2008. In addition, the Bank purchased a parcel of land in January 2008 in order to build a second free-standing full service banking facility in Crown Point, Indiana.

     The Bank’s revenue is primarily derived from interest on loans and investment securities and loan and deposit fees. The Bank’s operations are significantly impacted by general economic conditions, the monetary policy of the federal government, including the Board of Governors of the Federal Reserve System (FRB), legislative tax policies and governmental budgetary matters. The Bank’s revenue is largely dependent on net interest income, which is the difference between interest earned on interest-earning assets and the interest expense paid on interest-bearing liabilities.

AVAILABLE INFORMATION

     CFS Bancorp, Inc. is a public company and files annual, quarterly and special reports, proxy statements and other information with the SEC. The Company makes available, free of charge, on its website, www.citz.com, its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to these documents under the “Investor Relations” section. These documents are available as soon as reasonably practicable after they are filed or furnished to the SEC.

CORPORATE GOVERNANCE

     The Company has established certain committees of its Board of Directors, specifically Audit, Compensation, and Nominating Committees. The charters of these committees as well as the Company’s Code of Conduct and Ethics can be found on the Company’s website listed above. The information is also available in printed form to any shareholder who requests it by writing to the Company in care of its Vice President – Corporate Secretary, 707 Ridge Road, Munster, Indiana 46321.

MARKET AREA AND COMPETITION

     The Bank maintains 22 banking centers in Lake and Porter Counties in northwest Indiana and in Cook, DuPage and Will Counties in Illinois. All areas served by the Bank are part of the Chicago Metropolitan Statistical Area.

     The Bank has historically concentrated its efforts in the markets surrounding its offices. The Bank may also invest in areas outside of its market through the direct origination of commercial loans and purchase of commercial participation loans. The Bank’s market area reflects diverse socio-economic factors. Historically, the market area in northwest Indiana and the south-suburban areas of Chicago were heavily dependent on manufacturing. While

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manufacturing is still an important component of the local economies, service-related industries have become increasingly significant to the region in the last decade. Growth in the local economies can be expected to occur largely as a result of the continued interrelation with Chicago as well as suburban business centers in the area.

     The Bank faces significant competition both in making loans and in attracting deposits. The Chicago metropolitan area is one of the largest money centers and the market for deposit funds is one of the most competitive in the United States. The Bank’s competition for loans comes principally from commercial banks, other savings banks, savings associations, mortgage-banking companies and more recently, conduit lenders and insurance companies. The Bank’s most direct competition for deposits has historically come from savings banks, commercial banks and credit unions. The Bank faces additional competition for deposits from short-term money market funds, other corporate and government securities funds and other non-depository financial institutions such as brokerage firms and insurance companies.

LENDING ACTIVITIES

General

     The Bank originates commercial and retail loans. Included in the Bank’s commercial loan portfolio are commercial real estate, construction and land development, and commercial and industrial loans. The retail loan portfolio includes one-to-four family residential mortgage loans, lot loans and consumer loans including home equity loans, home equity lines of credit (HELOCs) and auto loans. See the Company’s loans receivable composition table in “Loans” within “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Annual Report on Form 10-K.

     The Bank has also invested, on a participating basis, in loans originated by other lenders. These participations may be within or outside of the Bank’s market area. The Bank applies the same underwriting guidelines applicable to loans it originates when considering investing in these participation loans. At December 31, 2007, the Bank had $82.6 million of purchased participations, of which $31.7 million was to borrowers located outside of the Bank’s market area. The Bank has historically invested in participation loans to supplement the direct origination of its commercial and construction loan portfolio. During 2007, the Bank experienced marginal pricing and increased credit risk in this segment. As a result, the Bank intends to significantly reduce its reliance on purchased participation loans during 2008.

     The Bank’s lending strategy seeks to diversify its portfolio in an effort to limit risks associated with any particular loan type or industry while building a quality loan portfolio. The Bank has established specific collateral concentration limits in a manner it believes will not hamper its lenders in the pursuit of new business in a variety of sectors. The Bank’s commercial loan underwriting focuses on the cash flow from business operations, the financial strength of the borrower and guarantors, and the underlying collateral.

     The Bank utilizes secondary market standards for underwriting one-to-four family residential mortgage loans which facilitates its ability to sell these loans into the secondary market. Secondary market requirements place limitations on debt-to-income ratios and loan size among other factors. As part of the underwriting process, the Bank evaluates, among other things, the applicants’ credit history, income, employment stability, repayment capacity and collateral. Although the Bank has sold certain of its one-to-four family residential mortgage loans, it intends to retain these loans originated during 2008.

     The Bank utilizes a Risk-Based Lending approach for underwriting its home equity products and other consumer loans. This approach evaluates the borrower’s credit score, debt-to-income ratio and the collateral value. Borrowers with a higher credit score generally qualify for a lower interest rate.

     The types of loans that the Bank may originate are subject to federal and state laws and regulations. Interest rates charged by the Bank on loans are affected principally by the demand for such loans, the supply of money available for lending purposes, the rates offered by its competitors and the risks involved on such loans. These factors are, in turn, affected by general economic conditions, the monetary policy of the federal government, including the FRB, legislative tax policies and governmental budgetary matters.

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     Certain officers of the Bank have been authorized by the Board of Directors to approve loans up to specific designated amounts. The Bank’s Loan Committee meets weekly and reviews all loans that exceed individual loan approval limits. New loans and loan modifications are reviewed by the Bank’s full Board of Directors as part of its monthly review of the Loan Committee minutes.

     A federal savings bank generally may not make loans to one borrower and related entities in an amount which exceeds 15% of its unimpaired capital and surplus (or approximately $19.2 million in the case of the Bank at December 31, 2007), although loans in an amount equal to an additional 10% of unimpaired capital and surplus may be made to a borrower if the loans are fully secured by readily marketable securities. Since January 2003, the Bank has had a general guideline of limiting multiple loans to the same borrower to 75% of the regulatory limit.

     The Bank is also required to monitor its aggregate loans to corporate groups. These are loans that are made to individual entities that have a similar ownership group but are not considered to be a common enterprise. While the individual loans are secured by separate property and underwritten based on separate cash flows, the entities may all be owned or controlled by one individual or a group of individuals. The Bank is required by regulation to limit its aggregate loans to any corporate group to 50% of Tier 1 capital. At December 31, 2007, the Bank’s Tier 1 capital was $120.2 million. The Bank’s two largest corporate group relationships at December 31, 2007 equaled $23.3 million and $17.2 million, respectively. Both of these relationships are well below the group limit of $60.1 million and are performing in accordance with their terms.

COMMERCIAL AND CONSTRUCTION LENDING

General

     The Company’s commercial and construction lending portfolio includes commercial real estate loans, construction and development financing, and commercial and industrial loans. The business banking division is responsible for growing the Company’s commercial loan portfolio by generating loans of $100,000 or more to small businesses. These commercial and construction loans generally have variable interest rates indexed to the prime lending rate, the London Interbank Offered Rate (LIBOR) or the three- or five-year U.S. Treasury obligations.

Commercial Real Estate

     The majority of the Bank’s commercial loan portfolio is made up of loans secured by commercial real estate, including multi-family residential loans. These loans generally have three to ten year terms with an amortization period of 25 years or less. The Bank offers fixed interest rate loans and variable rate loans with fixed interest rates for the initial three- or five-year period which then adjust at each three- or five-year interval to a designated index such as the prime lending rate or LIBOR plus a stipulated margin for the remainder of the term. Commercial real estate loans generally have shorter terms to maturity and higher yields than the Bank’s one-to-four family residential mortgage loans. Upon closing, the Bank usually receives fees of between 0.25% and 1.0% of the principal loan balance. These loans are typically subject to prepayment penalties. The Bank generally obtains personal guarantees for commercial real estate loans from any principal owning 20% of more of the business.

     The Bank evaluates various aspects of commercial real estate loans in an effort to manage credit risk to an acceptable level. In underwriting these loans, consideration is given to the stability of the property’s cash flow, future operating projections, management experience, current and projected occupancy, location and physical condition. In addition, the Bank in most cases performs sensitivity analysis on cash flows utilizing various occupancy and interest rate assumptions when underwriting the loans to determine how different scenarios may impact the borrowers’ ability to repay the loans. The Bank has generally imposed a debt coverage ratio (the ratio of net income before interest, depreciation and debt payments to debt service) of not less than 110% for commercial real estate loans. The underwriting analysis also includes a review of the financial condition of borrowers and guarantors as well as cash flows from global resources. An appraisal report is prepared by an independent appraiser commissioned by the Bank to determine property values based upon current market conditions. All appraisal reports and any necessary environmental site assessments are reviewed by the Bank before the loan closes.

     Commercial real estate lending entails substantial risks because these loans often involve large loan balances to single borrowers and the payment experience on these loans is typically dependent on the successful operation of the project or the borrower’s business. These risks can also be significantly affected by supply and demand conditions

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in the local market for apartments, offices, warehouses or other commercial space. The Bank attempts to minimize its risk exposure by considering properties with existing operating performances that can be analyzed, requiring conservative debt coverage ratios and periodically monitoring the operation and physical condition of the collateral as well as the business occupying the property.

     The Bank’s commercial real estate loans are secured by hotels, medical office facilities, multi-family residential buildings, churches, small office buildings, strip shopping centers and other commercial uses. These loans were previously originated in amounts of less than $15.0 million; the Bank is currently limiting these loans to amounts of less than $5.0 million. At December 31, 2007, the average outstanding balance of the Bank’s commercial real estate loans approximated $730,000.

Construction and Land Development Loans

     The Bank currently offers construction loans for commercial real estate and multi-family residential properties along with construction loans to local residential builders. The Bank’s construction portfolio also includes construction/permanent one-to-four family residential loans which will convert to permanent mortgage loans upon the completion of the construction. At the time of conversion, these loans will become part of the Bank’s one-to-four family residential mortgage loan portfolio.

     The Bank also originates loans to developers for the purpose of developing the land (i.e., roads, sewer and water) for sale. These loans are secured by a mortgage on the property which is generally limited to the lesser of 75% of its appraised value or 75% of its cost and are typically made for a period of up to three years. The Bank requires monthly interest payments during the loan’s term. The principal of the loan is reduced as lots are sold and released. The majority of the Bank’s land development loans are secured by property located in its primary market area. In addition, the Bank generally obtains personal guarantees from the borrower’s principals for construction and land development loans.

     The Bank’s loan underwriting and processing procedures require a property appraisal by an approved independent appraiser and each construction and development loan is reviewed by independent architects, engineers or other qualified third parties for verification of costs. Disbursements during the construction phase are based on regular on-site inspections and approved certifications. In the case of construction loans on commercial projects where the Bank provides the permanent financing, the Bank usually requires firm lease commitments on some portion of the property under construction from qualified tenants. In addition, the Bank primarily provides residential and commercial construction lending within its market area.

     Construction and development financing is generally considered to involve a higher degree of risk of loss than long-term financing on improved, owner-occupied real estate. The Bank’s risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the property’s value at completion of construction or development, the estimated cost (including interest) of construction, and the absorption rate utilized in the original appraisal report. If the estimate of construction cost proves to be inaccurate, the Bank typically seeks to require the borrower to inject cash equity to cover any shortfall. The Bank may then need to advance funds beyond the amount originally committed to ensure completion of the development.

     In evaluating any new originations of construction and development loans, the Bank generally considers evidence of the availability of permanent financing or a takeout commitment to the borrower, the reputation of the borrower and the contractor, the amount of the borrower’s equity in the project, independent valuations and reviews of cost estimates, pre-construction sale or leasing information, and cash flow projections of the borrower. To reduce the inherent lending risk, the Bank may require performance bonds in the amount of the construction contract and generally obtains personal guarantees from the principals of the borrower.

     At December 31, 2007, the average outstanding balance of the Bank’s construction and land development loans was approximately $846,000.

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Commercial and Industrial Loans

     The Bank also originates commercial loans that are primarily secured by business assets other than real estate and secured and unsecured operating lines of credit. These types of loans undergo an underwriting process similar to the other types of commercial lending the Bank offers; however, these loans tend to have different risks associated with them since repayment is based on the cash flows of the business operation. As of December 31, 2007, the average outstanding balance of the Bank’s commercial and industrial loans was approximately $163,000.

RETAIL LENDING

General

     The Bank’s retail lending program includes one-to-four family residential loans, home equity loans, HELOCs, lot loans, auto loans and other consumer loans. The Bank’s senior personal bankers are responsible for originating its retail loans. Retail loans may also be originated by its customer call center or via the internet at the Bank’s website, www.citz.com. Previously, the Bank’s primary focus was on originating and retaining variable-rate retail products; however, the Bank began retaining certain fixed-rate amortizing one-to-four family residential loans toward the end of 2007 and anticipates that it will continue to retain the one-to-four family residential loans it originates during 2008.

One-to-Four Family Residential Loans

     Substantially all of the Bank’s one-to-four family residential mortgage loans consist of conventional loans. Conventional loans are neither insured by the Federal Housing Administration (FHA) nor partially guaranteed by the Department of Veterans Affairs (VA). The vast majority of the Bank’s one-to-four family residential mortgage loans are secured by properties located in the Bank’s market areas.

     The Bank’s residential mortgage loans have either fixed interest rates or variable interest rates which adjust periodically during the term of the loan. Fixed-rate loans generally have maturities between 10 and 30 years and are fully amortizing with monthly loan payments sufficient to repay the total amount of the loan and interest by the maturity date. The Bank does not originate non-amortizing one-to-four family residential loans. Substantially all of the Bank’s one-to-four family residential mortgage loans contain due-on-sale clauses, which permit the Bank to declare the unpaid balance to be due and payable upon the sale or transfer of any interest in the property securing the loan. The Bank enforces such due-on-sale clauses.

     The Bank’s fixed-rate loans are generally originated under terms, conditions and documentation which permit them to be sold in the secondary market. At December 31, 2007, $86.2 million, or 40.5%, of the Bank’s one-to-four family residential mortgage loans were fixed-rate loans. During 2007, the Bank sold approximately $10.9 million of fixed-rate loans, of which $9.2 million were sold with servicing retained.

     The adjustable-rate one-to-four family residential mortgage (ARM) loans currently offered by the Bank have interest rates which are fixed for the initial three- or five-year period and then adjust annually to the corresponding constant maturity (CMT) plus a stipulated margin. The Bank’s ARMs generally have a cap of 2% on any increase or decrease in the interest rate at any adjustment date and include a specified cap on the maximum interest rate increases over the life of the loan. This cap is generally 6% above the initial rate. The Bank’s ARMs require that any payment adjustment resulting from a change in the interest rate of an adjustable-rate loan be sufficient to result in full amortization of the loan by the end of the loan term and do not permit any of the increased payment to be added to the principal amount of the loan, or so-called negative amortization. The Bank does not have any interest-only adjustable rate one-to-four family residential loans in its portfolio. At December 31, 2007, $126.4 million, or 59.5%, of the Bank’s one-to-four family residential mortgage loans were adjustable-rate loans.

     The Bank’s one-to-four family residential loans generally do not exceed amounts limited to the maximum amounts contained in U.S. Government sponsored agency guidelines. In addition, the Bank’s maximum loan-to-value (LTV) ratio for these loans is generally 95% of the lesser of the secured property’s sales price or appraised value and generally obtains private mortgage insurance on the portion of the principal amount that exceeds 80% of the appraised value.

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     Although the Bank has generally sought to avoid making sub-prime loans, it has limited exposure to these types of loans. At December 31, 2007, the Company’s retail loan portfolio included $15.5 million of loans to borrowers who meet the Bank’s internal guidelines of a sub-prime retail borrower, which is primarily determined by the borrower’s credit scores at the time of approval. The average outstanding balance for these loans is $52,000. Of the total retail loans considered by the Company’s management to be sub-prime, over 88% were current in their payments at December 31, 2007.

Home Equity Products

     The majority of the Bank’s home equity products are HELOCs which are structured as a variable-rate line of credit with terms up to 20 years including a 10 year repayment period. The Bank also offers home equity loans with a 10 year term which have a fixed-rate through maturity. The Bank’s home equity products are secured by the underlying equity in the borrower’s residence. These products generally require LTV ratios of 90% or less after taking into consideration any first mortgage loan. There is a higher risk associated with this type of lending since these products are typically secured by a second mortgage on the borrower’s residence. The Bank looks to the borrower’s credit score as an indication of the applicant’s ability to pay and a factor in establishing the interest rate on the loan or line of credit.

Other Loans

     The Bank’s other retail loans consist primarily of consumer loans, loans secured by deposit accounts and auto loans. The Bank is not actively marketing these types of loans and offers them primarily as an accommodation to its existing relationship customers.

SECURITIES ACTIVITIES

     The Company’s investment policy, which has been established by the Board of Directors, is designed to prescribe authorized investments and outline the Company’s practices for managing risks involved with investment securities. The investments of the Company are managed to balance the following objectives:

• preserving principal;
   
• providing liquidity for loan demand, deposit fluctuations and other statement of condition changes;
   
• insulating net interest income from the impact of changes in market interest rates;
   
• maximizing return on invested funds within acceptable risk guidelines; and
   
• meeting pledging and liquidity requirements.

     The Company’s investment policy permits investments in various types of securities including obligations of the U.S. Treasury, federal agencies, government sponsored entities (GSEs), investment grade corporate obligations (A rated or better), trust preferred securities, other equity securities, commercial paper, certificates of deposit, and federal funds sold to financial institutions approved by the Board of Directors. The Company currently does not participate in hedging programs, interest rate swaps or other activities involving the use of off-balance sheet derivative instruments.

     The Company evaluates all 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 Financial Accounting Standards Board (FASB) Staff Position (FSP) 115-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. In evaluating the possible impairment of securities, consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial conditions and near-term prospects of the issuer, and the ability and intent of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an issuer’s financial condition, the Company may consider whether the securities are issued by the federal government or its agencies or government sponsored agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer’s financial condition. If management determines that an investment experienced an OTTI, the loss is recognized in the income statement as a realized loss. Any recoveries related to the value of these securities are recorded as an unrealized gain (as other comprehensive income (loss) in stockholders’

9

equity) and not recognized in income until the security is ultimately sold. The Company from time to time 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.

SOURCE OF FUNDS

General

     Deposits are the primary source of the Bank’s funds for lending and other investment purposes. In addition to deposits, the Bank derives funds from loan principal repayments and borrowings. Loan repayments are historically a relatively stable source of funds, while deposit inflows and outflows are significantly influenced by general interest rates and money market conditions. The Bank has used borrowings in the past, primarily Federal Home Loan Bank (FHLB) advances, to supplement its deposits as a source of funds.

Deposits

     The Bank’s deposit products include a broad selection of deposit instruments, including checking accounts, money market accounts, savings accounts and certificates of deposit. The Bank considers its checking, money market and savings accounts to be its core deposits. Deposit account terms may vary with principal differences including: (i) the minimum balance required; (ii) the time periods the funds must remain on deposit; and (iii) the interest rate paid on the account.

     The Bank utilizes traditional marketing methods to attract new customers and deposits. The Bank does not advertise for deposits outside of its market area nor does it currently utilize the services of deposit brokers. The Bank has increased the amount of public deposits with local municipalities by developing products attractive to these entities. Due to the relatively large size of these balances and the cyclical nature of the municipalities’ cash flows, the Bank’s total deposits can fluctuate as a result of changes in these balances. At times, the Bank has implemented initiatives to attract core deposits in all of its markets by offering various limited-time promotions for new deposit accounts. As the need for funds warrant, the Bank may continue to use deposit promotions in new and existing markets to build its customer base.

Borrowed Money

     Although deposits are the Bank’s primary source of funds, the Bank’s policy has been to utilize borrowings, such as advances from the FHLB. The advances from the FHLB – Indianapolis (FHLB–IN) are secured by capital stock of the FHLB–IN, a blanket pledge of certain of the Bank’s mortgage loans, and FHLB–IN time deposits. These advances are made in accordance with several different credit programs, each of which has its own interest rate and range of maturities. The Bank has, from time to time, utilized short-term Federal Funds purchased as a source of funds. The Bank also began offering sales of securities under agreements to repurchase (Repo Sweeps). These Repo Sweeps are treated as financings, and the obligations to repurchase securities sold are reflected as borrowed money in the Company’s consolidated statements of condition.

SUBSIDIARIES

     During 2007, the Bank had one active, wholly-owned subsidiary, CFS Holdings, Ltd. (CFS Holdings). This subsidiary was approved by the OTS in January 2001 and began operations in June 2001. CFS Holdings is located in Hamilton, Bermuda. It was funded with approximately $140.0 million of the Bank’s investment securities and performs a significant amount of the Bank’s securities investing activities. Certain of these activities are performed by a resident agent in Hamilton in accordance with the operating procedures and investment policy established by the Bank for CFS Holdings. Revenues of CFS Holdings were $4.1 million for the year ended December 31, 2007 compared to $3.3 million and $3.0 million for the years ended December 31, 2006 and 2005, respectively. Operating expenses of this subsidiary were $63,000 for the year ended December 31, 2007 compared to $61,000 and $65,000 for the years ended December 31, 2006 and 2005, respectively.

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REGULATION

Regulation of Savings and Loan Holding Companies

     The Company is a registered savings and loan holding company. The Home Owners’ Loan Act (HOLA), as amended, and OTS regulations generally prohibit a savings and loan holding company, without prior OTS approval, from acquiring, directly or indirectly, the ownership or control of any other savings association or savings and loan holding company, or all, or substantially all, of the assets or more than 5% of the voting shares thereof. These provisions also prohibit, among other things, any director or officer of a savings and loan holding company, or any individual who owns or controls more than 25% of the voting shares of such holding company, from acquiring control of any savings association not a subsidiary of such savings and loan holding company, unless the acquisition is approved by the OTS.

Holding Company Activities

     The Company currently operates as a unitary savings and loan holding company. Generally, there are limited restrictions on the activities of a unitary savings and loan holding company which existed as of May 4, 1999 (which would include the Company) and its non-savings association subsidiaries. If the Company ceases to be a unitary savings and loan holding company, the activities of the Company and its non-savings association subsidiaries would thereafter be subject to substantial restrictions.

     The HOLA requires every savings association subsidiary of a savings and loan holding company to give the OTS at least 30 days advance notice of any proposed dividends to be made on its guarantee, permanent or other non-withdrawable stock, or else such dividend will be invalid.

Affiliate Restrictions

     Transactions between a savings association and its “affiliates” are subject to quantitative and qualitative restrictions under Sections 23A and 23B of the Federal Reserve Act. Affiliates of a savings association include, among other entities, the savings association’s holding company and companies that are under common control with the savings association.

     In general, these restrictions limit the amount of the transactions between a savings association and its affiliates, as well as the aggregate amount of transactions between a savings association and all of its affiliates, impose collateral requirements in some cases and require transactions with affiliates to be on the same terms comparable to those with unaffiliated entities.

Financial Modernization

     Under the Gramm-Leach-Bliley Act enacted into law on November 12, 1999, no company may acquire control of a savings and loan holding company after May 4, 1999 unless the company is engaged only in activities traditionally permitted for a multiple savings and loan holding company or newly permitted for a financial holding company under Section 4(k) of the Bank Holding Company Act. Existing savings and loan holding companies, such as the Company, and those formed pursuant to an application filed with the OTS before May 4, 1999, may engage in any activity including non-financial or commercial activities provided such companies control only one savings and loan association that meets the Qualified Thrift Lender test. Corporate reorganizations are permitted, but the transfer of grandfathered unitary holding company status through acquisition is not permitted.

Sarbanes-Oxley Act of 2002

     The Sarbanes-Oxley Act of 2002 (Act) implemented legislative reforms intended to address corporate and accounting fraud. In addition to the establishment of a new accounting oversight board which enforces auditing, quality control and independence standards and is funded by fees from all publicly traded companies, the bill restricts provision of both auditing and consulting services by accounting firms. To ensure auditor independence, any non-audit services being provided to an audit client require pre-approval by the company’s audit committee members. In addition, the audit partners must be rotated. The bill requires the principal chief executive officer and the principal chief financial officer to certify to the accuracy of periodic reports filed with the SEC, subject to civil and criminal

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penalties if they knowingly or willfully violate this certification requirement. In addition, under the Act, counsel is required to report evidence of a material violation of the securities laws or a breach of fiduciary duty by a company to its chief executive officer or its chief legal officer, and, if such officer does not appropriately respond, to report such evidence to the audit committee or other similar committee of the board of directors or the board itself.

     The Act provides for disgorgement of bonuses issued to top executives prior to restatement of a company’s financial statements if such restatement was due to corporate misconduct. Executives are also prohibited from insider trading during retirement plan “blackout” periods, and loans to company executives are restricted. The legislation accelerated the time frame for disclosures by public companies, as they must immediately disclose any material changes in their financial condition or operations. Directors and executive officers must also provide information for most changes in ownership in a company’s securities within two business days of the change.

     The Act also increases the oversight of, and codifies certain requirements relating to audit committees of public companies and how they interact with the company’s registered public accounting firm (RPAF). Audit committee members must be independent and are barred from accepting consulting, advisory or other compensatory fees from the issuer. In addition, companies must disclose whether at least one member of the committee is a “financial expert” as defined by the SEC and if not, why not. As required by the Act, the SEC has prescribed rules requiring inclusion of an internal control report and assessment by management in the annual report to shareholders. The RPAF that issues the audit report must attest to and report on the effectiveness of the company’s internal controls. See “Item 9A. Controls and Procedures” of this Annual Report on Form 10-K.

Regulation of Federal Savings Banks

     As a federally insured savings bank, lending activities and other investments of the Bank must comply with various statutory and regulatory requirements. The Bank is regularly examined by the OTS and must file periodic reports concerning its activities and financial condition.

     Although the OTS is the Bank’s primary regulator, the Federal Deposit Insurance Corporation (FDIC) has backup enforcement authority over the Bank. The Bank’s eligible deposit accounts are insured by the FDIC up to applicable limits.

Regulatory Capital Requirements

     OTS capital regulations require savings banks to satisfy minimum capital standards: risk-based capital requirements, leverage requirements, and tangible capital requirements. Savings banks must meet each of these standards in order to be deemed in compliance with OTS capital requirements. In addition, the OTS may require a savings association to maintain capital above the minimum capital levels.

     All savings banks are required to meet a minimum risk-based capital requirement of total capital (core capital plus supplementary capital) equal to 8% of risk-weighted assets (which includes the credit risk equivalents of certain off-balance sheet items). In calculating total capital for purposes of the risk-based requirement, supplementary capital may not exceed 100% of core capital. Under the leverage requirement, a savings bank is required to maintain core capital equal to a minimum of 3% of adjusted total assets. In addition, under the prompt corrective action provisions of the OTS regulations, all but the most highly-rated institutions must maintain a minimum leverage ratio of 4% in order to be adequately capitalized. A savings bank is also required to maintain tangible capital in an amount at least equal to 1.5% of its adjusted total assets.

     These capital requirements are viewed as minimum standards by the OTS, and most institutions are expected to maintain capital levels well above these minimums. The OTS regulations provide that higher individual minimum regulatory capital requirements may be appropriate in circumstances where, among others: (i) a savings association has a high degree of exposure to interest rate risk, prepayment risk, credit risk, concentration of credit risk, certain risks arising from nontraditional activities, and similar risks of a high proportion of off-balance sheet risk; (ii) a savings association is growing, either internally or through acquisitions, at such a rate that supervisory problems are presented and are not managed adequately under OTS regulations; or (iii) a savings association may be adversely affected by the activities or condition of its holding company, affiliates, subsidiaries or other persons or savings associations with which it has significant business relationships. The Bank is not subject to any such individual minimum regulatory capital requirement.

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     The Bank’s tangible and core capital ratios were 10.5%, and its total risk-based capital ratio was 13.93% at December 31, 2007. At such date, the Bank met the capital requirements of a “well-capitalized” institution under applicable OTS regulations. For further discussion related to the Bank’s capital ratios see “Note 12. Stockholders’ Equity and Regulatory Capital” in the notes to consolidated financial statements included in “Item 8. Financial Statements and Supplementary Data” of this Annual Report on Form 10-K.

Consequences of Failure to Comply with Regulatory Capital Requirements

     Any savings bank not in compliance with all of the capital requirements is required to submit a capital plan that addresses the bank’s need for additional capital and meets certain additional requirements. While the capital plan is being reviewed by the OTS, the savings bank must certify, among other things, that it will not, without the approval of its appropriate OTS Regional Director, grow beyond net interest credited or make capital distributions. If a savings bank’s capital plan is not approved, the bank will become subject to additional growth and other restrictions. In addition, the OTS, through a capital directive or otherwise, may restrict the ability of a savings bank not in compliance with the capital requirements to pay dividends and compensation, and may require such a bank to take one or more of certain corrective actions, including, without limitation: (i) increasing its capital to specified levels, (ii) reducing the rate of interest that may be paid on savings accounts, (iii) limiting receipt of deposits to those made to existing accounts, (iv) ceasing issuance of new accounts of any or all classes or categories except in exchange for existing accounts, (v) ceasing or limiting the purchase of loans or the making of other specified investments, and (vi) limiting operational expenditures to specified levels. Noncompliance with the standards established by the OTS or other regulators may also constitute grounds for other enforcement action by the federal banking regulators, including cease and desist orders and civil monetary penalty assessments.

     The HOLA permits savings banks not in compliance with the OTS capital standards to seek an exemption from certain penalties or sanctions for noncompliance. If an exemption is granted by the OTS, the savings bank still may be subject to enforcement actions for other violations of law or unsafe or unsound practices or conditions.

Prompt Corrective Action

     The prompt corrective action regulation of the OTS, promulgated under the Federal Deposit Insurance Corporation Improvement Act of 1991, requires certain mandatory actions and authorizes certain other discretionary actions to be taken by the OTS against a savings bank that falls within certain undercapitalized capital categories specified in the regulation. The regulation establishes five categories of capital classification: “well-capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized.” Under the regulation, the ratio of total capital to risk-weighted assets, core capital to risk-weighted assets and the leverage ratio are used to determine an institution’s capital classification. At December 31, 2007, the Bank met the capital requirements of a “well-capitalized” institution under applicable OTS regulations. For further discussion related to the Bank’s capital ratios see “Note 12. Stockholders’ Equity and Regulatory Capital” in the notes to consolidated financial statements included in “Item 8. Financial Statements and Supplementary Data” of this Annual Report on Form 10-K.

Capital Distribution Regulation

     OTS regulations impose limitations upon all capital distributions by a savings institution if the institution would not be “well-capitalized” after the distributions. Capital distributions include cash dividends, payments to repurchase or otherwise acquire the institution’s own stock, payments to shareholders of another institution in a cash-out merger and other distributions charged against capital. The regulations provide that an institution must submit an application to the OTS to receive approval of the capital distributions if the institution (i) is not eligible for expedited treatment; or (ii) proposes capital distributions for the applicable calendar year that exceed in the aggregate its net income for that year to date plus its retained income for the preceding two years; or (iii) would not be at least adequately capitalized following the distribution; or (iv) would violate a prohibition contained in a statute, regulation or agreement between the institution and the OTS by performing the capital distribution. Under any other circumstances, the institution would be required to provide a written notice to the OTS prior to the capital distribution. Based on its retained income for the preceding two years, the Bank is currently restricted from making any capital distributions without prior written approval from the OTS. During 2007, the Bank requested (and received) approval from the OTS to pay dividends to the Company in the amount of $7.0 million to be paid on a quarterly basis.

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Qualified Thrift Lender Test

     Like all OTS-regulated institutions, the Bank is required to meet a Qualified Thrift Lender (QTL) test or the Internal Revenue Service (IRS) tax code Domestic Building and Loan Association (DBLA) test to avoid certain restrictions on its operations, including restrictions on its ability to branch interstate and the Company’s mandatory registration as a savings and loan holding company under the HOLA. A savings association satisfies the QTL test if: (i) on a monthly average basis in at least nine months out of each twelve month period, at least 65% of a specified asset base of the savings association consists of loans to small businesses, credit card loans, educational loans, or certain assets related to domestic residential real estate, including residential mortgage loans and mortgage securities; or (ii) at least 60% of the savings association’s total assets consist of cash, U.S. government or government agency debt or equity securities, fixed assets, or loans secured by deposits, real property used for residential, educational, church, welfare, or health purposes, or real property in certain urban renewal areas. To be a QTL under the DBLA test, a savings association must meet a “business operations test” and a “60 percent of assets test.” The business operations test requires the business of a DBLA to consist primarily of acquiring the savings of the public and investing in loans. An institution meets the public savings requirement when it meets one of two conditions: (i) the institution acquires its savings in conformity with OTS rules and regulations and (ii) the general public holds more than 75% of its deposits, withdrawable shares, and other obligations. An institution meets the investing in loans requirement when more than 75% of its gross income consists of interest on loans and government obligations, and various other specified types of operating income that financial institutions ordinarily earn. The 60% of assets test requires that at least 60% of a DBLA’s assets must consist of assets that savings associations normally hold, except for consumer loans that are not educational loans. The Bank met the requirements of the DBLA test by maintaining 63% of such assets at December 31, 2007.

     A savings association which fails to meet either test must either convert to a bank or be subject to the following penalties: (i) it may not enter into any new activity except for those permissible for both a national bank and for a savings association; (ii) its branching activities shall be limited to those of a national bank; and (iii) it shall be bound by regulations applicable to national banks respecting payment of dividends. Within three years of failing the QTL test or DBLA test the association must dispose of any investment or activity not permissible for both a national bank and a savings association. If such a savings association is controlled by a savings and loan holding company, then such holding company must, within a prescribed time period, become registered as a bank holding company and become subject to all rules and regulations applicable to bank holding companies (including restrictions as to the scope of permissible business activities).

Regulation by the FDIC and Deposit Insurance Premiums

     The Bank is a member of the Deposit Insurance Fund (DIF), which is administered by the FDIC. The deposits of the Bank are insured to the maximum extent permitted by the FDIC and the insurance is backed by the full faith and credit of the U.S. Government. As insurer, the FDIC is authorized to conduct examinations of, and to require reporting by, FDIC-insured institutions. It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the DIF. The FDIC also has the authority to initiate enforcement actions against savings institutions, after giving the OTS an opportunity to take such action.

     The FDIC merged the Bank Insurance Fund (BIF) and the Savings Association Insurance Fund (SAIF) to form the DIF on March 31, 2006 in accordance with the Federal Deposit Insurance Reform Act of 2005. The FDIC maintains the DIF by assessing depository institutions an insurance premium. The FDIC annually sets the reserve level of the DIF within a statutory range between 1.15% and 1.50% of insured deposits. The FDIC set the reserve level at 1.25% for 2007 and it will remain at that level for 2008. If the reserve level of the insurance fund falls below 1.15%, or is expected to do so within six months, the FDIC must adopt a restoration plan that will restore the DIF to a 1.15% ratio generally within five years. If the reserve level exceeds 1.35%, the FDIC may return some of the excess in the form of dividends to insured institutions.

     The FDIC Board approved a new risk-based premium system in November 2006 which was effective January 1, 2007. The FDIC’s new regulations for risk-based deposit insurance assessments establish four Risk Categories. Risk Category I, for well-capitalized institutions that are financially sound with only a few minor weaknesses, includes approximately 95% of FDIC-insured institutions. Risk Categories II, III, and IV consist of institutions that present progressively greater risks to the DIF. Effective January 1, 2007, Risk Category I institutions pay quarterly

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assessments for deposit insurance at annual rates of five to seven basis points for every $100 of deposit accounts. The rates for Risk Categories II, III, and IV are seven, 28, and 43 basis points, respectively. Rates are subject to change with advance notice to insured institutions.

     An institution (or its successor) insured by the FDIC on December 31, 1996 which had previously paid high premiums in the past to bolster the FDIC’s insurance reserves were assigned assessment credits to initially offset all of their premiums in 2007. The Bank was assigned a $1.2 million credit to be applied to future insurance premiums and utilized $470,000 of the credit towards the full payment of its 2007 insurance premiums. On November 5, 2007, the FDIC announced that it would decide whether to adjust the existing premium levels in March 2008.

     In addition to the FDIC insurance premium, the Bank is required to pay a semi-annual Financing Corporation (FICO) assessment in order to share in the payment of interest due on bonds used to provide liquidity to the savings and loan industry in the 1980s. During 2007, the Bank’s FICO assessment totaled $104,000, or 1.16 basis points of its insured deposits for the year ended December 31, 2007.

Termination of Deposit Insurance

     The FDIC may terminate the deposit insurance of any insured depository institution, including the Bank, if it determines after a hearing that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed by an agreement with the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC. There are no pending proceedings to terminate the deposit insurance of the Bank.

Community Reinvestment Act and the Fair Lending Laws

     Savings institutions have a responsibility under the Community Reinvestment Act (CRA) and related regulations of the OTS to help meet the credit needs of their communities, including low and moderate-income neighborhoods. In addition, the Equal Credit Opportunity Act and the Fair Housing Act (together, Fair Lending Laws) prohibit lenders from discriminating in their lending practices on the basis of characteristics specified in those statutes. An institution’s failure to comply with the provisions of CRA could, at a minimum, result in regulatory restrictions on its activities. Failure to comply with the Fair Lending Laws could result in enforcement actions by the OTS, as well as other federal regulatory agencies and the Department of Justice. The Bank received a satisfactory rating during its latest CRA examination in 2006.

Safety and Soundness Guidelines

     The OTS and the other federal banking agencies have established guidelines for safety and soundness, addressing operational and managerial, as well as compensation matters for insured financial institutions. Institutions failing to meet these standards are required to submit compliance plans to their appropriate federal regulators. The OTS and the other agencies have also established guidelines regarding asset quality and earnings standards for insured institutions.

Change of Control

     Subject to certain limited exceptions, no company can acquire control of a savings association without the prior approval of the OTS, and no individual may acquire control of a savings association if the OTS objects. Any company that acquires control of a savings association becomes a savings and loan holding company subject to extensive registration, examination and regulation by the OTS. Conclusive control exists, among other ways, when an acquiring party acquires more than 25% of any class of voting stock of a savings association or savings and loan holding company, or controls in any manner the election of a majority of the directors of the company. In addition, a rebuttable presumption of control exists if, among other things, a person acquires more than 10% of any class of a savings association’s or savings and loan holding company’s voting stock (or 25% of any class of stock) and, in either case, any of certain additional control factors exist.

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     Companies subject to the Bank Holding Company Act of 1956, as amended (BCHA), that acquire or own savings associations are no longer defined as savings and loan holding companies under the HOLA and, therefore, are not generally subject to supervision and regulation by the OTS. OTS approval is not required for a bank holding company to acquire control of a savings association, although the OTS has a consultative role with the FRB in examination, enforcement and acquisition matters. Holding companies that control both a bank and a savings association, however, are subject to registration, examination and regulation under the BCHA and FRB regulations promulgated thereunder.

Consumer Lending Laws

     The Bank is subject to many federal consumer protection statutes and regulations including the Equal Credit Opportunity Act, the Fair Housing Act, the Truth in Lending Act, the Truth in Savings Act, the Real Estate Settlement Procedures Act and the Home Mortgage Disclosure Act. Among other things, these acts:

• require lenders to disclose credit terms in meaningful and consistent ways;
   
• prohibit discrimination against an applicant in any consumer or business credit transaction;
   
• prohibit discrimination in housing-related lending activities;
   
• require certain lenders to collect and report applicant and borrower data regarding loans for home purchases or improvement projects;
   
• require lenders to provide borrowers with information regarding the nature and cost of real estate settlements;
   
• prohibit certain lending practices and limit escrow account amounts with respect to real estate transactions; and
   
• prescribe possible penalties for violations of the requirements of consumer protection statutes and regulations.

Federal Fair Lending Laws

     The Fair Lending Laws prohibit discriminatory lending practices. The Equal Credit Opportunity Act prohibits discrimination against an applicant in any credit transaction, whether for consumer or business purposes, on the basis of race, color, religion, national origin, sex, marital status, age (except in limited circumstances), receipt of income from public assistance programs or good faith exercise of any rights under the Consumer Credit Protection Act. Under the Fair Housing Act, it is unlawful for any lender to discriminate in its housing-related lending activities against any person because of race, color, religion, national origin, sex, handicap or familial status. Among other things, these laws prohibit a lender from denying or discouraging credit on a discriminatory basis, making excessively low appraisals of property based on racial considerations, or charging excessive rates or imposing more stringent loan terms or conditions on a discriminatory basis. In addition to private actions by aggrieved borrowers or applicants for actual and punitive damages, the U.S. Department of Justice and other regulatory agencies can take enforcement action seeking injunctive and other equitable relief for alleged violations.

Fair Credit Reporting Act

     In connection with the passage of the Fair and Accurate Credit Transactions (FACT) Act, the Bank’s financial regulator has issued final rules and guidelines, effective November 1, 2008, requiring the Bank to adopt and implement a written identify theft prevention program, paying particular attention to 26 identified “red flag” events. The program must also assess the validity of address change requests for card issuers and for users of consumer reports to verify the subject of a consumer report in the event of notice of an address discrepancy.

     The FACT Act also gives consumers the ability to challenge the Bank with respect to credit reporting information provided by the Bank. The new rule also prohibits the Bank from using certain information it may acquire from an affiliate to solicit the consumer for marketing purposes unless the consumer has been given notice and an opportunity to opt out of such solicitation for a period of five years.

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Home Mortgage Disclosure Act

     The federal Home Mortgage Disclosure Act, or HMDA, grew out of public concern over credit shortages in certain urban neighborhoods. One purpose of HMDA is to provide public information that will help show whether financial institutions are serving the housing credit needs of the neighborhoods and communities in which they are located. HMDA also includes a “fair lending” aspect that requires the collection and disclosure of data about applicant and borrower characteristics as a way of identifying possible discriminatory lending patterns and enforcing anti-discrimination statutes. The HMDA requires institutions to report data regarding applications for loans for the purchase or improvement of one-to-four family and multi-family dwellings, as well as information concerning originations and purchases of such loans. Federal bank regulators rely, in part, upon data provided under HMDA to determine whether depository institutions engage in discriminatory lending practices.

     The appropriate federal banking agency, or in some cases the Department of Housing and Urban Development, enforces compliance with HMDA and implements its regulations. Administrative sanctions, including civil money penalties, may be imposed by supervisory agencies for violations of this act.

Real Estate Settlement Procedures Act

     The federal Real Estate Settlement Procedures Act, or RESPA, requires lenders to provide borrowers with disclosures regarding the nature and cost of real estate settlements. RESPA also prohibits certain abusive practices, such as kickbacks, and places limitations on the amount of escrow accounts. Violations of RESPA may result in imposition of penalties, including: (1) civil liability equal to three times the amount of any charge paid for the settlement services or civil liability of up to $1,000 per claimant, depending on the violation; (2) awards of court costs and attorneys’ fees; and (3) fines of not more than $10,000 or imprisonment for not more than one year, or both.

Truth in Lending Act

     The federal Truth in Lending Act is designed to ensure that credit terms are disclosed in a meaningful way so that consumers may compare credit terms more readily and knowledgeably. As result of the act, all creditors must use the same credit terminology and expressions of rates, and disclose the annual percentage rate, the finance charge, the amount financed, the total of payments and the payment schedule for each proposed loan.

     Violations of the Truth in Lending Act may result in regulatory sanctions and in the imposition of both civil and, in the case of willful violations, criminal penalties. Under certain circumstances, the Truth in Lending Act also provides a consumer with a right of rescission, which if exercised within three business days would require the creditor to reimburse any amount paid by the consumer to the creditor or to a third party in connection with the loan, including finance charges, application fees, commitment fees, title search fees and appraisal fees. Consumers may also seek actual and punitive damages for violations of the Truth in Lending Act.

Federal Home Loan Bank System

     The Bank is a member of the Federal Home Loan Bank system, which consists of 12 regional FHLBs. The FHLB system provides a central credit facility primarily for member institutions. The Bank, as a member of the FHLB of Indianapolis (FHLB–IN), is required to acquire and hold shares of capital stock in this FHLB in an amount at least equal to 1% of the aggregate principal amount of its unpaid residential mortgage loans and similar obligations at the beginning of each year, or 1/20 of its advances (borrowings) from this FHLB, whichever is greater. At December 31, 2007, the Bank had advances from FHLB–IN with aggregate outstanding principal balances of $113.1 million, and the Bank’s investment in FHLB–IN stock of $23.9 million was $16.8 million in excess of its minimum requirement. FHLB advances must be secured by specified types of collateral and are available to member institutions primarily for the purpose of providing funds for residential housing finance. FHLBs also purchase mortgages in the secondary market through their Mortgage Purchase Program (MPP). The Bank has not sold loans to MPP since December 2005.

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     Regulatory directives, capital requirements and net income of the FHLBs affect their ability to pay dividends to their members. In addition, FHLBs are required to provide funds to cover certain obligations and to fund the resolution of insolvent thrifts and to contribute funds for affordable housing programs. These requirements could reduce the amount of dividends that the FHLBs pay to their members and could also result in the FHLBs imposing a higher rate of interest on advances to their members.

ITEM 1A. RISK FACTORS

     Investments in CFS Bancorp, Inc. common stock involve risk. The following discussion highlights risks management believes are material for our company, but does not necessarily include all risks that we may face.

Our operations are subject to interest rate risk and variations in interest rates may negatively affect financial performance.

     Our earnings and cash flows are largely dependent upon our net interest income. Net interest income is the difference between interest income earned on interest-earning assets such as loans and securities and interest expense paid on interest-bearing liabilities such as deposits and borrowed money. Changes in the general level of interest rates may have an adverse effect on our business, financial condition and result of operations. Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the FRB. Changes in monetary policy, including changes in interest rates, influence the amount of interest income that we receive on loans and securities and the amount of interest that we pay on deposits and borrowings. Changes in monetary policy and interest rates also can adversely affect:

• our ability to originate loans and obtain deposits;
   
• the fair value of our financial assets and liabilities; and
   
• the average duration of our securities portfolio.

     If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, our net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings.

     We measure interest rate risk under various rate scenarios using specific criteria and assumptions. A summary of this process, along with the results of our net interest income simulations is presented within “Item 7A. Quantitative and Qualitative Disclosures About Market Risk” of this Annual Report on Form 10-K.

We are subject to lending risk and could suffer losses in our loan portfolio despite our underwriting practices.

     There are inherent risks associated with our lending activities. There are risks inherent in making any loan, including those related to dealing with individual borrowers, nonpayment, uncertainties as to the future value of collateral and changes in economic and industry conditions. We attempt to closely manage our credit risk through prudent loan underwriting and application approval procedures, careful monitoring of concentrations of our loans within specific industries and periodic independent reviews of outstanding loans by third party loan review specialists. We cannot assure that such approval and monitoring procedures will reduce these credit risks.

     Increases in interest rates and/or weakening economic conditions could adversely impact the ability of borrowers to repay their outstanding loans. In the past, we have focused on providing ARMs to decrease the risk related to changes in the interest rate environment; however, these types of loans also involve other risks. As interest rates rise, the borrowers’ payments on an ARM also increase to the extent permitted by the loan terms thereby increasing the potential for default. Also, when interest rates decline substantially, borrowers tend to refinance into fixed-rate loans.

     As of December 31, 2007, approximately 65% of our loan portfolio consisted of commercial and industrial, construction and land development, and commercial real estate loans. These types of loans involve increased risks because the borrower’s ability to repay the loan typically depends primarily on the successful operation of the business or the property securing the loan. Additionally, these loans are made to small- or middle-market business customers who may have vulnerability to economic conditions and who may not have experienced a complete business or economic cycle. These types of loans are also typically larger than one-to-four family residential mortgage loans or

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consumer loans. Because our loan portfolio contains a significant number of commercial and industrial, construction and land development, and commercial real estate loans with relatively large balances, the deterioration of one or a few of these loans could cause a significant increase in non-performing loans. An increase in non-performing loans would result in a reduction in interest income recognized on loans and also could require us to increase the provision for losses on loans and increase loan charge-offs, all of which would reduce our net income. All of these could have a material adverse effect on our financial condition and results of operations. See further discussion on our commercial loan portfolio in “Loans” within “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Annual Report on Form 10-K.

Our allowance for losses on loans may be insufficient to cover actual losses on loans.

     We maintain an allowance for losses on loans at a level we believe adequate to absorb credit losses inherent in the loan portfolio. The allowance for losses on loans is a reserve established through a provision for losses on loans charged to expense that represents our estimate of probable incurred losses within the loan portfolio at each statement of condition date and is based on the review of available and relevant information. The level of the allowance for losses on loans reflects our consideration of historical charge-offs and recoveries; levels of and trends in delinquencies, impaired loans and other classified loans; concentrations of credit within the commercial loan portfolio; volume and type of lending; and current and anticipated economic conditions. The determination of the appropriate level of the allowance for losses on loans inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the allowance for losses on loans. In addition, bank regulatory agencies periodically review our allowance for losses on loans and may require an increase in the provision for losses on loans or the recognition of further loan charge-offs, based on judgments different from ours. Also, if charge-offs in future periods exceed the allowance for losses on loans, we will need additional provisions to increase our allowance for losses on loans. Any increases in the allowance for losses on loans will result in a decrease in net income and possibly capital, and may have a material adverse effect on our financial condition and results of operations. For further discussion related to our process for determining the appropriate level of the allowance for losses on loans see “Critical Accounting Policies” and “Allowance for Losses on Loans” within “Item 7. Management’s Discussion and Analysis of Financial Results and Operations” of this Annual Report on Form 10-K.

We operate in a highly competitive industry and market area with other financial institutions offering products and services similar to those we offer.

     We compete with savings associations, national banks, regional banks and other community banks in making loans, attracting deposits and recruiting and retaining talented employees. We also compete with securities and brokerage companies, mortgage companies, insurance companies, finance companies, money market mutual funds, credit unions and other non-bank financial service providers. Many of these competitors are not subject to the same regulatory restrictions we are subject to and therefore are able to provide customers with a feasible alternative to traditional banking services.

     The competition in our market for making commercial and construction loans has resulted in more competitive pricing and credit structure as well as intense competition for skilled commercial lending officers. These trends could have a material adverse effect on our ability to grow and remain profitable. Significant discounting of interest rates offered on loans negatively impacts interest income and can therefore adversely impact net interest income. If increased competition causes us to modify our underwriting standards, we could be exposed to higher losses from lending activities. An inability to recruit and retain skilled commercial lending officers poses a significant barrier to retaining and growing our customer base.

     The competition in our market for attracting deposits also has resulted in more competitive pricing. To successfully compete in our market area, we have at times offered higher deposit rates within the same market area. Increasing rates paid on deposits in response to competitive pressure could decrease our net interest margin.

     While management believes it can and does successfully compete with other financial institutions in our market, we may face a competitive disadvantage as a result of our smaller size and lack of geographic diversification.

19

The trading volume in our common stock is less than that of larger public companies which can contribute to volatility in our stock price.

     The trading history of our common stock has been characterized by relatively low trading volume. The value of a shareholder’s investment may be subject to sudden decreases due to the volatility of the price of our common stock which trades on the NASDAQ National Market.

     The market price of our common stock may be volatile and subject to fluctuations in response to numerous factors, including, but not limited to, the factors discussed in other risk factors and the following:

• actual or anticipated fluctuation in our operating results;
    
• changes in interest rates;
   
• changes in the legal or regulatory environment in which we operate;
   
• press releases, announcements or publicity relating to us or our competitors or relating to trends in our industry;
   
• changes in expectations as to our future financial performance, including financial estimates or recommendations by securities analysts and investors;
   
• future sales of our common stock;
   
• changes in economic conditions in our market, general conditions in the U.S. economy, financial markets or the banking industry; and
   
• other developments affecting us or our competitors.

     These factors may adversely affect the trading price of our common stock, regardless of our actual operating performance, and could prevent a shareholder from selling common stock at or above the current market price.

We may experience difficulties in managing our growth, and our growth strategy involves risks that may negatively impact our net income.

     We may expand into additional communities or attempt to strengthen our position in our current market and in surrounding areas by opening new branches and acquiring existing branches of other financial institutions. To the extent that we undertake additional branch openings and acquisitions, we are likely to continue to experience the effects of higher operating expenses relative to operating income from the new operations, which may have an adverse effect on our levels of reported net income, return on average equity and return on average assets. Other effects of engaging in such growth strategies may include potential diversion of management’s time and attention from other aspects of our business and the general disruption to our business.

We are subject to extensive government regulation and supervision which could adversely affect our operations.

     We are subject to extensive federal and state regulations and supervision. Banking regulations are primarily intended to protect depositors’ funds, federal deposit insurance funds and the banking system as a whole; not shareholders. These regulations affect our lending practices, capital structure, investment practices, dividend policy and growth, among other things. Congress and federal agencies continually review banking laws, regulations and policies for possible changes. Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect us in substantial and unpredictable ways. Such changes could subject us to additional costs, limit the types of financial services and products we may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with applicable laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could have a material adverse effect on our business, financial condition and results of operations. While we have policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur. For further discussion related to these regulations see

20

“Regulation” within “Item 1. Business” and also “Note 12. Stockholders’ Equity and Regulatory Capital” in the notes to consolidated financial statements included in “Item 8. Financial Statements and Supplementary Data” of this Annual Report on Form 10-K.

We may be subject to examinations by taxing authorities which could adversely affect our results of operations.

     In the normal course of business, we may be subject to examinations from federal and state taxing authorities regarding the amount of taxes due in connection with investments we have made and the businesses in which we are engaged. Recently, federal and state taxing authorities have become increasingly aggressive in challenging tax positions taken by financial institutions. The challenges made by taxing authorities may result in adjustments to the timing or amount of taxable income or deductions or the allocation of income among tax jurisdictions. If any such challenges are made and are not resolved in our favor, they could have an adverse effect on our financial condition and results of operations.

We may not be able to attract and retain the skilled employees necessary for our business.

     Our success depends, in large part, on our ability to attract and retain key employees. Competition for the best employees in most of our business lines can be intense, and we may not be able to hire or retain the necessary employees for meeting our business goals. The unexpected loss of services of one or more of our key personnel could have a material adverse impact on our business because of their skills, knowledge of our market, years of industry experience and the difficulty of promptly finding qualified replacement personnel.

Our information systems may experience an interruption or breach in security that could impact our operational capabilities.

     We rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan and other systems. While we have policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrences of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.

Our ability to pay dividends is subject to regulatory limitations and may be restricted.

     Although we have been paying quarterly dividends regularly since 1998, our ability to pay dividends to shareholders depends to a large extent upon the dividends we receive from the Bank. Dividends paid by the Bank are subject to restrictions under various federal and state banking laws. Currently, the Bank must submit an application to the OTS and receive OTS approval prior to paying any dividends to us. In addition, the Bank must maintain certain capital levels, which may restrict the ability of the Bank to pay dividends to us. The Bank’s regulators have the authority to prohibit the Bank or us from engaging in unsafe or unsound practices in conducting our business. As a consequence, bank regulators could deem the payment of dividends by the Bank to be an unsafe or unsound practice, depending on the Bank’s financial condition or otherwise, and prohibit such payments. If the Bank were unable to pay dividends to us, the Board of Directors might cease paying or reduce the rate or frequency at which we pay dividends to shareholders. For further discussion related to these regulations see “Regulation” within “Item 1. Business” and also “Note 12. Stockholders’ Equity and Regulatory Capital” in the notes to consolidated financial statements included in “Item 8. Financial Statements and Supplementary Data” of this Annual Report on Form 10-K.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

21

ITEM 2. PROPERTIES

Offices and Properties

     The following table sets forth certain information relating to the Bank’s offices at December 31, 2007. In addition, the Bank maintains 36 automated teller machines (ATMs), 23 of which are located at its branch offices.

			Net Book Value of
		Lease	Property and Leasehold
	Owned or	Expiration	Improvements at	Deposits at
Location	Leased	Date	December 31, 2007	December 31, 2007
			(Dollars in thousands)
Executive Office:
707 Ridge Road (1)	Owned	—	$2,195	$152,136
Munster, IN 46321
Indiana Branch Offices:
155 North Main Street	Owned	—	257	67,615
Crown Point, IN 46307
1100 East Joliet Street	Leased	2008	112	87,363
Dyer, IN 46311
4740 Indianapolis Boulevard	Owned	—	437	34,804
East Chicago, IN 46312
2121 East Columbus Drive (2)	Leased	2008	368	20,270
East Chicago, IN 46312
5311 Hohman Avenue	Owned	—	292	53,194
Hammond, IN 46320
3853 45th Street	Owned	—	755	26,285
Highland, IN 46322
803 West 57th Avenue (3)	—	—	—	—
Merrillville, IN 46410
6101 Harrison Street (4)	Owned	—	1,290	24,260
Merrillville, IN 46410
1720 45th Street	Owned	—	255	100,485
Munster, IN 46321
7650 Harvest Drive (5)	Owned	—	1,680	25,558
Schererville, IN 46375
855 Thornapple Way	Owned	—	205	42,281
Valparaiso, IN 46383

22

			Net Book Value of
		Lease	Property and Leasehold
	Owned or	Expiration	Improvements at		Deposits at
Location	Leased	Date	December 31, 2007		December 31, 2007
			(Dollars in thousands)
Illinois Branch Offices:
310 South Weber Road	Owned	—	$	1,073	$	6,300
Bolingbrook, IL 60490
8301 South Cass Avenue (6)	Owned	—		3,266		16,013
Darien, IL 60561
3301 West Vollmer Road	Leased	2009		—		38,772
Flossmoor, IL 60422
154th Street at Broadway (7)	Leased	—		110		21,768
Harvey, IL 60426
13323 South Baltimore	Owned	—		261		28,457
Hegewisch/Chicago, IL 60633
9161 West 151st Street	Leased	2009		5		13,963
Orland Park, IL 60462
7101 West 127th Street	Owned	—		192		43,389
Palos Heights, IL 60463
601 East 162nd Street	Owned	—		209		44,380
South Holland, IL 60473
425 East 170th Street (8)	Owned	—		229		—
South Holland, IL 60473
7231 West 171st Street	Owned	—		1,397		3,083
Tinley Park, IL 60477
7229 South Kingery Highway	Leased	2012		34		12,896
Willowbrook, IL 60527
Other Properties:
8149 Kennedy Avenue (9)	Leased	2009		12		—
Highland, IN 46322
Lot 4 at Ronald Reagan Boulevard &	Owned	—		465		—
Essington Road (10)
Bolingbrook, IL 60490
3619 Park Drive (11)	Owned	—		492		—
Olympia Fields, IL 60461

____________________
 

(1)      Includes 5,604 square feet of space currently under lease to third parties.

23

(2)	Full service branch facility located in grocery store chain.
(3)	Leased location closed on November 10, 2007.
(4)	New full-service banking facility that opened on November 13, 2007.
(5)	Includes 3,570 square feet of space currently under lease to a third party.
(6)	Includes 3,120 square feet of space currently under lease to third parties.
(7)	Facility is on a month-to-month lease.
(8)	Deposits included with office located at 162nd St., South Holland, IL.
(9)	Operations and Customer Call Center.
(10)	Land purchased for new full-service banking facility in Bolingbrook, IL.
(11)	Land purchased for new full-service banking facility in Olympia Fields, IL to replace the current Flossmoor facility.

ITEM 3. LEGAL PROCEEDINGS

LEGAL PROCEEDINGS

     The case of Betty and Raymond Crenshaw v. CFS Bancorp, et al. was filed in the United States District Court for the Northern District of Indiana sitting in Hammond, Indiana on December 6, 2005 under Cause No. 2:05 CV 440. The lawsuit names the Company, a police officer who was purportedly acting as the Bank’s security guard, along with three other police officers and the City of East Chicago as defendants. The lawsuit was brought in connection with an incident that occurred at a Bank branch on February 6, 2004. The complaint seeks compensation for alleged personal injuries, violations of civil rights, battery, false arrest, intentional infliction of emotional distress and loss of consortium. The plaintiffs also seek punitive damages and attorneys’ fees in this cause of action. The Company’s defense in this matter has been tendered to and accepted by the Company’s insurance carrier. An appearance has been filed on behalf of the Company by trial counsel retained by the Company’s insurance carrier. The case was in the discovery phase in 2006 and 2007. In the event that judgment is entered for the plaintiffs, insurance would not be available to indemnify the Company for punitive damages should they be assessed. The total potential exposure to the Company is not quantifiable at this stage of the proceedings insofar as the amount of damages being sought was not specifically set forth in the complaint and no other demand has been made by the plaintiffs to the Company.

     Other than the above-referenced matters, the Company is involved in routine legal proceedings occurring in the ordinary course of its business, which, in the aggregate, are believed to be immaterial to the financial condition of the Company.

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

None.

24

PART II.

ITEM 5.  MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

       (a)      The Company’s common stock is traded on the NASDAQ National Market under the symbol “CITZ”. As of December 31, 2007, there were 10,705,510 shares of common stock outstanding which were held by 2,005 stockholders of record. The following table sets forth the quarterly share price and cash dividends paid per share during each quarter of 2007 and 2006. See further information regarding the Company’s ability to pay dividends in “Regulation” within “Item 1. Business” and also “Note 12. Stockholders’ Equity and Regulatory Capital” in the notes to consolidated financial statements included in “Item 8. Financial Statements and Supplementary Data” of this Annual Report on Form 10-K.

			Cash
	Share Price		Dividend
	High	Low	Paid
2006
First Quarter	$14.98	$14.32	$0.12
Second Quarter	14.90	14.10	0.12
Third Quarter	15.04	14.58	0.12
Fourth Quarter	14.90	14.21	0.12
2007
First Quarter	$15.00	$14.48	$0.12
Second Quarter	15.12	14.53	0.12
Third Quarter	14.65	13.93	0.12
Fourth Quarter	14.89	14.09	0.12

     The information for equity compensation plans is incorporated by reference from “Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” of this Annual Report on Form 10-K.

(b)	Not applicable.
(c)	The following table presents information related to purchases made by or on behalf of the Company of shares of the Company’s common stock during the indicated periods:

				Total Number of Shares		Maximum Number of
				Purchased as Part of		Shares that May Yet Be
	Total Number of		Average Price	Publicly Announced		Purchased Under the
Period	Shares Purchased		Paid Per Share	Plans or Programs		Plans or Programs (1)
October 1-31, 2007		—	—		—	257,190
November 1-30, 2007		21,237	14.13		21,237	235,953
December 1-31, 2007		109,228	14.77		109,228	126,725
Total		130,465	14.67		130,465	126,725

____________________
 

(1)      The Company publicly announced on June 15, 2006 a repurchase program for 600,000 shares. This repurchase program was completed during the first quarter of 2007 when 188,283 shares were repurchased pursuant to this plan. On February 27, 2007, the Company publicly announced a new share repurchase plan for an additional 600,000 shares. The remaining 75,245 shares from the first quarter of 2007 plus 398,030 shares repurchased in the second, third and fourth quarters of 2007 were repurchased pursuant to this plan.

25

PERFORMANCE GRAPH

     The following graph compares the cumulative total returns for the Company’s common stock to the total returns for the Standard and Poor’s 500 Index (S&P 500) and the NASDAQ Bank Index. The graph assumes that $100 was invested on December 31, 2002 in the Company’s common stock, the S&P 500 Index, and the NASDAQ Bank Index. The cumulative total return on each investment is as of December 31 of each of the subsequent five years and assumes dividends are reinvested.

	Period Ending
Index	12/31/02	12/31/03	12/31/04	12/31/05	12/31/06	12/31/07
CFS Bancorp, Inc.	$100.00	$106.69	$106.11	$110.05	$116.49	$120.70
S&P 500	100.00	128.68	142.69	149.70	173.34	182.86
NASDAQ Bank Index	100.00	129.93	144.21	137.97	153.15	119.35

26

ITEM 6. SELECTED FINANCIAL DATA

	December 31,
	2007			2006			2005			2004			2003
	(Dollars in thousands except per share data)
Selected Financial Condition Data:
Total assets	$	1,150,278		$	1,254,390		$	1,242,888		$	1,314,714		$	1,569,270
Loans receivable		793,136			802,383			917,405			988,085			982,579
Allowance for losses on loans		8,026			11,184			12,939			13,353			10,453
Securities, available-for-sale		224,594			298,925			218,550			202,219			326,304
Securities, held-to-maturity		3,940			—			—			—			—
Deposits		863,272			907,095			828,635			863,178			978,440
Borrowed money		135,459			202,275			257,326			286,611			418,490
Stockholders’ equity		130,414			131,806			142,367			147,911			155,953
Book value per outstanding share	$	12.18		$	11.84		$	11.86		$	11.94		$	12.78
Average stockholders’ equity to average assets		10.75	%		10.54	%		11.38	%		10.58	%		10.01	%
Non-performing assets to total assets		2.67			2.22			1.74			2.14			1.46
Allowance for losses on loans to non-performing loans		27.11			40.64			61.49			48.25			46.01
Allowance for losses on loans to total loans		1.01			1.39			1.41			1.35			1.06

	Year Ended December 31,
	2007			2006			2005			2004			2003
	(Dollars in thousands except per share data)
Selected Operations Data:
Interest income	$	72,241		$	75,547		$	69,464		$	68,986		$	71,389
Interest expense		38,134			42,644			39,603			38,900			43,678
Net interest income		34,107			32,903			29,861			30,086			27,711
Provision for losses on loans		2,328			1,309			1,580			8,885			2,326
Net interest income after provision for losses on loans		31,779			31,594			28,281			21,201			25,385
Non-interest income		11,515			10,542			11,397			11,610			12,788
Non-interest expense		33,459			36,178			33,485			46,592			34,034
Income (loss) before income taxes		9,835			5,958			6,193			(13,781	)		4,139
Income tax expense (benefit)		2,310			618			1,176			(7,204	)		601
Net income (loss)	$	7,525		$	5,340		$	5,017		$	(6,577	)	$	3,538
Earnings (loss) per share (basic)	$	0.71		$	0.48		$	0.43		$	(0.57	)	$	0.31
Earnings (loss) per share (diluted)		0.69			0.47			0.42			(0.57	)		0.30
Cash dividends declared per common share		0.48			0.48			0.48			0.44			0.44
Dividend payout ratio		69.57	%		102.13	%		114.29	%		NM			146.67	%

27

	Year Ended December 31,
	2007			2006			2005			2004			2003
	(Dollars in thousands except per share data)
Selected Operating Ratios:
Net interest margin		3.02	%		2.73	%		2.48	%		2.13	%		1.87	%
Average interest-earning assets to average interest-bearing liabilities		113.27			113.03			113.44			111.59			110.45
Ratio of non-interest expense to average total assets		2.76			2.83			2.62			3.14			2.19
Return (loss) on average assets		0.62			0.42			0.39			(0.44	)		0.23
Return (loss) on average equity		5.78			3.96			3.45			(4.19	)		2.28
Efficiency Ratio Calculations (1)
Efficiency Ratio:
Non-interest expense	$	33,459		$	36,178		$	33,485		$	46,592		$	34,034
Net interest income plus non-interest income	$	45,622		$	43,445		$	41,258		$	41,696		$	40,499
Efficiency ratio		73.34	%		83.27	%		81.16	%		111.74	%		84.04	%
Core Efficiency Ratio:
Non-interest expense	$	33,459		$	36,178		$	33,485		$	46,592		$	34,034
Adjustment for the prepayment penalty
on the early extinguishment of debt		––			––			––			(10,298	)		––
Non-interest expense – as adjusted	$	33,459		$	36,178		$	33,485		$	36,294		$	34,034
Net interest income plus non-interest income	$	45,622		$	43,445		$	41,258		$	41,696		$	40,499
Adjustments:
Net realized (gains) losses on sales of securities available-for-sale		(536	)		(750	)		238			(719	)		(1,900	)
Other-than-temporary impairment of securities available-for-sale		—			—			240			1,018			120
Net realized (gains) losses on sales of assets		(22	)		994			(354	)		(225	)		(39	)
Amortization of deferred premium on the early extinguishment of debt		4,540			9,624			14,381			2,052			––
Net interest income plus non-interest income – as adjusted	$	49,604		$	53,313		$	55,763		$	43,822		$	38,680
Core efficiency ratio		67.45	%		67.86	%		60.05	%		82.82	%		87.99	%

____________________
 

(1)      See “Results of Operations – Non-Interest Expense” within “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” for further discussions about the Company’s non-GAAP efficiency ratio and core efficiency ratio disclosures.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

     The Company’s net income for the year ended December 31, 2007 increased 40.9% to $7.5 million from $5.3 million for the 2006 period which reflects an improved net interest margin and reduced operating costs. Diluted earnings per share for the 2007 period increased 46.8% to $0.69 when compared to $0.47 for the 2006 period.

The Company’s net interest margin expanded to 3.02% for the year ended December 31, 2007 from 2.73% for the comparable 2006 period. The increase was primarily a result of higher rates earned on interest-earning assets coupled with a reduction in the cost of borrowed money due to decreases in the amortization of the deferred premium on the early extinguishment of the Company’s Federal Home Loan Bank (FHLB) debt (Premium Amortization). Partially offsetting these favorable impacts was an increase in deposit costs.

     The Company’s initiatives to improve operating efficiencies in 2007 resulted in reduced operating expenses of $2.7 million to $33.5 million for the year ended December 31, 2007 from $36.2 million for the comparable 2006 period. This reduction combined with increases in net interest income resulted in the improvement in the Company’s efficiency ratio to 73.3% for 2007 from 83.3% for 2006. The Company’s core efficiency ratios were 67.5% and 67.9%, respectively, for 2007 and 2006. For the Company’s calculations of its efficiency and core efficiency ratios see the “Results of Operations – Non-Interest Expense” below in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations”.

28

     Total loans receivable were $793.1 million at December 31, 2007, a $9.2 million decrease from December 31, 2006. During 2007, the Company funded $287.1 million of loans and purchased $65.6 million of participation loans. These increases were offset by $331.2 million of loan repayments and $24.1 million of loan sales. The Company’s loan sales include the sale of $12.8 million of impaired and potential problem assets that were sold during the fourth quarter of 2007.

     During 2007, the Company increased its provision for losses on loans to $2.3 million from $1.3 million in 2006. The increase in the provision was the result of an increase in non-performing loans combined with a $1.3 million increase in impairment reserves related to a purchased participation in a land development loan and a commercial real estate loan. Non-performing assets increased during 2007 due to the addition of two construction and land development loans totaling $10.5 million in the aggregate and two commercial real estate loans totaling $3.2 million in the aggregate. Non-performing assets were positively impacted by the aforementioned sale which included $9.1 million in non-performing commercial real estate loans.

     Management continues to explore ways to reduce its credit risk related to the non-performing assets through various alternatives, including the potential sale of certain of these assets. Given current economic uncertainties and the potential for credit deterioration relating to housing and speculative real estate, management has decided to shift the focus for loan origination from large commercial real estate loans and participations purchased toward commercial and industrial loans and smaller commercial real estate loans. While this shift may reduce the size of the loan portfolio in the near future, it is also expected to diversify and reduce the overall credit risk within the portfolio.

CRITICAL ACCOUNTING POLICIES

     The Company’s consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (GAAP), which require the Company to establish various accounting policies. Certain of these accounting policies require management to make estimates, judgments or assumptions that could have a material effect on the carrying value of certain assets and liabilities. The estimates, judgments and assumptions used by management are based on historical experience, projected results, internal cash flow modeling techniques and other factors which management believes are reasonable under the circumstances.

     The Company’s significant accounting policies are presented in Note 1 to the consolidated financial statements included in “Item 8. Financial Statements and Supplementary Data” of this 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 the Company’s financial statements. Management views 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. Management currently views the determination of the allowance for losses on loans and the accounting for income taxes to be critical accounting policies.

Allowance for Losses on Loans

     The Company maintains an allowance for losses on loans at a level management believes is sufficient to absorb credit losses inherent in the loan portfolio. The allowance for losses on loans represents the Company’s estimate of probable incurred losses in the loan portfolio at each statement of condition date and is based on the review of available and relevant information.

     One component of the allowance for losses on loans contains allocations for probable inherent but undetected losses within various pools of loans with similar characteristics pursuant to Statement of Financial Accounting Standards (SFAS) No. 5, Accounting for Contingencies. This component is based in part on certain loss factors applied to various loan pools as stratified by the Company. In determining the appropriate loss factors for these loan pools, management considers 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.

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     The second component of the allowance for losses on loans contains allocations for probable losses that have been identified relating to specific borrowing relationships pursuant to SFAS No. 114, Accounting by Creditors for Impairment of a Loan. This component consists of expected losses resulting in specific credit allocations for individual loans not considered within the above mentioned loan pools. The analysis of each loan involves a high degree of judgment in estimating the amount of the loss associated with the loan, including the estimation of the amount and timing of future cash flows and collateral values.

     Loan losses are charged off against the allowance, while recoveries of amounts previously charged off are credited to the allowance. The Company assesses the adequacy of the allowance for losses on loans on a quarterly basis and adjusts the allowance for losses on loans by recording a provision for losses on loans in an amount sufficient to maintain the allowance at a level deemed appropriate by management. The evaluation of the adequacy of the allowance for losses on loans 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 that actual outcomes differ from management estimates, an additional provision for losses on loans could be required which could adversely affect earnings or the Company’s financial position in future periods. In addition, various regulatory agencies, as an integral part of their examination processes, periodically review the allowance for losses on loans for the Bank and the carrying value of its other non-performing loans, based on information available to them at the time of their examinations. Any of these agencies could require the Bank to make additional provisions for losses on loans.

Income Tax Accounting

     Income tax expense recorded in the Company’s consolidated statements of income involves management’s interpretation and application of certain accounting pronouncements and federal and state tax codes. As such, the Company has identified income tax accounting as a critical accounting policy. The Company is subject to examination by various regulatory taxing authorities. There can be no assurance that future events, such as court decisions or positions of federal and state taxing authorities, will not differ from management’s current assessment of tax liabilities, the impact of which could be significant to the consolidated results of operations and reported earnings.

     In addition, the Company adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of SFAS 109 (FIN48) effective January 1, 2007. FIN 48 requires significant judgment in determining what constitutes an individual tax position as well as assessing the outcome of each tax position. Changes in judgment as to recognition or measurement of tax positions can materially affect the estimate of the effective tax rate and consequently, affect the Company’s operating results. Management believes the tax liabilities are adequately and properly recorded in the Company’s consolidated financial statements.

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AVERAGE BALANCES, NET INTEREST INCOME, YIELDS EARNED AND RATES PAID

     The following table provides information regarding (i) the Company’s interest income recognized from interest-earning assets and their related average yields; (ii) the amount of interest expense realized on interest-bearing liabilities and their related average rates; (iii) net interest income; (iv) interest rate spread; and (v) net interest margin. Information is based on average daily balances during the indicated periods.

	Year Ended December 31,
	2007						2006							2005
											Average
	Average				Average		Average				Yield/			Average				Average
	Balance		Interest		Yield/Cost		Balance		Interest		Cost			Balance		Interest		Yield/Cost
	(Dollars in thousands)
Interest-earning assets:
Loans receivable (1)	$	806,626	$	56,678	7.03	%	$	854,268	$	59,852		7.01	%	$	960,486	$	60,880		6.34	%
Securities (2)		265,116		12,684	4.72			292,140		12,713		4.29			207,880		7,388		3.51
Other interest-earning assets (3)		59,215		2,879	4.86			59,753		2,982		4.99			36,837		1,196		3.25
Total interest-earning assets		1,130,957		72,241	6.39			1,206,161		75,547		6.26			1,205,203		69,464		5.76
Non-interest earning assets		79,370						74,433							74,161
Total assets	$	1,210,327					$	1,280,594						$	1,279,364
Interest-bearing liabilities:
Deposits:
Checking accounts	$	100,781		955	0.95		$	102,049		1,024		1.00		$	107,434		839		0.78
Money market accounts		176,538		5,947	3.37			145,756		4,306		2.95			131,121		1,785		1.36
Savings accounts		142,018		941	0.66			159,936		693		0.43			187,441		633		0.34
Certificates of deposit		400,607		18,379	4.59			391,844		16,140		4.12			351,555		10,429		2.97
Total deposits		819,944		26,222	3.20			799,585		22,163		2.77			777,551		13,686		1.76
Borrowings:
Other short-term
borrowings (4)		19,828		811	4.09			19,353		902		4.66			1,040		35		3.37
FHLB borrowings (5)(6)(7)		158,667		11,101	6.90			248,211		19,579		7.78			283,859		25,882		8.99
Total borrowed money		178,495		11,912	6.58			267,564		20,481		7.55			284,899		25,917		8.97
Total interest-bearing
liabilities		998,439		38,134	3.82			1,067,149		42,644		4.00			1,062,450		39,603		3.73
Non-interest bearing deposits		64,315						61,350							53,845
Non-interest bearing liabilities		17,475						17,158							17,453
Total liabilities		1,080,229						1,145,657							1,133,748
Stockholders’ equity		130,098						134,937							145,616
Total liabilities and        stockholders’ equity	$	1,210,327					$	1,280,594						$	1,279,364
Net interest-earning assets	$	132,518					$	139,012						$	142,753
Net interest income/ interest rate spread			$	34,107	2.57	%			$	32,903		2.26	%			$	29,861		2.03	%
Net interest margin					3.02	%						2.73	%						2.48	%
Ratio of average interest-earning assets        to average interest-bearing liabilities					113.27	%						113.03	%						113.44	%

____________________
 

(1)	The average balance of loans receivable includes non-performing loans, interest on which is recognized on a cash basis.
(2)	Average balances of 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 and Repo Sweeps.

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(5)	The 2007 period includes an average of $162.4 million of contractual FHLB borrowings reduced by an average of $3.7 million of unamortized deferred premium on the early extinguishment of debt. Interest expense on borrowings for the 2007 period includes $4.5 million of amortization of the deferred premium on the early extinguishment of debt. The amortization of the deferred premium for the 2007 period increased the average cost of borrowed money as reported to 6.58% compared to an average contractual rate of 4.14%.
(6)	The 2006 period includes an average of $259.1 million of contractual FHLB borrowings reduced by an average of $10.9 million of unamortized deferred premium on the early extinguishment of debt. Interest expense on borrowings for the 2006 period includes $9.6 million of amortization of the deferred premium on the early extinguishment of debt. The amortization of the deferred premium for the 2006 period increased the average cost of borrowed money as reported to 7.55% compared to an average contractual rate of 3.93%.
(7)	The 2005 period includes an average of $307.3 million of contractual FHLB borrowings reduced by an average of $22.4 million of unamortized deferred premium on the early extinguishment of debt. Interest expense on borrowings for the 2005 period includes $14.4 million of amortization of the deferred premium on the early extinguishment of debt. The amortization of the deferred premium for the 2005 period increased the average cost of borrowed money as reported to 9.10% compared to an average contractual rate of 3.77%.

RATE/VOLUME ANALYSIS

     The following table details the effects of changing rates and volumes on the Company’s net interest income. Information is provided with respect to (i) effects on interest income attributable to changes in rate (changes in rate multiplied by prior volume); (ii) effects on interest income attributable to changes in volume (changes in volume multiplied by prior rate); and (iii) changes in rate/volume (changes in rate multiplied by changes in volume).

	Year Ended December 31,
	2007 Compared to 2006												2006 Compared to 2005
	Increase (Decrease) Due to												Increase (Decrease) Due to
							Rate/			Total Net									Rate/			Total Net
	Rate			Volume			Volume			Inc/(Dec)			Rate			Volume			Volume			Inc/(Dec)
	(Dollars in thousands)
Interest-earning assets:
Loans receivable	$	174		$	(3,338	)	$	(10	)	$	(3,174	)	$	6,414		$	(6,733	)	$	(709	)	$	(1,028	)
Securities		1,263			(1,175	)		(117	)		(29	)		1,658			2,995			672			5,325
Other interest-earning assets		(79	)		(25	)		1			(103	)		642			744			400			1,786
Total net change in income on interest-
earning assets		1,358			(4,538	)		(126	)		(3,306	)		8,714			(2,994	)		363			6,083
Interest-bearing liabilities:
Deposits:
Checking accounts		(57	)		(13	)		1			(69	)		239			(42	)		(12	)		185
Money market accounts		604			909			128			1,641			2,089			199			233			2,521
Savings accounts		367			(78	)		(41	)		248			179			(93	)		(26	)		60
Certificates of deposit		1,837			361			41			2,239			4,052			1,195			464			5,711
Total deposits		2,751			1,179			129			4,059			6,559			1,259			659			8,477
Borrowings:
Other short-term borrowings		(110	)		22			(3	)		(91	)		14			616			237			867
FHLB borrowings		(2,213	)		(7,063	)		798			(8,478	)		(3,491	)		(3,250	)		438			(6,303	)
Total borrowings		(2,323	)		(7,041	)		795			(8,569	)		(3,477	)		(2,634	)		675			(5,436	)
Total net change in expense on interest-
bearing liabilities		428			(5,862	)		924			(4,510	)		3,082			(1,375	)		1,334			3,041
Net change in net interest income	$	930		$	1,324		$	(1,050	)	$	1,204		$	5,632		$	(1,619	)	$	(971	)	$	3,042

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RESULTS OF OPERATIONS

Year Ended December 31, 2007 Compared to Year Ended December 31, 2006

Net Income

     The Company’s net income for 2007 increased by 40.9% to $7.5 million from $5.3 million in 2006. Diluted earnings per share increased by 46.8% to $0.69 per share from $0.47 in 2006. The Company’s 2007 earnings were positively impacted by an increase in net interest income of 3.7% and a decrease in non-interest expense of 7.5% from the 2006 period which were offset in part by an increase in the provision for losses on loans and income tax expense.

Net Interest Income

     Net interest income before the provision for losses on loans is the principal source of earnings for the Company and consists of interest income received on loans and investment securities less interest expense paid on deposits and borrowed money. The Company’s net interest income totaled $34.1 million for 2007 representing a 3.7% increase from $32.9 million for 2006. The Company’s net interest margin, net interest income as a percentage of average interest-earning assets, for 2007 improved 29 basis points to 3.02% from 2.73% for 2006. The increases in net interest income and net interest margin were primarily a result of an increase in the weighted-average yields on interest-earning assets coupled with a reduction in the average balances of borrowed money and the amortization of the deferred premium on the early extinguishment of debt. Partially offsetting these favorable impacts was an increase in deposit costs.

Interest Income

     The Company’s interest income was $72.2 million for 2007 compared to $75.5 million for 2006. The decrease was primarily due to a 6.2% decrease in the average balance of interest-earning assets to $1.1 billion for 2007 from $1.2 billion for 2006 as a result of (i) the Company utilizing proceeds from security sales and maturities and other interest-earning assets to fund the repayment of maturing FHLB debt, and Company stock repurchases and (ii) the managed run-off of single-service, high-rate certificates.

     The weighted-average yield on interest-earning assets increased 13 basis points to 6.39% for 2007 from 6.26% for the comparable 2006 period as a result of the Company’s reinvestment of proceeds from sales and maturities of relatively low rate securities into higher yielding securities.

Interest Expense

     The Company’s total interest expense decreased to $38.1 million for 2007 from $42.6 million for the 2006 period. The Company’s average cost of interest-bearing liabilities decreased to 3.82% for 2007 when compared to 2006 as increases in the cost of deposits were more than offset by decreases in the cost of borrowed money.

     Interest expense on interest-bearing deposits increased to $26.2 million for 2007 from $22.2 million for 2006. The average cost of interest-bearing deposits increased 43 basis points for 2007 from 2006 due to the upward repricing of money market accounts and certificates of deposit as a result of higher market interest rates existing since early 2006. To mitigate the impact of increasing market interest rates, the Company continues to focus on growing non-interest bearing deposits.

     The Company’s total interest expense for 2007 was positively impacted by a 41.8% decrease in interest expense on borrowed money to $11.9 million for 2007 from $20.5 million for 2006. The decrease was primarily the result of lower average balances of the Company’s FHLB debt as a result of the maturities and repayments. In addition, the amortization of the deferred premium on the early extinguishment of debt (Premium Amortization) that was included in the Company’s total interest expense on borrowings decreased to $4.5 million for 2007 from $9.6 million for 2006 which resulted in a decrease in the Company’s cost of borrowings to 6.58% for 2007 from 7.55% for 2006.

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     The Company continues to experience the positive effects of its 2004 FHLB debt restructuring through the reduction of the amount of FHLB borrowings outstanding and the contractual interest rates paid; however, the related Premium Amortization continues to adversely affect the Company’s net interest margin. The Premium Amortization reduced the net interest margin by 40 basis points in 2007 and 80 basis points in 2006. The Company’s interest expense on borrowings is detailed in the tables below for the periods indicated.

	Year Ended
	December 31,
	2007		2006		$ change			% change
	(Dollars in thousands)
Interest expense on short-term borrowings at contractual rates	$	811	$	902	$	(91	)	(10.1	)%
Interest expense on FHLB borrowings at contractual rates		6,561		9,955		(3,394	)	(34.1	)
Premium Amortization		4,540		9,624		(5,084	)	(52.8	)
Total interest expense on borrowings	$	11,912	$	20,481	$	(8,569	)	(41.8	)

     The interest expense related to the Premium Amortization is expected to be $1.4 million and $200,000 before taxes in the years ended December 31, 2008 and 2009, respectively.

Provision for Losses on Loans

     The Company’s provision for losses on loans was $2.3 million for 2007 compared to $1.3 million in 2006 reflecting required changes to the allowance for losses on loans as determined by its quarterly analysis of the adequacy of the allowance for losses on loans. For more information, see “Changes in Financial Condition – Allowance for Losses on Loans” below in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations”.

Non-Interest Income

The following table identifies the changes in non-interest income for the periods presented:

	Year Ended
	December 31,
	2007		2006			$ change			% change
	(Dollars in thousands)
Service charges and other fees	$	6,795	$	6,739		$	56		0.8	%
Card-based fees		1,489		1,313			176		13.4
Commission income		147		197			(50	)	(25.4	)
Subtotal fee based revenues		8,431		8,249			182		2.2
Income from bank-owned life insurance		1,634		1,592			42		2.6
Other income		892		945			(53	)	(5.6	)
Subtotal		10,957		10,786			171		1.6
Securities gains, net		536		750			(214	)	(28.5	)
Other asset gains (losses), net		22		(994	)		1,016		NM
Total non-interest income	$	11,515	$	10,542		$	973		9.2	%

     Non-interest income before securities and other asset gains (losses) increased 1.6% for 2007 from 2006 primarily due to increased income from card-based fees. Card-based fees increased during 2007 as a result of an increase in the Company’s number of active ATM and debit cards and the related usage. The Company’s service charges and other fees have been impacted by lower volume of overdrafts during 2007 as deposit customers continue to change their behavior patterns related to overdrafts and fees. Commission income from the Company’s third-party service provider for the sale of investment products was lower for 2007 as rates offered on certificates of deposit have become more competitive relative to the yields available on non-deposit products.

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     The change in other asset gains (losses) from 2006 to 2007 was primarily related to the $1.3 million loss on the 2006 sale of property that was collateral for an impaired commercial real estate loan which was transferred to other real estate owned. Partially offsetting the 2006 loss was a $285,000 gain on the sale of another property that had been held in other real estate owned.

Non-Interest Expense

     The following table identifies the changes in non-interest expense for the periods presented:

	Year Ended
	December 31,
	2007		2006		$ change			% change
	(Dollars in thousands)
Compensation and mandatory benefits	$	16,236	$	15,655	$	581		3.7	%
Retirement and stock related compensation		1,054		3,453		(2,399	)	(69.5	)
Medical and life benefits		1,025		1,412		(387	)	(27.4	)
Other employee benefits		91		270		(179	)	(66.3	)
Subtotal compensation and employee benefits		18,406		20,790		(2,384	)	(11.5	)
Net occupancy expense		2,847		2,533		314		12.4
Furniture and equipment expense		2,241		2,013		228		11.3
Data processing		2,169		2,404		(235	)	(9.8	)
Professional fees		1,540		1,514		26		1.7
Marketing		842		1,332		(490	)	(36.8	)
Other general and administrative expenses		5,414		5,592		(178	)	(3.2	)
Total non-interest expense	$	33,459	$	36,178	$	(2,719	)	(7.5	)%

     The Company’s non-interest expense for 2007 when compared to 2006 was positively impacted by the following:

• reduced retirement and stock-related compensation expense pertaining to the Company’s 2007 ESOP loan modification totaling $1.1 million;
   
• reduced pension expense totaling $1.5 million due to higher 2006 voluntary contributions to its multi-employer defined benefit plan;
   
• decreased medical and life benefits expense of $387,000 due to the realization of cost savings from switching the Company’s service provider during 2006 and a reduction in the number of large medical claims during 2007;
   
• decreased data processing expenses totaling $235,000 primarily as a result of bringing items processing in-house; and
   
• reduced marketing expenses totaling $490,000 primarily due to the elimination of certain legacy marketing initiatives no longer deemed to be effective and the reassessment of current marketing strategies and outsourcing arrangements.

     The above decreases were partially offset by an increase in compensation and mandatory benefits due to separation expenses totaling $345,000 during the fourth quarter of 2007 related to the separation of two senior officers as previously disclosed in separate regulatory filings and the consolidation of retail lending operations. The Company also incurred separation expense of $280,000 during the first quarter of 2007 related to its reduction in force. In addition, net occupancy expense and furniture and equipment expense increased during 2007 as a result of the opening of two new full-service banking centers in Tinley Park, Illinois and Merrillville, Indiana combined with the implementation of the Company’s new digital phone system.

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     The Company’s efficiency ratio was 73.3% and 83.3%, respectively, for 2007 and 2006. The Company’s core efficiency ratio was 67.5% and 67.9%, respectively, for 2007 and 2006. The efficiency ratio and core efficiency ratio during 2007 were positively impacted by the increases in net interest income and non-interest income and by the decrease in non-interest expense as discussed above. For the Company’s reconciliation of its efficiency ratio and core efficiency ratio, see “Item 6. Selected Financial Data” of this Annual Report on Form 10-K.

     Management has historically used an efficiency ratio that is a non-GAAP financial measure of operating expense control and operating efficiency. The efficiency ratio is typically defined as the ratio of non-interest expense to the sum of non-interest income and net interest income before the provision for losses on loans. Many financial institutions, in calculating the efficiency ratio, adjust non-interest income (as calculated under GAAP) to exclude certain component elements, such as gains or losses on sales of securities and assets. Management follows this practice to calculate its core efficiency ratio and utilizes this non-GAAP measure in its analysis of the Company’s performance. The core efficiency ratio is different from the GAAP-based efficiency ratio. The GAAP-based measure is calculated using non-interest expense, net interest income before the provision for losses on loans and non-interest income as presented on the consolidated statements of income.

     The Company’s core efficiency ratio is calculated as non-interest expense divided by the sum of net interest income before the provision for losses on loans, excluding the Premium Amortization, and non-interest income, adjusted for gains or losses on the sale of securities and other assets and other-than-temporary impairments. Management believes that the core efficiency ratio enhances investors’ understanding of its business and performance. The measure is also believed to be useful in understanding the Company’s performance trends and to facilitate comparisons with the performance of others in the financial services industry. Management further believes the presentation of the core efficiency ratio provides useful supplemental information, a clearer understanding of the Company’s financial performance, and better reflects the Company’s core operating activities.

     The risks associated with utilizing operating measures (such as the efficiency ratio) 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 of the Company compensates for these limitations by providing detailed reconciliations between GAAP information and its core efficiency ratio above.

Income Tax Expense

     The Company’s income tax expense was $2.3 million and $618,000, respectively, for 2007 and 2006 and the effective income tax rate was 23.5% and 10.4%. The increase in the effective tax rate was mainly a result of a decrease in the percentage of permanent tax items to pre-tax income and the recognition in 2006 of tax benefits relating to certain tax positions taken on prior year tax returns that had not been recognized for financial reporting purposes. During the fourth quarter of 2006, management determined that the tax liabilities established for these tax uncertainties were no longer required. The Company’s effective tax rate remains lower than the statutory tax rate primarily due to the Company’s investment in bank-owned life insurance and the application of available tax credits.

Year Ended December 31, 2006 Compared to Year Ended December 31, 2005

Net Income

     The Company’s net income for 2006 totaled $5.3 million, or $0.47 per diluted share, a 6.4% increase from net income of $5.0 million, or $0.42 per diluted share, for 2005.

Net Interest Income

     The Company’s net interest income totaled $32.9 million for 2006 representing a 10.2% increase from $29.9 million for 2005. The Company’s net interest margin for 2006 improved 25 basis points to 2.73% from 2.48% for 2005. The increases in net interest income and net interest margin were primarily a result of an increase in the yield on interest-earning assets and a reduction in the amortization of deferred premium on the early extinguishment of debt from the 2004 FHLB debt restructuring.

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Interest Income

     Interest income increased 8.7% to $75.5 million for 2006 from $69.5 million in 2005. The yield on interest-earning assets increased 50 basis points to 6.26% during 2006 from 5.76% in 2005. The increases in 2006 were primarily a result of the upward repricing of adjustable-rate loans reflecting higher market rates of interest during 2006 coupled with the reinvestment of loan and securities repayments into additional securities which yielded higher interest rates. The Company’s average investment in other interest-earning assets (including its investment in FHLB stock, money market accounts, federal funds sold and interest-bearing bank deposits) increased $22.9 million or 62.2% from 2005 due to excess liquidity during 2006.

Interest Expense

     Interest expense totaled $42.6 million for 2006 compared to $39.6 million for 2005. The change was primarily due to increased market rates paid on money market and certificate of deposit accounts which were partially offset by decreased borrowing costs.

     The Company’s interest expense on deposits totaled $22.2 million during 2006 and $13.7 million in 2005 and its cost of deposits increased to 2.77% during 2006 compared to 1.76% for 2005, due to the upward repricing of money market and certificate of deposit accounts and the migration of balances from lower-cost checking and savings accounts to higher-cost money market and certificate of deposit accounts. To mitigate the impact of increasing market rates of interest, the Company grew the average balance of non-interest bearing deposits by 13.9% during 2006.

     The Company’s total interest expense for 2006 was positively impacted by a decrease in interest expense on borrowed money of $5.4 million or 21.0% from 2005. The decrease in interest expense was the result of lower Premium Amortization of $9.6 million during 2006 compared to $14.4 million for 2005.

The Company’s cost of borrowings decreased to 7.55% during 2006 from 8.97% during 2005. The decrease was primarily the result of a decrease in the average balance of the Company’s FHLB borrowings, a decrease in the unamortized deferred premium on the early extinguishment of debt related to the FHLB restructuring completed in 2004 and a decrease in the Premium Amortization that is included in total interest expense on borrowings. The Premium Amortization reduced the net interest margin by 80 basis points in 2006 and 119 basis points in 2005. The Company’s interest expense on borrowings is detailed in the tables below for the periods indicated.

	Year Ended
	December 31,
	2006		2005		$ change			% change
	(Dollars in thousands)
Interest expense on short-term borrowings at contractual rates	$	902	$	35	$	867		NM
Interest expense on FHLB borrowings at contractual rates		9,955		11,501		(1,546	)	(13.4	)%
Premium Amortization		9,624		14,381		(4,757	)	(33.1	)
Total interest expense on borrowings	$	20,481	$	25,917	$	(5,436	)	(21.0	)%

Provision for Losses on Loans

     The Company’s provision for losses on loans was $1.3 million for 2006 compared to $1.6 million in 2005 reflecting required changes to the allowance for losses on loans as determined by its quarterly analysis of the adequacy of the allowance for losses on loans. For more information, see “Changes in Financial Condition – Allowance for Losses on Loans” below in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations”.

37

Non-Interest Income

The following table identifies the changes in non-interest income for the periods presented:

	Year Ended
	December 31,
	2006			2005			$ change			% change
	(Dollars in thousands)
Service charges and other fees	$	6,739		$	7,381		$	(642	)	(8.7	)%
Card-based fees		1,313			1,211			102		8.4
Commission income		197			523			(326	)	(62.3	)
Subtotal fee based revenues		8,249			9,115			(866	)	(9.5	)
Income from bank-owned life insurance		1,592			1,529			63		4.1
Other income		945			877			68		7.8
Subtotal		10,786			11,521			(735	)	(6.4	)
Securities gains (losses), net		750			(238	)		988		NM
Impairment on securities available-for-sale		—			(240	)		240		NM
Other asset gains (losses), net		(994	)		354			(1,348	)	NM
Total non-interest income	$	10,542		$	11,397		$	(855	)	(7.5	)%

     Non-interest income before securities and other asset gains (losses) decreased in 2006 by 6.4% from 2005 primarily due to lower service charges and other fees caused by decreased overdraft fees as deposit customers changed their behavior patterns related to overdrafts and fees. Lower commission income in 2006 from the Company’s third-party service provider for the sale of investment products also negatively impacted non-interest income as rates offered on certificates of deposit became more competitive relative to the yields available on non-deposit products.

     The Company’s non-interest income for 2006 was also impacted by a $1.3 million loss on the sale of property that was collateral for an impaired commercial real estate loan which was transferred to other real estate owned during 2006. Partially offsetting this loss was a $285,000 gain in the fourth quarter on the sale of an other real estate owned property that had been held since 2004.

     Net realized gains on the sales of available-for-sale securities were $750,000 in 2006 compared to net realized losses of $238,000 in 2005. The Company realized an $877,000 gain on the sale during 2006 of its investment in certain trust preferred securities. During 2005, the Company incurred a $240,000 impairment charge on available-for-sale securities due to an impairment on an investment in a Freddie Mac fixed-rate perpetual preferred stock.

Non-Interest Expense

The following table identifies the changes in non-interest expense for the periods presented:

	Year Ended
	December 31,
	2006		2005		$ change			% change
	(Dollars in thousands)
Compensation and mandatory benefits	$	15,655	$	14,635	$	1,020		7.0	%
Retirement and stock related compensation		3,453		2,234		1,219		54.6
Medical and life benefits		1,412		1,329		83		6.2
Other employee benefits		270		227		43		18.9
Subtotal compensation and employee benefits		20,790		18,425		2,365		12.8
Net occupancy expense		2,533		2,679		(146	)	(5.4	)
Furniture and equipment expense		2,013		1,582		431		27.2
Data processing		2,404		2,689		(285	)	(10.6	)
Professional fees		1,514		1,698		(184	)	(10.8	)
Marketing		1,332		986		346		35.1
Other general and administrative expenses		5,592		5,426		166		3.1
Total non-interest expense	$	36,178	$	33,485	$	2,693		8.0	%

38

     The 7.3% increase in the Company’s compensation and mandatory benefits was primarily the result of increased compensation and employee benefits expense as a result of bringing item processing in-house and staffing for growth coupled with increased pension expense. The Company’s increase of 52.6% in retirement and stock related compensation was related to its pension expense which included higher voluntary contributions made to its multi-employer defined benefit plan.

     In addition, furniture and equipment expense increased during 2006 due to the Company’s investment for in-house item processing equipment, new signage, and software expenses. Marketing expenses increased during 2006 as the Company supported growth initiatives through expanded marketing campaigns and brand development.

     The Company’s efficiency ratio was 83.3% and 81.2%, respectively, for 2006 and 2005. The Company’s core efficiency ratio was 67.9% and 60.1%, respectively, for 2006 and 2005. The efficiency ratio and core efficiency ratio during 2006 were impacted by the increases in non-interest expense discussed above. For the Company’s reconciliation of its efficiency ratio and core efficiency ratio, see “Item 6. Selected Financial Data” of this Annual Report on Form 10-K.

Income Tax Expense

     The Company’s income tax expense was $618,000 and $1.2 million, respectively, for 2006 and 2005 and the effective income tax rate was 10.4% and 19.0%. The decrease in the effective tax rate was mainly a result of the recognition of tax benefits relating to certain tax positions taken on prior year tax returns that had not been recognized for financial reporting purposes. During 2006, management determined that the tax liabilities established for these tax uncertainties were no longer required. The Company’s effective tax rate remains lower than the statutory tax rate primarily due to the Company’s investment in bank-owned life insurance and the application of available tax credits.

CHANGES IN FINANCIAL CONDITION FOR 2007

General

     During 2007, the Company’s total assets decreased by $104.1 million to $1.15 billion from $1.25 billion at December 31, 2006. The significant changes in the composition of the Company’s statement of condition during 2006 include a net decrease in:

• cash and cash equivalents of $28.3 million;
   
• securities of $70.4 million;
   
• loans receivable of $9.2 million;
   
• total deposits of $43.8 million; and
   
• borrowed money of $66.8 million.

     The decrease in total assets was a direct result of the decrease in the Company’s deposits and borrowed money. The Company utilized its excess cash and the proceeds from significant loan repayments and sales and maturities of securities to reduce its FHLB advances during the year as well as to fund the managed run-off of high-rate single-service deposit customers.

Securities

     The Company manages its 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.

39

     The Company adjusts the size and composition of its securities portfolio according to a number of factors including expected loan growth, the interest rate environment and projected liquidity. The amortized cost of the Company’s available-for-sale securities and their fair values were as follows for the dates indicated:

	December 31,
	2007				2006				2005
	Amortized		Fair		Amortized		Fair		Amortized		Fair
	Cost		Value		Cost		Value		Cost		Value
	(Dollars in thousands)
Available-for-sale securities:
Government sponsored entity securities (GSE)	$	140,301	$	143,146	$	267,148	$	266,914	$	167,047	$	165,209
Mortgage-backed securities		12,587		12,563		20,234		19,988		29,927		29,456
Collateralized mortgage obligations		56,672		57,180		10,612		10,522		22,553		22,338
Trust preferred securities		8,900		8,900		—		—		85		136
Equity securities		3,344		2,805		1,385		1,501		1,386		1,411
	$	221,804	$	224,594	$	299,379	$	298,925	$	220,998	$	218,550

     Securities available-for-sale were $224.6 million at December 31, 2007 compared to $298.9 million at December 31, 2006. During 2007, the Company repositioned its securities portfolio to improve interest rate risk and to take advantage of market imbalances by shifting the focus from non-callable agency debentures to higher yielding, AAA rated collateralized mortgage obligations. Purchases focused on senior tranches of 15-year, fixed-rate loan collateral originated prior to 2005 with loans-to-value under 50%, historical delinquencies at or near zero, and weighted-average credit scores in excess of 725. As part of this repositioning the Company sold $109.9 million in securities and realized net gains of $536,000. In addition, the Company used proceeds received from sales and maturities to repay $72.0 million of maturing FHLB borrowings.

     At December 31, 2007, the Company also had held-to-maturity securities with an amortized cost of $3.9 million invested in state and municipal securities. The securities had $38,000 in gross unrecognized holding gains at December 31, 2007. The Company did not hold any held-to-maturity securities at December 31, 2006.

     The Company evaluates all securities on a quarterly basis, and more frequently when economic conditions warrant additional evaluations, to determine if an other-than-temporary impairment (OTTI) exists pursuant to guidelines established in FSP 115-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. In evaluating the possible impairment of securities, consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial conditions and near-term prospects of the issuer, and the ability and intent of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an issuer’s financial condition, the Company may consider whether the securities are issued by the federal government or its agencies or government sponsored agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer’s financial condition. If management determines that an investment experienced an OTTI, the loss is recognized in the income statement as a realized loss. Any recoveries related to the value of these securities are recorded as an unrealized gain (as other comprehensive income (loss) in stockholders’ equity) and not recognized in income until the security is ultimately sold.

     At December 31, 2007, management believes the $61,000 unrealized loss on its $21.9 million of securities available-for-sale that had a continuous loss position for twelve months or more were largely attributable to temporary changes in market liquidity. Management does not believe any of these securities represent an OTTI. As of December 31, 2007, the Company has both the intent and ability to hold these impaired securities for a period of time necessary to recover the unrealized losses; however, the Company 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.

40

     The following table sets forth certain information regarding the maturities and weighted average yield of the Company’s securities as of December 31, 2007. The amounts and yields listed in the table are based on amortized cost.

					Mortgage-				Collateralized				Trust								State
					Backed				Mortgage				Preferred				Equity				and
	GSE Securities				Securities(1)				Obligations(1)				Securities(2)				Securities(3)				Municipal				Total
	Amount		Yield		Amount		Yield		Amount		Yield		Amount		Yield		Amount		Yield		Amount		Yield		Amount		Yield
	(Dollars in thousands)
Maturities:
Within 1 year	$	40,301	4.86	%	$	7,140	3.62	%	$	17	7.63	%	$	—	—	%	$	—	—	%	$	940	3.52	%	$	48,398	4.65	%
1 — 5 years		100,000	5.09			5,447	4.67			36,658	5.23			—	—			—	—			3,000	3.60			145,105	5.08
5 — 10 years		—	—			—	—			19,997	5.39			—	—			—	—			—	—			19,997	5.39
Other		—	—			—	—			—	—			8,900	6.38			3,344	6.71			—	—			12,244	6.47
Total securities	$	140,301	5.03		$	12,587	4.08		$	56,672	5.29		$	8,900	6.38		$	3,344	6.71		$	3,940	3.58		$	225,744	5.09
Average months
to Maturity		20				13				43				350				—				27				39

____________________

(1)	The Company’s mortgage-backed securities and collateralized mortgage obligations are amortizing in nature. As such, the maturities presented in the table for these securities are based on historical and estimated prepayment rates for the underlying mortgage collateral and were calculated using prepayment speeds based on the trailing three-month Constant Prepayment Rate. The estimated average lives may differ from actual principal cash flows since cash flows include prepayments and scheduled principal amortization.
(2)	The Company’s Trust Preferred Securities have floating rates. The projected yields to maturity are based on the coupon rates at December 31, 2007.
(3)	Equity Securities have no stated maturity dates and are not included in the average months to maturity.

LOANS

     The following table sets forth the composition of the Bank’s loans receivable and the percentage of loans by category as of the dates indicated.

	2007				2006				2005				2004				2003
			Percent				Percent				Percent				Percent				Percent
	Amount		of Total		Amount		of Total		Amount		of Total		Amount		of Total		Amount		of Total
Commercial and construction loans:
Commercial real estate	$	328,427	41.4	%	$	339,110	42.2	%	$	381,956	41.6	%	$	396,420	40.1	%	$	429,883	43.7	%
Construction and land development		128,584	16.2			128,529	16.0			136,558	14.9			145,162	14.7			125,636	12.8
Commercial and industrial		60,398	7.6			35,743	4.5			61,956	6.8			58,682	5.9			36,222	3.7
Total commercial and
construction loans		517,409	65.2			503,382	62.7			580,470	63.3			600,264	60.7			591,741	60.2
Retail loans:
One-to-four family residential		212,598	26.8			225,007	28.1			235,359	25.7			277,501	28.1			316,774	32.2
Home equity lines of credit		60,326	7.6			70,527	8.8			96,403	10.5			102,981	10.5			71,360	7.3
Other		2,803	0.4			3,467	0.4			5,173	0.5			7,339	0.7			2,704	0.3
Total retail loans		275,727	34.8			299,001	37.3			336,935	36.7			387,821	39.3			390,838	39.8
Total loans receivable, net of
unearned fees	$	793,136	100.0	%	$	802,383	100.0	%	$	917,405	100.0	%	$	988,085	100.0	%	$	982,579	100.0	%

     At December 31, 2007, the Company’s net loan portfolio included $179.9 million of variable-rate loans indexed to the prime lending rate as listed in the Wall Street Journal and another $317.0 million of variable-rate loans tied to other indices.

     The Company’s loans receivable totaled $793.1 million at December 31, 2007 compared to $802.4 million at December 31, 2006. The commercial and construction loan portfolio increased $14.0 million or 2.8% primarily as a result of a $24.7 million or 69.0% increase in commercial and industrial loans partially offset by a $10.7 million or 3.2% decrease in commercial real estate loans. The decrease in commercial real estate loans is due to the Company’s

41

shift in focus from large dollar loans collateralized by commercial real estate to commercial and industrial loans. In addition, the Company’s commercial real estate portfolio decreased upon the sale of three large non-performing loans totaling $9.1 million.

The retail loan portfolio decreased $23.3 million or 7.8% primarily as a result of a decrease of $12.4 million or 5.5% in one-to-four family residential loans and a $10.2 million or 14.5% decrease in HELOCs. The Company’s HELOCs are variable rate loans subject to increased interest rates in a rising rate environment thus causing many borrowers to reduce their outstanding balances through principal repayments or through conversion of all or a portion of their balance to a fixed-rate amortizing loan product. In addition, the Company has reduced its marketing focus on retail loans due to the current economic environment.

Loan Concentrations

     Loan concentrations are considered to exist when there are amounts loaned to a multiple number of borrowers engaged in similar activities which would cause them to be similarly impacted by economic or other conditions. At December 31, 2007, the Company had a concentration of loans secured by office and/or warehouse buildings of $181.7 million or 22.9% of its total loan portfolio. Loans secured by these types of collateral involve higher principal amounts. The repayment of these loans generally is dependent, in large part, on the successful operation of the property securing the loan or the business conducted on the property securing the loan. These loans may be more adversely affected by general conditions in the real estate market or in the economy. At December 31, 2007, the Company also had a concentration of loans secured by properties utilized in the hotel and motel industry of $77.9 million or 9.8% of the Company’s total loan portfolio. These loans include loans to resort hotels, corporate meeting hotels and travel hotels/motels. The hotel and motel business is very competitive and the success of the hotel and motel operators and their ability to repay loans is dependent on local and general economic conditions, among other factors. At December 31, 2007, the Company had no other concentrations of loans to any industry exceeding 10% of its total loan portfolio.

Contractual Principal Repayments and Interest Rates

     The following table sets forth scheduled contractual amortization of the Bank’s commercial and construction loans at December 31, 2007, as well as the dollar amount of such loans which are scheduled to mature after one year which have fixed or adjustable interest rates. Demand loans and loans having no scheduled repayments and no stated maturity are reported as due in one year or less.

	Total at		Principal Repayments Contractually Due
	December 31,		in Year(s) Ended December 31,
	2007		2008		2009-2011		Thereafter
	(Dollars in thousands)
Commercial and construction loans:
Commercial real estate	$	329,031	$	55,302	$	92,605	$	181,124
Construction and land development		128,770		67,862		43,485		17,423
Commercial and industrial		60,321		35,087		17,475		7,759
Total commercial and construction loans		518,122	$	158,251	$	153,565	$	206,306

____________________

(1)	Gross loans receivable does not include deferred fees and costs of $713,000 as of December 31, 2007.
(2)	Of the $359.9 million of loan principal repayments contractually due after December 31, 2008, $137.8 million have fixed interest rates and $222.1 million have variable interest rates which reprice from one month up to five years.

     Scheduled contractual loan amortization does not reflect the expected term of the Bank’s loan portfolio. The average life of loans is substantially less than their contractual terms because of prepayments and due-on-sale clauses, which give the Bank the right to declare a conventional loan immediately due and payable in the event, among other things, that the borrower sells the real property subject to the mortgage and the loan is not repaid. The average life of mortgage loans tends to increase when current market rates of interest for mortgage loans are higher than rates on existing mortgage loans and, conversely, decrease when rates on existing mortgage loans are higher than current market rates as borrowers refinance adjustable-rate and fixed-rate loans at lower rates. Under the latter circumstance, the yield on loans decreases as higher yielding loans are repaid or refinanced at lower rates.

42

ALLOWANCE FOR LOSSES ON LOANS

     The allowance for losses on loans is maintained at a level management believes is sufficient to absorb credit losses inherent in the loan portfolio. The allowance for losses on loans represents management’s estimate of inherent losses existing in the loan portfolio that are both probable and reasonable to estimate at each statement of condition date and are based on the review of available and relevant information. Management’s quarterly evaluation of the adequacy of the allowance is based in part on the Company’s historical charge-offs and recoveries; levels of and trends in delinquencies; impaired loans and other classified loans; concentrations of credit within the commercial and construction loan portfolio; volume and type of lending; and current and anticipated economic conditions. The Company’s charge-off policy varies with respect to the category of and specific circumstances surrounding each loan under consideration. The Company records charge-offs on the basis of management’s ongoing evaluation of collectibility. Loans which are determined to be uncollectible are reviewed and approved by the Bank’s Loan Committee. All charged-off amounts reduce the Company’s allowance for losses on loans; recoveries of loans previously charged-off are credited to the allowance. Management believes the allowance for losses on loans is adequate to absorb credit losses inherent in the loan portfolio at December 31, 2007. See further analysis in the “Critical Accounting Policies” previously discussed in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” as well as “Note 1. Summary of Significant Accounting Policies” in the notes to consolidated financial statements included in “Item 8. Financial Statements and Supplementary Data” of this Annual Report on Form 10-K.

     The following table sets forth the activity in the Bank’s allowance for losses on loans during the periods indicated:

	Year Ended December 31,
	2007			2006			2005			2004			2003
	(Dollars in thousands)
Allowance at beginning of period	$	11,184		$	12,939		$	13,353		$	10,453		$	8,721
Provision		2,328			1,309			1,580			8,885			2,326
Charge-offs:
Commercial and construction loans:
Commercial real estate		(4,260	)		(2,987	)		(877	)		(3,635	)		(178	)
Construction and land development		(776	)		—			—			(1,206	)		(142	)
Commercial and industrial		(231	)		(241	)		(505	)		(903	)		(92	)
Total commercial and construction loans		(5,267	)		(3,228	)		(1,382	)		(5,744	)		(412	)
Retail loans:
One-to-four family residential		(1	)		(109	)		(320	)		(217	)		(83	)
Home equity lines of credit		(208	)		(80	)		(201	)		—			—
Other		(200	)		(211	)		(270	)		(268	)		(265	)
Total retail loans		(409	)		(400	)		(791	)		(485	)		(348	)
Total charge-offs		(5,676	)		(3,628	)		(2,173	)		(6,229	)		(760	)
Recoveries:
Commercial and construction loans:
Commercial real estate		102			318			21			7			4
Construction and land development		18			43			73			––			90
Commercial and industrial		9			110			2			105			14
Total commercial and construction loans		129			471			96			112			108
Retail loans:
One-to-four family residential		—			18			1			104			40
Home equity lines of credit		14			12			29			3			—
Other		47			63			53			25			18
Total retail loans		61			93			83			132			58
Total recoveries		190			564			179			244			166
Net loans charged-off to allowance for losses on loans		(5,486	)		(3,064	)		(1,994	)		(5,985	)		(594	)
Allowance at end of period	$	8,026		$	11,184		$	12,939		$	13,353		$	10,453
Allowance for losses on loans to total non-performing loans at end of
period		27.11	%		40.64	%		61.49	%		48.25	%		46.01	%
Allowance for losses on loans to total loans at end of period		1.01			1.39			1.41			1.35			1.06
Ratio of net loans charged-off to average loans
outstanding for the period		0.68			0.36			0.21			0.60			0.06

43

     Net charge-offs for 2007 totaled $5.5 million, or 0.7% of average loans outstanding, as compared to $3.1 million or 0.4% of average loans outstanding for 2006. At December 31, 2007, the allowance for losses on loans decreased by $3.2 million, or 28.2%, from 2006. The decrease in the allowance for losses on loans is primarily a result of reductions in the estimated SFAS 114 component of the allowance for losses on loans for impaired loans due to the charge-offs totaling $4.2 million relating to the sale of $12.8 million of loans with previously identified impairment reserves totaling $4.0 million.

     The provision for losses on loans increased to $2.3 million in 2007 from $1.3 million in 2006 and $1.6 million in 2005. The increase in the provision is the result of an increase in non-performing loans combined with increases in the impairment reserves related to commercial real estate and land development loans during 2007.

     Gross charge-offs in 2007 totaled $5.7 million and includes $4.2 million of charge-offs related to the fourth quarter 2007 sale of $12.8 million in impaired and potential problem loans. Prior to the sale, these loans had impairment reserves totaling $4.0 million. During 2007, the Company also realized $776,000 of partial charge-offs related to two impaired construction and land development loans, one of which had a previous impairment reserve of $500,000.

     The allowance for losses on loans represented 27.1% and 40.6%, respectively, of the Bank’s non-performing loans and 1.01% and 1.39%, respectively, of its total loans receivable at December 31, 2007 and 2006. The changes in the ratios are directly related to the large charge-offs discussed above and included impaired loans that were sold in 2007 with required impairment reserves that had already been established in previous years.

Allocation of the Allowance for Losses on Loans

     The Bank allocates its allowance for losses on loans by loan category. Various percentages are assigned to the loan categories based on their historical loss factors. These historical loss factors are adjusted for various qualitative factors including trends in delinquencies and impaired loans; charge-offs and recoveries; volume and terms of loans; underwriting practices; lending management and staff; economic trends and conditions; industry conditions; and credit concentrations. The allocation of the allowance for losses on loans is reviewed and approved by the Bank’s Loan Committee. The following table shows the allocation of the allowance for losses on loans by loan type for each of the last five years:

	December 31,
	2007				2006				2005				2004				2003
			Allowance				Allowance				Allowance				Allowance				Allowance
	Allowance		as a % of		Allowance		as a % of		Allowance		as a % of		Allowance		as a % of		Allowance		as a % of
	Allocation		Category		Allocation		Category		Allocation		Category		Allocation		Category		Allocation		Category
	(Dollars in thousands)
Residential real estate:
One-to-four family owner occupied	$	1,266	0.46	%	$	1,395	0.47	%	$	1,064	0.33	%	$	730	0.20	%	$	488	0.13	%
One-to-four family non-owner
occupied		127	0.46			129	0.47			88	0.33			56	0.20			134	0.24
Multi-family		430	1.15			437	1.09			362	0.67			1,005	1.20			2,352	2.31
Business/Commercial real estate		3,944	1.33			7,437	2.53			9,711	2.45			9,368	2.34			5,155	1.48
Business/Commercial
non-real estate		659	1.15			653	1.34			1,137	2.28			1,412	3.36			1,096	1.71
Developed Lots		319	0.62			224	0.39			105	0.36			125	0.36			102	1.04
Land		1,069	2.12			695	1.34			149	0.36			289	0.63			566	1.57
Consumer non-real estate		212	4.35			214	3.90			323	3.89			368	3.55			447	12.70
Other assets		—	—			—	—			––	—			—	—			113	—
Unallocated		—	—			—	—			—	—			––	—			—	—
	$	8,026			$	11,184			$	12,939			$	13,353			$	10,453

44

ASSET QUALITY

General

     All of the Bank’s assets are subject to review under its classification system. See discussion on “Potential Problem Assets” below. Impaired loans are reviewed quarterly by the Bank’s Loan Committee. The Board of Directors reviews the Bank’s classified assets (including impaired loans) on a quarterly basis. When a borrower fails to make a required payment on a loan, the Bank attempts to cure the deficiency by contacting the borrower and seeking payment. Contacts are generally made prior to 30 days after a payment is due. Late charges are generally assessed after 15 days with additional efforts being made to collect the past due payments. While the Bank generally prefers to work with borrowers to resolve delinquency problems, when the account becomes 90 days delinquent, the Bank may institute foreclosure or other proceedings, as deemed necessary, to minimize any potential loss.

     Loans are placed on non-accrual status when, in the judgment of management, the probability of collection of interest is deemed to be insufficient to warrant further accrual. When a loan is placed on non-accrual status, previously accrued but unpaid interest is deducted from interest income. The Bank generally does not accrue interest on loans past due 90 days or more.

     Real estate acquired by the Bank as a result of foreclosure or by deed-in-lieu of foreclosure is classified as other real estate owned until sold. Foreclosed assets are held for sale and such assets are carried at the lower of fair value minus estimated costs to sell the property or cost (generally the balance of the loan on the property at the date of acquisition). After the date of acquisition, all costs incurred in maintaining the property are expensed, and costs incurred for the improvement or development of such property are capitalized up to the extent of the property’s net realizable value.

Non-Performing Assets

     The following table summarizes the Company’s non-accrual loans as well as information relating to the Company’s non-performing assets at the dates indicated. Loans are placed on non-accrual status when, in management’s judgment, the probability of collection of interest is deemed to be insufficient to warrant further accrual.

	December 31,
	2007			2006			2005			2004			2003
	(Dollars in thousands)
Non-accrual loans:
Commercial and construction loans:
Commercial real estate	$	9,605		$	15,863		$	17,492		$	19,197		$	11,460
Construction and land development		16,240			7,192			77			1,895			4,180
Commercial and industrial		281			455			94			236			1,205
Total commercial and construction loans		26,126			23,510			17,663			21,328			16,845
Retail loans:
One-to-four family residential		2,706			3,177			2,929			5,855			5,584
Home equity lines of credit		749			772			429			460			272
Other		19			58			20			32			19
Total retail loans		3,474			4,007			3,378			6,347			5,875
Total non-accrual loans		29,600			27,517			21,041			27,675			22,720
Other real estate owned, net		1,162			321			540			525			206
Total non-performing assets	$	30,762		$	27,838		$	21,581		$	28,200		$	22,926
90 days past due loans still accruing interest		—			—			—			—			—
Total non-performing assets plus 90 days past due
loans still accruing interest	$	30,762		$	27,838		$	21,581		$	28,200		$	22,926
Non-performing assets to total assets		2.67	%		2.22	%		1.74	%		2.14	%		1.46	%
Non-performing loans to total loans		3.73			3.43			2.29			2.80			2.31

45

     During 2007 the Company’s non-performing loans increased to $29.6 million, or $2.1 million, from 2006 primarily as a result of a $9.0 million increase in construction and land development loans due to the transfer of a $3.0 million loan to non-accrual status during the second quarter of 2007 and the transfer of a $7.5 million purchased participation loan to non-accrual status during the fourth quarter of 2007. Commercial real estate non-performing loans decreased primarily due to the fourth quarter sale of three large non-performing loans totaling $9.1 million which was partially offset by the transfer to non-accrual status of two loans totaling $3.2 million in the aggregate during 2007. Other real estate owned increased $841,000 during 2007 mainly due to the transfer of one non-accrual construction and land development loan totaling $500,000 during the third quarter of 2007. Of the Company’s total non-performing loans at December 31, 2007, $12.6 million are purchased participations.

     The Company continues to explore ways to reduce its overall exposure in these non-performing loans through various alternatives, including the potential sale of certain of these non-performing assets. Any future impact to the Company’s allowance for losses on loans in the event of such sales or other similar actions cannot be reasonably determined at this time.

     The interest income that would have been recorded during 2007, if all of the Bank’s non-performing loans at the end of the year had been current in accordance with their terms during the year, was $1.7 million. The actual amount of interest recorded as income (on a cash basis) on these loans during the year totaled $402,000.

     The Company’s disclosure with respect to impaired loans is contained in “Note 3. Loans Receivable” in the notes to consolidated financial statements included in “Item 8. Financial Statements and Supplementary Data” of this Annual Report on Form 10-K.

Potential Problem Assets

     Federal regulations require that each insured institution maintain an internal classification system as a means of reporting problem and potential problem assets. Furthermore, in connection with examinations of insured institutions, federal examiners have the authority to identify problem assets and, if appropriate, classify them. There are three adverse classifications for problem assets:

• Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected.
   
• Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high probability of loss.
   
• Loss assets are considered uncollectible and of such little value that continuance as an asset of the institution is not warranted.

     Federal examiners have designated another category as “special mention” for assets which have some identified weaknesses but do not currently expose an insured institution to a sufficient degree of risk to warrant classification as substandard, doubtful or loss.

     The Company uses this internal classification system to identify potential problem assets which management defines as loans rated substandard, doubtful or loss pursuant to the Company’s internal loan grading system that do not meet the definition of a non-performing loan. These loans are identified as such due to the borrowers’ financial operations or financial condition which caused the Bank’s management to question the borrowers’ ability in the future to comply with their contractual repayment terms. The Company’s decision to include performing loans in potential problem loans does not necessarily mean that it expects losses to occur but that it recognizes potential problem loans carry a higher probability of default. Potential problem loans totaled $4.4 million at December 31, 2007 and $5.6 million at December 31, 2006. The decrease in the Company’s potential problem loans from 2006 was primarily due to the transfer of a $212,000 potential problem loan into non-accrual status and the payoff during 2007 of a $108,000 previously identified potential problem loan. In addition, three loans totaling $691,000 in the aggregate that were previously identified as potential problem assets were brought current in 2007.

46

DEPOSITS

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

	December 31,
	2007				2006				2005
	Amount		Percentage		Amount		Percentage		Amount		Percentage
	(Dollars in thousands)
Checking accounts:
Non-interest bearing	$	62,306	7.2	%	$	58,547	6.5	%	$	66,116	8.0	%
Interest-bearing		107,467	12.5			100,912	11.1			106,938	12.9
Money market accounts		171,470	19.9			182,153	20.1			121,667	14.7
Savings accounts		127,297	14.7			148,707	16.4			170,619	20.6
Core deposits		468,540	54.3			490,319	54.1			465,340	56.2
Certificates of deposit:
Less than $100,000		263,134	30.5			281,810	31.1			261,977	31.6
$100,000 or more		131,598	15.2			134,966	14.9			101,318	12.2
Time deposits		394,732	45.7			416,776	45.9			363,295	43.8
Total deposits	$	863,272	100.0	%	$	907,095	100.0	%	$	828,635	100.0	%

     As of December 31, 2007, the aggregate amount of outstanding time certificates of deposit in amounts greater than or equal to $100,000 was $131.6 million. The following table presents the maturity of these time certificates of deposit.

	December 31, 2007
	(Dollars in thousands)
3 months or less		$	56,235
Over 3 months through 6 months			34,519
Over 6 months through 12 months			24,921
Over 12 months			15,923
		$	131,598

     The Company’s total deposits decreased 4.8% to $863.3 million at December 31, 2007 from $907.1 million at December 31, 2006. Growth in the Company’s checking deposits totaled $10.3 million, or 6.5%, and was driven by growth in the number of checking accounts as a result of the customer-centric relationship management program that was implemented in early 2007 and its focus on building relationships with local businesses. Total core deposits decreased by $21.8 million, or 4.4%, primarily due to a decrease in money market and savings accounts. Money market accounts decreased $10.7 million as a result of a $20.4 million decrease in business and municipal money market accounts which were primarily related to the cyclical nature of municipal deposits. This decrease was partially offset by an increase in retail money market accounts of $9.8 million as a result of the Company’s relationship management program. Total savings accounts decreased by $21.4 million as depositors sought higher-yielding deposit and investment products. Total certificates of deposit accounts decreased $22.0 million due to the Company’s managed run-off of single-service high-rate certificates.

47

     The Company offers specific deposit agreements to local municipalities and other public entities. The following table identifies the dollar amount of municipal deposits in each deposit category for the dates indicated.

	December 31,
	2007				2006				2005
	Amount		Percentage		Amount		Percentage		Amount		Percentage
	(Dollars in thousands)
Checking accounts:
Non-interest bearing	$	1,028	1.6	%	$	59	0.1	%	$	4,212	53.6	%
Interest-bearing		13,022	20.9			369	0.7			164	2.1
Money market accounts		31,610	50.6			46,321	85.0			2,305	29.4
Core deposits		45,660	73.1			46,749	85.8			6,681	85.1
Certificates of deposit		16,803	26.9			7,728	14.2			1,172	14.9
Total municipal deposits	$	62,463	100.0	%	$	54,477	100.0	%	$	7,853	100.0	%

     In addition, the Company offers 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 a pool of multiple securities owned by the Bank. The swept funds are not recorded as deposits by the Bank and instead are classified as other short-term borrowings which provide a lower-cost funding alternative for the Company as compared to FHLB advances. At December 31, 2007, the Company had $18.0 million in Repo Sweeps which are not included in the above deposit totals, of which $13.3 million were Repo Sweeps with municipalities and other public entities.

BORROWED MONEY

     The Company’s borrowed money consisted of the following at the dates indicated:

	December 31,
	2007					2006
	Weighted					Weighted
	Average					Average
	Contractual					Contractual
	Rate		Amount			Rate		Amount
	(Dollars in thousands)
Repo Sweep accounts	3.42	%	$	18,014		4.75	%	$	23,117
Overnight Federal Funds purchased	4.50			6,000		—			—
FHLB – Indianapolis advances	4.14			113,072		3.93			185,325
Less: deferred premium on early extinguishment of debt				(1,627	)				(6,167	)
Total borrowed money	4.06	%	$	135,459		4.02	%	$	202,275

     The Company’s Repo Sweeps are treated as financings; the obligations to repurchase securities sold are reflected as short-term borrowings. The securities underlying these Repo Sweeps continue to be reflected as assets of the Company.

     In order to reduce its reliance on wholesale funding and as a result of the flat to inverted yield curve, the Company repaid $72.0 million of maturing FHLB advances during 2007.

     The Company’s FHLB advances are reduced by the deferred premium on the early extinguishment of debt as a result of its 2004 FHLB debt restructure. As a result of the restructuring, the Company paid $42.0 million of prepayment penalties related to the restructured advances, a portion of which is deferred over the life of the new borrowings. The deferred premium on the early extinguishment of debt totaled $32.2 million and is being amortized as a charge to interest expense over the remaining life of the new borrowings. The Company internally computed the effect of the amortization on interest expense over the life of each of the new advances. For the years ended December 31, 2007 and 2006, the Company’s increase in interest expense related to the Premium Amortization was

48

$4.5 million and $9.6 million, respectively. The increase in interest expense related to the remaining unamortized deferred premium is expected to be $1.4 million and $200,000 in the years ended December 31, 2008 and 2009, respectively.

CAPITAL RESOURCES

     Stockholders’ equity at December 31, 2007 was $130.4 million compared to $131.8 million at December 31, 2006. The decrease during 2007 was primarily due to:

• repurchases of shares of the Company’s common stock during 2007 totaling $9.8 million and
    
• cash dividends declared during 2007 totaling $5.1 million.

The following increases in stockholder’s equity during 2007 partially offset the aforementioned decreases:

• net income of $7.5 million;
   
• proceeds from stock option exercises totaling $2.8 million; and
   
• an increase in accumulated other comprehensive income of $2.1 million.

     During 2007, the Company repurchased 661,558 shares of its common stock at an average price of $14.74 per share pursuant to its share repurchase programs. At December 31, 2007, the Company had 126,725 shares remaining to be repurchased under its current program. Since its initial public offering in 1998, the Company has repurchased an aggregate of 13,846,047 shares of its common stock at an average price of $12.20 per share.

At December 31, 2007, the Bank was deemed to be well capitalized based on its internal calculations with tangible and core regulatory capital ratios of 10.50% and a risk-based capital ratio of 13.93%. For further information on the Bank’s regulatory capital see “Note 12. Stockholders’ Equity and Regulatory Capital” in the consolidated financial statements included in “Item 8. Financial Statements and Supplementary Data” of this Annual Report on Form 10-K.

LIQUIDITY AND COMMITMENTS

     The Company’s liquidity, represented by cash and cash equivalents, is a product of operating, investing and financing activities. The Company’s primary sources of funds have been:

• deposits and Repo Sweeps,
   
• scheduled payments of amortizing loans and mortgage-backed securities,
   
• prepayments and maturities of outstanding loans and mortgage-backed securities,
   
• maturities of investment securities and other short-term investments,
   
• funds provided from operations, and
   
• borrowings from the FHLB.

     Scheduled payments from the amortization of loans, mortgage-backed securities, 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 December 31, 2007, the Company had cash and cash equivalents of $38.9 million, a decrease from $67.2 million at December 31, 2006. The decrease was mainly the result of:

• purchases of available-for-sale securities totaling $121.0 million;
   
• decreases in deposit accounts totaling $44.0 million; and
   
• repayment of FHLB debt totaling $124.3 million.

The above cash outflows were partially offset by:

• proceeds from sales, maturities and paydowns of securities aggregating $198.7 million and
   
• proceeds from FHLB variable advances totaling $52.0 million.

49

     The Company uses its sources of funds primarily to meet its ongoing commitments, fund loan commitments, fund maturing certificates of deposit and savings withdrawals, and maintain a securities portfolio. The Company anticipates that it will continue to have sufficient funds to meet its current commitments.

     The liquidity needs of the parent company, CFS Bancorp, Inc., consist primarily of operating expenses, dividend payments to stockholders and stock repurchases. The primary sources of liquidity are cash and cash equivalents and dividends from the Bank. CFS Bancorp, Inc. also has $5.0 million of available liquidity under a line of credit. 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. On a parent company-only basis, during 2007, the Company received $9.0 million in dividends from the Bank. At December 31, 2007, the parent company had $3.0 million in cash and cash equivalents and $134,000 in securities available-for-sale. See also “Note 12. Stockholders’ Equity and Regulatory Capital” in the consolidated financial statements included in “Item 8. Financial Statements and Supplementary Data” of this Annual Report on Form 10-K for a further discussion of the Bank’s ability to pay dividends.

Contractual Obligations

     The following table presents significant fixed and determinable contractual obligations to third parties by payment date as of December 31, 2007.

	Payments Due by Period
			Over One
	One		through		Over Three			Over
	Year		Three		through			Five
	or Less		Years		Five Years			Years		Total
	(Dollars in thousands)
Federal Home Loan Bank advances (1)	$	72,271	$	30,602	$		689	$	9,510	$	113,072
Short-term borrowings (2)		24,014		—			—		—		24,014
Operating leases		620		446			117		—		1,183
Dividends payable on common stock		1,301		—			—		—		1,301
	$	98,206	$	31,048		$	806	$	9,510	$	139,570

____________________
 

(1)	Does not include interest expense at the weighted-average contractual rate of 4.14% for the periods presented.
(2)	Does not include interest expense at the weighted-average contractual rate of 3.69% for the periods presented.

     See the “Borrowed Money” section for further discussion surrounding the Company’s FHLB advances. The Company’s operating lease obligations reflected above include the future minimum rental payments, by year, required under the lease terms for premises and equipment. Many of these leases contain renewal options, and certain leases provide options to purchase the leased property during or at the expiration of the lease period at specific prices. See also “Note 4. Office Properties and Equipment” in the consolidated financial statements included in “Item 8. Financial Statements and Supplementary Data” of this Annual Report on Form 10-K for further discussion related to the Company’s operating leases.

     The Company also has commitments to fund certificates of deposit which are scheduled to mature within one year or less. These deposits total $344.7 million at December 31, 2007. Based on historical experience and the fact that these deposits are at current market rates, management believes that a significant portion of the maturing deposits will remain with the Bank.

Off-Balance-Sheet Obligations

     The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the statement of condition. The Company’s 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. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

50

     The following table details the amounts and expected maturities of significant commitments at December 31, 2007.

			Over One		Over Three		Over
	One Year		through		through		Five
	or Less		Three Years		Five Years		Years		Total
	(Dollars in thousands)
Commitments to extend credit:
Commercial	$	29,538	$	1,665	$	2,304	$	374	$	33,881
Retail		7,411		—		—		—		7,411
Commitments to fund unused construction loans		24,200		26,286		2,210		3,138		55,834
Commitments to fund unused lines of credit:
Commercial		21,566		10,673		—		247		32,486
Retail		12,082		10		250		54,683		67,025
Letters of credit		7,117		405		699		—		8,221
Credit enhancements		8,487		22,770		—		—		31,257
	$	110,401	$	61,809	$	5,463	$	58,442	$	236,115

     The commitments listed above do not necessarily represent future cash requirements, in that these commitments often expire without being drawn upon. All commitments to extend credit or to purchase loans expire within the following year. Letters of credit expire at various times through 2012. Credit enhancements expire at various times through 2010.

     The Company also has 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 $1.2 million to be funded over seven 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 project. These commitments are not included in the commitment table above. See additional disclosures in “Note 14. Variable Interest Entities” in the consolidated financial statements included in “Item 8. Financial Statements and Supplementary Data” of this Annual Report on Form 10-K.

     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 a triple-A rating, which provides for a lower interest rate, the FHLB issues, in favor of the bond trustee, an Irrevocable Direct Pay Letter of Credit (IDPLOC) for the account of the Bank. Since the Bank, in accordance with the terms and conditions of a Reimbursement Agreement between the FHLB and the Bank, would be required to reimburse the FHLB for draws against the IDPLOC, these facilities are analyzed, appraised, secured by real estate mortgages, and monitored as if the Bank had funded the project initially.

IMPACT OF INFLATION AND CHANGING PRICES

     The consolidated financial statements and related financial data presented herein have been prepared in accordance with U.S. generally accepted accounting principles, which require the measurement of financial position and operating results generally in terms of historical dollars, without considering changes in relative purchasing power over time due to inflation. Unlike most industrial companies, virtually all of the Company’s assets and liabilities are monetary in nature. Monetary items, such as cash, loans and deposits, are those assets and liabilities which are or will be converted into a fixed number of dollars regardless of changes in prices. As a result, changes in interest rates generally have a more significant impact on a financial institution’s performance than general inflation. Over short periods of time, interest rates may not necessarily move in the same direction or of the same magnitude as inflation.

51

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     The Bank, like other financial institutions, is 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 its assets, liabilities and off-balance sheet contracts. IRR is primarily the result of imbalances between the price sensitivity of the Bank’s assets and its liabilities. These imbalances can be caused by differences in the maturity, repricing and coupon characteristics of various assets and liabilities as well as options (such as loan prepayment options).

     The Bank maintains 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 Company’s Board of Directors who in turn assigns its formulation, revision and administration to the Asset/Liability Committee (ALCO). ALCO meets monthly and consists of certain senior officers of the Bank and one outside director. The results of the monthly meetings are reported to the Company’s Board 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 the Bank’s capital position, review the current and prospective liquidity positions and monitor alternative funding sources. The policy requires management to measure the Bank’s overall IRR exposure using NPV analysis and earnings at risk analysis.

     NPV is defined as the net present value of the Bank’s existing assets, liabilities and off-balance sheet contracts. NPV analysis measures the sensitivity of the Bank’s 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 issues, 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 December 31, 2007 and 2006, an analysis of the Bank’s 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. As illustrated in the table, the Bank’s NPV in the base case (0 basis point change) decreased $10.9 million from $178.3 million at December 31, 2006 to $167.4 million at December 31, 2007. The primary causes for this decrease were changes in the composition of the Bank’s assets and liabilities along with changes in interest rates.

		Net Portfolio Value
		At December 31,
		2007							2006
		$ Amount		$ Change			% Change		$ Amount		$ Change			% Change
		(Dollars in thousands)
Assumed Change in Interest Rates
(Basis Points)
	+300	$	148,908	$	(18,532	)	(11.1	)%	$	145,688	$	(32,565	)	(18.3	)%
	+200		158,403		(9,037	)	(5.4	)		157,889		(20,364	)	(11.4	)
	+100		166,898		(542	)	(0.3	)		168,493		(9,760	)	(5.5	)
	0		167,440		—		—			178,253		—		—
	-100		178,059		10,619		6.3			185,481		7,228		4.1
	-200		180,955		13,515		8.1			192,248		13,995		7.9

     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 the Bank’s earnings.

52

     A key assumption which is controlled by the Bank for use in its earnings at risk model is the assumed repricing sensitivity of its non-maturing core deposit accounts. The following assumptions were used by the Bank for the repricing of non-maturity core deposit accounts.

	Percentage
	of Deposits
	Maturing In
	First Year
	At December 31,
Deposit Category:	2007		2006
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 Bank’s projected changes in net interest income over a twelve month period for the various interest rate change (rate shocks) scenarios at December 31, 2007 and 2006.

	Percentage Change in
	Net Interest Income
	Over a Twelve Month
	Time Period
	2007		2006
Assumed Change in Interest Rates
(Basis Points):
+300	(0.8	)%	(1.8	)%
+200	0.0		(0.8	)
+100	0.3		(0.2	)
-100	(1.3	)	(0.6	)
-200	(4.3	)	(3.1	)

     The earnings at risk analysis suggests the Bank is subject to higher IRR in a falling rate environment than in a rising rate environment. The table above indicates that if interest rates were to move up 300 basis points, net interest income would be expected to decrease 0.8% in year one; and if interest rates were to move down 200 basis points, net interest income would be expected to decrease 4.3% in year one. The primary causes for the changes in net interest income over the twelve month period were a result of the changes in the composition of the Bank’s assets and liabilities along with changes in interest rates.

     The Bank manages its IRR position by holding assets on the statement of condition with desired IRR characteristics, implementing certain pricing strategies for loans and deposits and implementing various securities portfolio strategies. The Bank currently plans on continuing to reduce its exposure to falling interest rates by lengthening the duration of its securities portfolio increasing its core deposit balances and replacing fixed-rate borrowings with variable-rate borrowings. On a quarterly basis, the ALCO reviews the calculations of all IRR measures for compliance with the Board approved tolerance limits. At December31, 2007, the Bank was in compliance with all of its tolerance limits.

     The above IRR analyses include the assets and liabilities of the Bank only. Inclusion of Company-only assets and liabilities would have a non-material impact on the results presented.

53

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Report of Independent Registered Public Accounting Firm

Audit Committee, Board of Directors and Stockholders
CFS Bancorp, Inc.
Munster, Indiana

     We have audited the accompanying consolidated statements of condition of CFS Bancorp, Inc. as of December 31, 2007 and 2006, and the related consolidated statements of income, changes in stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2007. The Company’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.

     We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. Our audits included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

     In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of CFS Bancorp, Inc. as of December 31, 2007, and 2006, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2007, in conformity with accounting principles generally accepted in the Unites States of America.

     We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), CFS Bancorp, Inc.’s internal control over financial reporting as of December 31, 2007, based on criteria established in InternalControl-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 3, 2008, expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

 

Indianapolis, Indiana
March 3, 2008

54

CFS BANCORP, INC.

Consolidated Statements of Condition

	December 31,
	2007			2006
	(Dollars in thousands
	except per share data)
ASSETS
Cash and amounts due from depository institutions	$	25,825		$	33,194
Interest-bearing deposits		9,744			20,607
Federal funds sold		3,340			13,366
Cash and cash equivalents		38,909			67,167
Securities available-for-sale, at fair value		224,594			298,925
Securities held-to-maturity, at cost		3,940			—
Investment in Federal Home Loan Bank stock, at cost		23,944			23,944
Loans receivable		793,136			802,383
Allowance for losses on loans		(8,026	)		(11,184	)
Net loans		785,110			791,199
Interest receivable		5,505			7,523
Other real estate owned		1,162			321
Office properties and equipment		19,326			17,797
Investment in bank-owned life insurance		36,475			35,876
Other assets		10,079			10,339
Goodwill and intangible assets		1,234			1,299
Total assets	$	1,150,278		$	1,254,390
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits	$	863,272		$	907,095
Borrowed money		135,459			202,275
Advance payments by borrowers for taxes and insurance		3,341			4,194
Other liabilities		17,792			9,020
Total liabilities		1,019,864			1,122,584
Commitments and contingencies		—			—
Stockholders’ equity:
Preferred stock, $.01 par value; 15,000,000 shares authorized		—			—
Common stock, $.01 par value; 85,000,000 shares authorized; 23,423,306
shares issued; 10,705,510 and 11,134,331 shares outstanding		234			234
Additional paid-in capital		191,162			190,825
Retained earnings		97,029			94,344
Treasury stock, at cost; 12,583,856 and 12,164,754 shares		(154,895	)		(148,108	)
Treasury stock held in Rabbi Trust, at cost; 133,940 and 124,221 shares		(1,766	)		(1,627	)
Unallocated common stock held by Employee Stock Ownership Plan		(3,126	)		(3,564	)
Accumulated other comprehensive income (loss), net of tax		1,776			(298	)
Total stockholders’ equity		130,414			131,806
Total liabilities and stockholders’ equity	$	1,150,278		$	1,254,390

See accompanying notes.

55

CFS BANCORP, INC.

Consolidated Statements of Income

	Year Ended December 31,
	2007		2006			2005
	(Dollars in thousands except per share data)
Interest income:
Loans	$	56,678	$	59,852		$	60,880
Securities		12,684		12,713			7,388
Other		2,879		2,982			1,196
Total interest income		72,241		75,547			69,464
Interest expense:
Deposits		26,222		22,163			13,686
Borrowed money		11,912		20,481			25,917
Total interest expense		38,134		42,644			39,603
Net interest income		34,107		32,903			29,861
Provision for losses on loans		2,328		1,309			1,580
Net interest income after provision for losses on loans		31,779		31,594			28,281
Non-interest income:
Service charges and other fees		6,795		6,739			7,381
Card-based fees		1,489		1,313			1,211
Commission income		147		197			523
Security gains (losses), net		536		750			(238	)
Other asset gains (losses), net		22		(994	)		354
Impairment on securities available-for-sale		—		—			(240	)
Income from bank-owned life insurance		1,634		1,592			1,529
Other income		892		945			877
Total non-interest income		11,515		10,542			11,397
Non-interest expense:
Compensation and employee benefits		18,406		20,790			18,425
Net occupancy expense		2,847		2,533			2,679
Furniture and equipment expense		2,241		2,013			1,582
Data processing		2,169		2,404			2,689
Professional fees		1,540		1,514			1,698
Marketing		842		1,332			986
Other general and administrative expenses		5,414		5,592			5,426
Total non-interest expense		33,459		36,178			33,485
Income before income taxes		9,835		5,958			6,193
Income tax expense		2,310		618			1,176
Net income	$	7,525	$	5,340		$	5,017
Per share data:
Basic earnings per share	$	0.71	$	0.48		$	0.43
Diluted earnings per share		0.69		0.47			0.42
Weighted-average shares outstanding		10,547,853		11,045,857			11,728,073
Weighted-average diluted shares outstanding		10,842,782		11,393,863			11,965,014

See accompanying notes.

56

CFS BANCORP, INC.

Consolidated Statements of Changes in Stockholders’ Equity

												Unearned			Unearned
												Common			Accumulated			Accumulated
			Additional									Stock			Stock			Other
	Common		Paid-In			Retained			Treasury			Acquired			Acquired			Comprehensive
	Stock		Capital			Earnings			Stock			by ESOP			by RRP			Income (Loss)				Total
	(Dollars in thousands)
Balance at January 1, 2005	$	234	$	189,991		$	94,904		$	(130,689	)	$	(5,959	)	$	(148	)		$	(422	)	$	147,911
Net income for 2005		—		—			5,017			—			—			—				—			5,017
Comprehensive loss:
Change in unrealized appreciation
on available-for-sale securities,
net of reclassification and tax		—		—			—			—			—			—				(1,124	)		(1,124	)
Total comprehensive income		—		—			—			—			—			—				—			3,893
Purchase of treasury stock		—		—			—			(7,253	)		—			—				—			(7,253	)
Shares earned under ESOP		—		449			—			—			1,197			—				—			1,646
Amortization of award under RRP		—		12			—			—			—			37				—			49
Exercise of stock options		—		(229	)		—			1,713			—			—				—			1,484
Tax benefit related to stock options
exercised		—		179			—			—			—			—				—			179
Dividends declared on common stock
($0.48 per share)		—		—			(5,542	)		—			—			—				—			(5,542	)
Balance at December 31, 2005		234		190,402			94,379			(136,229	)		(4,762	)		(111	)			(1,546	)		142,367
Net income for 2006		—		—			5,340			—			—			—				—			5,340
Comprehensive income:
Change in unrealized appreciation
on available-for-sale securities,
net of reclassification and tax		—		—			—			—			—			—				1,248			1,248
Total comprehensive income		—		—			—			—			—			—				—			6,588
Purchase of treasury stock		—		—			—			(15,730	)		—			—				—			(15,730	)
Cumulative effect of change in
accounting for Rabbi Trust shares,
see Note 1		—		—			(92	)		(1,609	)		—			—				—			(1,701	)
Net purchases of Rabbi Trust shares		—		—			—			(18	)		—			—				—			(18	)
Shares earned under ESOP		—		574			—			—			1,198			—				—			1,772
Reclassification of unearned
compensation to APIC upon the
adoption of SFAS 123(R)		—		(111	)		—			—			—			111				—			—
Amortization of award under RRP		—		48			—			—			—			—				—			48
Exercise of stock options		—		(551	)		—			3,851			—			—				—			3,300
Tax benefit related to stock options
exercised		—		463			—			—			—			—				—			463
Dividends declared on common stock
($0.48 per share)		—		—			(5,283	)		—			—			—				—			(5,283	)
Balance at December 31, 2006		234		190,825			94,344			(149,735	)		(3,564	)		—				(298	)		131,806
Net income for 2007		—		—			7,525			—			—			—				—			7,525
Comprehensive income:
Change in unrealized appreciation
on available-for-sale securities,
net of reclassification and tax		—		—			—			—			—			—				2,074			2,074
Total comprehensive income		—		—			—			—			—			—				—			9,599
Purchase of treasury stock		—		—			—			(9,751	)		—			—				—			(9,751	)
Net purchases of Rabbi Trust shares		—		—			—			(139	)		—			—				—			(139	)
Shares earned under ESOP		—		202			—			—			438			—				—			640
Amortization of award under RRP		—		48			—			—			—			—				—			48
Cumulative effect of change in
accounting principle upon the
adoption of FIN 48		—		—			240			—			—			—				—			240
Exercise of stock options		—		(201	)		—			2,964			—			—				—			2,763
Tax benefit related to stock options
exercised		—		288			—			—			—			—				—			288
Dividends declared on common stock
($0.48 per share)		—		—			(5,080	)		—			—			—				—			(5,080	)
Balance at December 31, 2007	$	234	$	191,162		$	97,029		$	(156,661	)	$	(3,126	)	$	—			$	1,776		$	130,414

See accompanying notes.

57

CFS BANCORP, INC.

Consolidated Statements of Cash Flows

	Year Ended December 31,
	2007			2006			2005
		(Dollars in thousands)
OPERATING ACTIVITIES
Net income	$	7,525		$	5,340		$	5,017
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for losses on loans		2,328			1,309			1,580
Depreciation and amortization		1,704			1,531			1,601
Premium amortization on early extinguishment of debt		4,540			9,624			14,381
Net premium amortization on securities available-for-sale		447			(546	)		762
Impairment of securities available-for-sale		—			—			240
Deferred income tax expense (benefit)		972			(330	)		(311	)
Amortization of cost of stock benefit plans		688			1,820			1,695
Tax benefit from exercises of nonqualified stock options		(288	)		(463	)		(179	)
Proceeds from sale of loans held-for-sale		10,882			9,965			28,103
Origination of loans held-for-sale		(10,804	)		(9,748	)		(26,205	)
Net realized (gains) losses on sales of securities available-for-sale		(536	)		(750	)		238
Dividends received on Federal Home Loan Bank stock		—			—			(587	)
Net realized (gains) losses on sales of other assets		(22	)		994			(354	)
Net increase in cash surrender value of bank-owned life insurance		(1,634	)		(1,591	)		(1,529	)
(Increase) decrease in other assets		(1,271	)		(5,750	)		6,128
Increase (decrease) in other liabilities		11,620			4,187			(324	)
Net cash provided by operating activities		26,151			15,592			30,256
INVESTING ACTIVITIES
Securities, available-for-sale:
Proceeds from sales		109,945			22,029			61,279
Proceeds from maturities and paydowns		88,706			76,263			39,806
Purchases		(120,986	)	(175,376		)		(120,452	)
Securities, held-to-maturity:
Purchases		(3,940	)		—			—
Redemption of Federal Home Loan Bank stock		—			4,308			—
Net loan fundings and principal payments received		(11,468	)		94,095			33,142
Proceeds from sale of loans and loan participations		13,188			11,165			33,354
Proceeds from sale of other real estate owned		642			4,996			753
Proceeds from bank owned life insurance		1,035			604			2
Purchases of properties and equipment		(3,168	)		(4,338	)		(1,233	)
Disposal of properties and equipment		5			93			490
Net cash flows provided by investing activities		73,959			33,839			47,141
FINANCING ACTIVITIES
Proceeds from exercise of stock options		2,763			3,300			1,484
Tax benefit from exercises of nonqualified stock options		288			463			179
Dividends paid on common stock		(5,311	)		(5,604	)		(5,783	)
Purchase of treasury stock		(9,751	)		(15,730	)		(7,253	)
Net purchase of Rabbi Trust shares		(139	)		(18	)		—
Net increase (decrease) in deposit accounts		(44,009	)		78,270			(34,739	)
Net decrease in advance payments by borrowers for taxes and insurance		(853	)		(2,447	)		(1,536	)
Increase in short-term borrowings		897			22,562			555
Proceeds from Federal Home Loan Bank debt		52,000			—			40,000
Repayments of Federal Home Loan Bank debt		(124,253	)		(87,237	)		(84,221	)
Net cash flows used in financing activities		(128,368	)		(6,441	)		(91,314	)
Increase (decrease) in cash and cash equivalents		(28,258	)		42,990			(13,917	)
Cash and cash equivalents at beginning of year		67,167			24,177			38,094
Cash and cash equivalents at end of year	$	38,909		$	67,167		$	24,177
Supplemental disclosures:
Loans transferred to other real estate owned	$	1,582		$	5,766		$	756
Cash paid for interest on deposits		26,089			22,018			13,571
Cash paid for interest on borrowings		7,500			10,992			11,590
Cash paid for taxes		1,550			1,020			425

See accompanying notes.

58

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2007

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization

     CFS Bancorp, Inc. (including its consolidated subsidiaries, the Company) incorporated in March 1998 for the purpose of becoming the holding company for Citizens Financial Bank (the Bank), formerly known as Citizens Financial Services, FSB. Pursuant to shareholder approval, in 2005, the Company changed its state of incorporation from Delaware to Indiana. The change was effectuated through a merger of the Delaware corporation with a wholly-owned Indiana subsidiary formed for that purpose. The Company is headquartered in Munster, Indiana. The Bank is a federal savings bank offering a full range of financial services to customers who are primarily located in northwest Indiana and the south and southwest Chicagoland area. The Bank is principally engaged in the business of attracting deposits from the general public and using such deposits to originate residential and commercial mortgage loans as well as other types of consumer and commercial loans.

     The Company provides financial services through its offices in northwest Indiana and the suburban areas south and southwest of Chicago. Its primary deposit products are checking, savings and money market accounts as well as certificates of deposit. Its primary lending products are commercial and construction loans and retail loans. Substantially all loans are secured by specific items of collateral including commercial and residential real estate, business assets and consumer assets. Commercial loans are expected to be repaid from cash flow from business operations. The customers’ ability to repay their loans is dependent on the general economic conditions in the area and the underlying collateral.

Principles of Consolidation

     The consolidated financial statements include the accounts and transactions of the Company and its wholly-owned subsidiary, the Bank. The Bank has one active subsidiary, CFS Holdings, Ltd. The Bank also has two inactive subsidiaries: CFS Insurance Agency, Inc. and CFS Investment Services, Inc. All significant intercompany accounts and transactions have been eliminated in consolidation.

Use of Estimates

     The preparation of the 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 consolidated financial statements and the disclosures provided. The determination of the allowance for losses on loans, the accounting for income tax expense and the determination of fair values of financial instruments are highly dependent on management’s estimates, judgments and assumptions where changes in any of those could have a significant impact on the financial statements.

Cash Flows

     Cash and cash equivalents include cash, non-interest and interest-bearing deposits in other financial institutions with terms of less than 90 days, and federal funds sold. Generally, federal funds sold are purchased and sold for one-day periods. Net cash flows are reported for customer loan and deposit transactions, interest-bearing deposits in other financial institutions and federal funds sold.

Securities

     Management determines the classification of securities at the time of purchase. Debt securities are classified as held-to-maturity and carried at amortized cost when management has the positive intent and the Company has the ability to hold the securities to maturity. Securities not classified as held-to-maturity are classified as available-

59

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

for-sale and are carried at fair value, with the unrealized holding gains and losses, net of tax, reported in other comprehensive income. Other securities, such as Federal Home Loan Bank stock, are carried at cost. The Company has no trading account securities.

     Interest income includes amortization of purchase premiums or discounts. The amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity, or in the case of mortgage-related securities, over the estimated life of the security using the level-yield method. Gains and losses on sales are recorded on the trade date and determined using the specific identification method.

     The Company evaluates all 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 Financial Accounting Standards Board (FASB) Staff Position (FSP) 115-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. In evaluating the possible impairment of securities, consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial conditions and near-term prospects of the issuer, and the ability and intent of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an issuer’s financial condition, the Company may consider whether the securities are issued by the federal government or its agencies or government sponsored agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer’s financial condition. The Company may also evaluate securities for OTTI more frequently when economic or market concerns warrant additional evaluations. If management determines that an investment experienced an OTTI, the loss is recognized in the income statement as a realized loss. Any recoveries related to the value of these securities are recorded as an unrealized gain (as other comprehensive income (loss) in stockholders’ equity) and not recognized in income until the security is ultimately sold.

     The Company from time to time 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.

Loans

     Loans that management has the ability and intent to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of deferred loan fees and costs and portions charged-off. Interest income on loans is accrued on the active unpaid principal balance. Loans held-for-sale, if any, are carried at the lower of aggregate cost or estimated market value.

     Interest income is not accrued on loans which are delinquent 90 days or more, or for loans which management believes, after giving consideration to economic and business conditions and collection efforts, collection of interest is doubtful. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.

     All interest accrued but not received for loans placed on non-accrual is reversed against interest income. Interest subsequently received on such loans is accounted for on the cash-basis until qualifying for return to accrual.

Loan Fees and Costs

     Loan origination and commitment fees and direct loan origination costs are deferred and amortized as an adjustment of the related loan’s yield. The Company accretes these amounts over the contractual life of the related loans. Remaining deferred loan fees and costs are reflected in interest income upon sale or repayment of the loan.

60

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Allowance for Losses on Loans

     The Company maintains an allowance for losses on loans at a level management believes is sufficient to absorb credit losses inherent in the loan portfolio. The allowance for losses on loans represents the Company’s estimate of probable incurred losses in the loan portfolio at the date of each statement of condition and is based on the review of available and relevant information.

     One component of the allowance for losses on loans consists of allocations for probable inherent but undetected losses within various pools of loans with similar characteristics pursuant to Statement of Financial Accounting Standards No. 5, Accounting for Contingencies (SFAS 5). This component is based in part on certain loss factors applied to various loan pools as stratified by the Company. In determining the appropriate loss factors for these loan pools, management considers historical charge-offs and recoveries; levels of and trends in delinquencies, impaired loans and other classified loans; concentrations of credit within the commercial loan portfolio; volume and type of lending; and current and anticipated economic conditions.

     The second component of the allowance for losses on loans consists of allocations for probable losses that have been identified related to specific borrowing relationships pursuant to Statement of Financial Accounting Standards No. 114, Accounting by Creditors for Impairment of a Loan. This component consists of expected losses resulting in specific credit allocations for individual loans not considered within the above mentioned loan pools. The analysis on each loan involves a high degree of judgment in estimating the amount of the loss associated with the loan, including the estimation of the amount and timing of future cash flows and collateral values.

     Loan losses are charged-off against the allowance, while recoveries of amounts previously charged-off are credited to the allowance. The Company assesses the adequacy of the allowance for losses on loans on a quarterly basis and adjusts the allowance for losses on loans by recording a provision for losses on loans in an amount sufficient to maintain the allowance at a level deemed appropriate by management. The evaluation of the adequacy of the allowance for losses on loans is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available or as future events occur. To the extent that actual outcomes differ from management estimates, an additional provision for losses on loans could be required which could adversely affect earnings or the Company’s financial position in future periods. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance for losses on loans for the Bank and the carrying value of its other non-performing loans, based on information available to them at the time of their examinations. Any of these agencies could require the Bank to make additional provisions for losses on loans.

Other Real Estate Owned

     Other real estate owned is comprised of property acquired through a foreclosure proceeding or acceptance of a deed-in-lieu of foreclosure. Other real estate owned is recorded at fair value at the date of foreclosure. After foreclosure, valuations are periodically performed by management, and the real estate is carried at the lower of cost or fair value minus estimated costs to sell.

Office Properties and Equipment

     Land is carried at cost. Office properties and equipment are stated at cost less accumulated depreciation. Buildings and related components are depreciated using the straight-line method with useful lives ranging from 30 to 40 years. Furniture, fixtures and equipment are depreciated using the straight-line method with useful lives ranging from 3 to 15 years. Leasehold improvements are amortized over the life of the lease.

Bank-Owned Life Insurance

     The Bank has purchased life insurance policies on certain of its employees. Bank-owned life insurance is recorded at its cash surrender value, or the amount that can be realized.

61

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Goodwill and Other Intangible Assets

     Goodwill results from business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed at least annually for impairment and any such impairment is recognized in the period identified.

     Other intangible assets consist of core deposit intangible assets arising from branch acquisitions. They are initially measured at fair value and then amortized on a straight-line basis over their estimated useful lives.

Long-Term Assets

     Premises and equipment, core deposit and other intangible assets, and other long-term assets are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value with the loss recorded in other non-interest expense.

Loan Commitments and Related Financial Instruments

     Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial letters of credit issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering the customer’s collateral or their ability to repay. These financial instruments are recorded when they are funded.

Share-Based Compensation

     Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123(R), Share-Based Payment (SFAS 123(R)). SFAS 123(R) addresses all forms of share-based payment awards, including shares under employee stock purchase plans, stock options, restricted stock and stock appreciation rights. SFAS 123(R) requires all share-based payments to be recognized as expense, based upon their fair values, in the financial statements over the vesting period of the awards. The Company has elected the modified prospective application.

     Prior to 2006, the Company accounted for its stock options in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) and related interpretations. No stock-based employee compensation expense was recognized in net income as all options granted under the plans had an exercise price equal to the market value of the underlying common stock on the grant date.

     Pursuant to Financial Accounting Standards Board (FASB) Statement No. 123, Accounting for Stock-Based Compensation, as amended (SFAS No. 123), pro forma net income and pro forma earnings per share were presented for disclosure purposes only in 2005 as if the fair value method of accounting for stock-based compensation plans had been utilized.

     Prior to the adoption of SFAS 123(R), unearned compensation related to the Company’s Recognition and Retention Plan (RRP) was classified as a separate component of stockholders’ equity. In accordance with the provisions of SFAS 123(R), on January 1, 2006, the remaining balance of the Company’s unearned common stock related to the RRP was reclassified to additional paid-in capital on the Company’s statement of financial condition.

     For additional details on the Company’s share-based compensation plans and related disclosures, see Note 9 to the consolidated financial statements.

Income Taxes

     Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates.

62

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Valuation allowances are established when necessary to reduce deferred tax assets to an amount expected to be realized. Deferred tax assets are recognized for net operating losses that expire between 2016 and 2024 because the benefit is more likely than not to be realized.

Employee Stock Ownership Plan

     The Bank sponsors an internally leveraged Employee Stock Ownership Plan (ESOP) which is accounted for in accordance with the AICPA Statement of Position 93-6, Employer’s Accounting for Employee Stock Ownership Plans (SOP 93-6). The cost of shares issued to the ESOP but not yet allocated to participants is shown as a reduction of stockholders’ equity. Contributions from the Bank and dividends on both allocated and unallocated shares in the ESOP are used to service the ESOP’s debt to the Company. The number of shares released is based on the amount of principal and interest paid to service the ESOP loan. Compensation expense is recognized on shares committed to be released from the Bank’s contributions and from shares released from dividends on unallocated shares using the current market price of these shares. ESOP shares not committed to be released are not considered outstanding for purposes of computing earnings per share.

Earnings Per Share

     Basic earnings per common share (EPS) is computed by dividing net income by the weighted-average number of common shares outstanding during the year. ESOP shares not committed to be released, RRP shares which have not vested and shares held in Rabbi Trust accounts are not considered to be outstanding for purposes of calculating basic EPS. Diluted EPS is computed by dividing net income by the average number of common shares outstanding during the year and includes the dilutive effect of stock options, unearned awards under the RRP, and treasury shares held in Rabbi Trust accounts pursuant to deferred compensation plans. The dilutive common stock equivalents are computed based on the treasury stock method using the average market price for the year.

Comprehensive Income

     Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available-for-sale which are also recognized as separate components of equity.

Pending Accounting Pronouncements

     In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (SFAS 157), which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements required under other accounting pronouncements, but does not change existing guidance as to whether an instrument is carried at fair value. Additionally, it establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. Earlier application is encouraged provided that the reporting entity has not yet issued financial statements for that fiscal year, including financial statements for an interim period within that fiscal year. The Company does not expect the adoption of SFAS 157 to have a material impact on its financial condition or results of operations.

     In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities – Including an Amendment of FASB Statement No. 115 (SFAS 159) which will permit entities to measure many financial instruments and certain other assets and liabilities at fair value on an instrument-by-instrument basis (the Fair Value Option). The Fair Value Option permits all entities to choose to measure eligible items at fair value at specified election dates. An entity will be required to report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. SFAS 159 is expected to improve financial reporting by providing entities with the opportunity to mitigate volatility without having to apply complex hedge accounting provisions and is effective as of the beginning of an entity’s first fiscal year that begins

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after November 15, 2007. Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007, provided the entity also elects to apply the provisions of SFAS 157. The Company has not elected to measure any financial instruments at fair value under SFAS 159 as of December 31, 2007.

     In December 2007, the FASB issued SFAS 141 (revised 2007), Business Combinations (SFAS 141R). SFAS 141R established principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree. SFAS 141R also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141R is effective for business combinations where the acquisition date is on or after fiscal years beginning after December 15, 2008. Earlier adoption is not allowed. The Company does not believe that the adoption of SFAS 141R will have a significant impact on its financial condition or results of operations.

     In December 2007, the FASB issues SFAS 160, Noncontrolling Interests in Consolidated Financial Statements – an amendment of ARB No. 51. SFAS 160 establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements and requires retroactive adoption of the presentation and disclosure requirements for existing minority interests. All other requirements of SFAS 160 shall be applied prospectively. The effective date of SFAS 160 is the same as that for SFAS 141R. The Company does not expect the adoption of SFAS 160 to have a material impact on its financial condition or results of operation.

Recently Adopted Accounting Pronouncements

     In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of SFAS 109 (FIN 48) which establishes a recognition threshold and measurement for income tax positions recognized in an enterprise’s financial statements in accordance with SFAS 109, Accounting for Income Taxes. FIN 48 also prescribes a two-step evaluation process for tax positions. The first step is recognition and the second is measurement. For recognition, an enterprise judgmentally determines whether it is more-likely-than-not that a tax position will be sustained upon examination, including resolution of related appeals or litigation processes, based on the technical merits of the position. If the tax position meets the more-likely-than-not recognition threshold, it is measured and recognized in the financial statements as the largest amount of tax benefit that is greater than 50% likely of being realized. If a tax position does not meet the more-likely-than-not recognition threshold, the benefit of that position is not recognized in the financial statements.

     Tax positions that meet the more-likely-than-not recognition threshold at the effective date of FIN 48 may be recognized or, continue to be recognized, upon adoption of this Interpretation. The cumulative effect of applying the provisions of FIN 48 must be reported as an adjustment to the opening balance of retained earnings for that fiscal year. FIN 48 is effective for fiscal years beginning after December 15, 2006. Accordingly, the Company adopted FIN 48 on January 1, 2007; there was no significant impact on its financial condition or results of operation upon adoption.

     In September 2006, the FASB ratified the consensus reached by the EITF in Issue No. 06-5, Accounting for Purchases of Life Insurance-Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4, Accounting for Purchases of Life Insurance (EITF 06-5). EITF 06-5 concluded that companies purchasing a life insurance policy including corporate-owned life insurance or bank-owned life insurance should record the amount that could be realized, considering any additional amounts beyond cash surrender value included in the contractual terms of the policy. The amount that could be realized should be based on assumed surrender at the individual policy or certificate level, unless all policies or certificates are required to be surrendered as a group. When it is probable that contractual restrictions would limit the amount that could be realized, such contractual limitations should be considered and any amounts recoverable at the insurance company’s discretion should be

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excluded from the amount that could be realized. Companies are permitted to recognize the effects of applying the consensus through either (1) a change in accounting principle through a cumulative-effect adjustment to retained earnings or to other components of equity or net assets as of the beginning of the year of adoption or (2) a change in accounting principle through retrospective application to all prior periods. The Company adopted EITF 06-5 on January 1, 2007; there was no significant impact on its financial condition or results of operations.

Loss Contingencies

     Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there are such matters that will have a material effect on the financial statements.

Restrictions on Cash

     Cash on hand or on deposit with the Federal Reserve Bank of $789,000 and $747,000 was required to be maintained in order to meet regulatory reserve and clearing requirements as of December 31, 2007 and 2006, respectively.

Fair Value of Financial Instruments

     Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in Note 15 below. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.

Segment Reporting

     Operating segments are components of a business about which separate financial information is available and that are evaluated regularly by the chief operating decision-maker in deciding how to allocate resources and assessing performance. Public companies are required to report certain financial information about operating segments in interim and annual financial statements. Senior management evaluates the operations of the Company as one operating segment, community banking, due to the materiality of the banking operation to the Company’s financial condition and results of operations, taken as a whole. As a result, separate segment disclosures are not required. The Company offers the following products and services to external customers: deposits, loans and investment services through an outsource partner. Revenues for the significant products and services are disclosed separately in the consolidated statements of income.

Reclassifications

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

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

2. SECURITIES

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

			Gross		Gross
	Amortized		Unrealized		Unrealized
	Cost		Gains		Losses			Fair Value
	(Dollars in thousands)
At December 31, 2007:
GSE and callable GSE securities	$	140,301	$	2,859	$	(14	)	$	143,146
Mortgage-backed securities		12,587		15		(39	)		12,563
Collateralized mortgage obligations		56,672		525		(17	)		57,180
Trust preferred securities		8,900		—		—			8,900
Equity securities		3,344		5		(544	)		2,805
	$	221,804	$	3,404	$	(614	)	$	224,594
At December 31, 2006:
GSE and callable GSE securities	$	267,148	$	905	$	(1,139	)	$	266,914
Mortgage-backed securities		20,234		8		(254	)		19,988
Collateralized mortgage obligations		10,612		22		(112	)		10,522
Equity securities		1,385		116		—			1,501
	$	299,379	$	1,051	$	(1,505	)	$	298,925

     At December 31, 2007, the Company also had held-to-maturity securities with an amortized cost of $3.9 million invested in state and municipal securities. The securities had $38,000 in gross unrecognized holding gains at December 31, 2007. The Company did not hold any held-to-maturity securities at December 31, 2006.

     Securities with unrealized losses as of December 31, 2007 and 2006, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are presented in the following tables.

	December 31, 2007
	Less than 12 Months					12 Months or More					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Losses			Value		Losses			Value		Losses
	(Dollars in thousands)
GSE and callable GSE securities	$	—	$	—		$	12,357		$(14	)	$	12,357	$	(14	)
Mortgage-backed securities		943		(3	)		7,105		(36	)		8,048		(39	)
Collateralized mortgage obligations		3,637		(6	)		2,410		(11	)		6,047		(17	)
Equity securities		2,116		(544	)		—		—			2,116		(544	)
	$	6,696	$	(553	)	$	21,872		$(61	)	$	28,568	$	(614	)
	December 31, 2006
	Less than 12 Months					12 Months or More					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Losses			Value		Losses			Value		Losses
	(Dollars in thousands)
GSE and callable GSE securities	$	58,159	$	(282	)	$	105,738	$	(857	)	$	163,897	$	(1,139	)
Mortgage-backed securities		236		(1	)		18,160		(253	)		18,396		(254	)
Collateralized mortgage obligations		—		—			9,874		(112	)		9,874		(112	)
	$	58,395	$	(283	)	$	133,772	$	(1,222	)	$	192,167	$	(1,505	)

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     At December 31, 2007, management believes all securities available-for-sale with a continuous loss position for twelve months or more were largely attributable to temporary changes in market liquidity. Management does not believe any of these securities represent an OTTI.

     The amortized cost and fair value of securities at December 31, 2007, 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. Securities not due at a single maturity date are shown separately.

	Available-for-Sale
	Amortized
	Cost		Fair Value
	(Dollars in thousands)
GSE and callable GSE securities:
Due in one year or less	$	40,301	$	40,380
Due after one year through five years		100,000		102,766
Mortgage-backed securities		12,587		12,563
Collateralized mortgage obligations		56,672		57,180
Trust preferred securities		8,900		8,900
Equity securities		3,344		2,805
	$	221,804	$	224,594

 

	Held-to-Maturity
	Amortized
	Cost		Fair Value
	(Dollars in thousands)
State and municipal securities:
Due in one year or less	$	940	$	944
Due after one year through five years		3,000		3,034
	$	3,940	$	3,978

     The following table provides information as to the amount of gross gains and losses realized through the sales of available-for-sale securities:

	2007			2006			2005
	(Dollars in thousands)
Available-for-sale securities:
Gross realized gains	$	762		$	920		$	250
Gross realized losses		(226	)		(170	)		(488	)
Impairment losses		—			—			(240	)
Net realized gains (losses)	$	536		$	750		$	(478	)
Income tax expense (benefit) on realized gains (losses)	$	200		$	289		$	(184	)

     The carrying value of securities pledged as collateral to secure public deposits and for other purposes was $59.8 million and $82.2 million, respectively, at December 31, 2007 and 2006. As of December 31, 2007 and 2006, there were no holdings of securities of any one issuer, other than the U.S. Government, its agencies, and GSEs, in an amount greater than 10% of stockholders’ equity.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

3. LOANS RECEIVABLE

Loans receivable, net of unearned fees, consist of the following:

	December 31,
	2007		2006
		(Dollars in thousands)
Commercial and construction loans:
Commercial real estate	$	328,427	$	339,110
Construction and land development		128,584		128,529
Commercial and industrial		60,398		35,743
Total commercial and construction loans		517,409		503,382
Retail loans:
One-to-four family residential		212,598		225,007
Home equity lines of credit		60,326		70,527
Other		2,803		3,467
Total retail loans		275,727		299,001
Total loans receivable, net of unearned fees	$	793,136	$	802,383

     The Bank’s lending activities have been concentrated primarily within its market area as well as the mid-western United States.

At December 31, 2007 and 2006, the Company had $45,000 and $123,000 of loans held for sale.

     At December 31, 2007 and 2006, the Company serviced $33.7 million and $14.6 million, respectively, of loans for others.

Activity in the allowance for losses on loans is summarized as follows:

	Year Ended December 31,
	2007			2006			2005
	(Dollars in thousands)
Balance at beginning of year	$	11,184		$	12,939		$	13,353
Loans charged-off		(5,676	)		(3,628	)		(2,173	)
Recoveries of loans previously charged-off		190			564			179
Net loans charged-off		(5,486	)		(3,064	)		(1,994	)
Provision for losses on loans		2,328			1,309			1,580
Balance at end of year	$	8,026		$	11,184		$	12,939

     Total nonperforming loans (defined as non-accruing loans) were as follows at the dates indicated:

	December 31,
	2007		2006
	(Dollars in thousands)
Nonaccrual loans:
Impaired loans	$	24,631	$	18,180
Other nonaccrual loans		4,969		9,337
Total nonaccrual loans	$	29,600	$	27,517
Loans past due 90 days and still accruing interest	$	—	$	—

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Impaired loans were as follows at the dates indicated:

	December 31,
	2007		2006
	(Dollars in thousands)
Impaired loans:
With a valuation reserve	$	10,190	$	12,343
With no valuation reserve required		14,441		5,837
Total impaired loans	$	24,631	$	18,180
Valuation reserve relating to impaired loans	$	1,202	$	4,541
Average impaired loans during year		20,675		17,527
Interest income recognized during impairment		41		75
Cash-basis interest income recognized during impairment		236		179

4. OFFICE PROPERTIES AND EQUIPMENT

     Office properties and equipment are summarized as follows:

	Estimated	December 31,
	Useful Lives	2007		2006
		(Dollars in thousands)
Land	—	$	4,408	$	3,506
Buildings	30-40 years		19,359		16,881
Leasehold improvements	Over term of lease		1,456		1,457
Furniture and equipment	3-15 years		14,257		14,159
Construction in progress	—		369		1,715
			39,849		37,718
Less: accumulated depreciation and amortization			20,523		19,921
		$	19,326	$	17,797

     Depreciation expense charged to operations for each of the years ended 2007, 2006 and 2005, was $1.6 million, $1.5 million and $1.5 million, respectively.

Operating Leases

     At December 31, 2007, the Company was obligated under certain noncancelable operating leases for premises and equipment, which expire at various dates through the year 2012. Many of these leases contain renewal options, and certain leases provide options to purchase the leased property during or at the expiration of the lease period at specific prices. Some leases contain escalation clauses calling for rentals to be adjusted for increased real estate taxes and other operating expenses, or proportionately adjusted for increases in the consumer or other price indices.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

     The following summary reflects the future minimum rental payments, by year, required under operating leases that, as of December 31, 2007, have initial or remaining noncancelable lease terms in excess of one year.

	(Dollars in thousands)
Year Ended December 31:
2008		$   620
2009		334
2010		112
2011		74
2012		43
		$1,183

     Rental expense charged to operations in 2007, 2006 and 2005, totaled $584,000, $539,000 and $633,000, respectively, including amounts paid under short-term cancelable leases.

5. GOODWILL AND INTANGIBLE ASSETS

     As of December 31, 2007 and 2006, the Company had $1.2 million of goodwill which was acquired through the Company’s 2003 acquisition of a bank branch in Illinois. The goodwill was not impaired during either 2007 or 2006.

     The Company also acquired core deposit intangibles in conjunction with the same bank branch acquisition. The intangible assets acquired amounted to $325,000 in cost and was amortized over five years. Amortization expense related to these intangibles totaled $65,000 for each of the years 2007, 2006 and 2005. Estimated amortization expense for 2008 is $49,000.

6. DEPOSITS

Deposits and interest rate data are summarized as follows:

	December 31,
	2007			2006
	(Dollars in thousands)
Checking accounts:
Non-interest bearing	$	62,306		$	58,547
Interest-bearing		107,467			100,912
Money market accounts		171,470			182,153
Savings accounts		127,297			148,707
Core deposits		468,540			490,319
Certificate of deposit accounts:
One year or less		344,664			357,742
Over one to two years		27,208			29,312
Over two to three years		11,602			14,650
Over three to four years		4,877			9,749
Over four to five years		5,395			4,026
More than five years		986			1,297
Total time deposits		394,732			416,776
Total deposits	$	863,272		$	907,095
Weighted-average cost of deposits		3.14	%		3.23	%

     The aggregate amount of deposits in denominations of $100,000 or more was $297.2 million and $306.3 million at December 31, 2007 and 2006, respectively.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

7. BORROWED MONEY

     The Company’s borrowed money included the following for the periods indicated:

	December 31,
	2007					2006
	Weighted					Weighted
	Average					Average
	Contractual					Contractual
	Rate		Amount			Rate		Amount
	(Dollars in thousands)
Short-term variable-rate borrowings:
Repo Sweep accounts	3.42	%	$	18,014		4.75	%	$	23,117
Overnight Federal Funds purchased	4.50			6,000		—			—
Secured advances from FHLB – Indianapolis:
Maturing in 2007 — fixed rate	—			—		3.65			87,000
Maturing in 2008 — fixed rate	3.89			72,000		3.89			72,000
Maturing in 2009 — fixed rate	3.99			30,000		4.09			15,000
Maturing in 2014 — fixed-rate (1)	6.71			1,169		6.71			1,190
Maturing in 2018 — fixed-rate (1)	5.54			2,707		5.54			2,763
Maturing in 2019 — fixed-rate (1)	6.31			7,196		6.31			7,372
				113,072					185,325
Less: deferred premium on early extinguishment of debt				(1,627	)				(6,167	)
Net FHLB – Indianapolis advances				111,445					179,158
Total borrowed money	4.06	%	$	135,459		4.03	%	$	202,275

____________________

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

Required principal payments of FHLB – Indianapolis (FHLB–IN) advances are as follows:

	(Dollars in thousands)
Year Ended December 31:
2008	$	72,271
2009		30,291
2010		311
2011		333
2012		356
Thereafter		9,510
	$	113,072

Pursuant to collateral agreements, FHLB–IN advances are secured by the following assets:

Description of Collateral	Amount Pledged
	(Dollars in thousands)
FHLB-IN stock	$	23,944
Loans secured by residential first mortgage loans		219,009
Loans secured by commercial first mortgage loans		140,051
	$	383,004

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

     The Company’s short-term borrowings include its Repo Sweeps which are treated as financings; the obligation to repurchase securities sold are reflected as short-term borrowings. The securities underlying these Repo Sweeps continue to be reflected as assets of the Company.

     During 2007 and 2006, the Company repaid $124.0 million and $87.0 million, respectively, of maturing FHLB advances.

     During 2004, the Company completed a restructuring of its FHLB advances by prepaying $400.0 million of callable fixed-rate advances with an average cost of 5.92% and an average remaining term of 64.2 months. These prepaid advances were replaced with $325.0 million of new non-callable FHLB advances. These new advances included an aggregate $271.0 million of non-callable fixed-rate FHLB advances with an average cost of 3.64% and an average term of 34.3 months in a laddered portfolio with maturities ranging from 21 to 60 months.

     In conjunction with the FHLB debt restructuring, the Company paid $42.0 million of prepayment penalties related to the prepaid advances and recognized $9.8 million on the early extinguishment of debt as a charge to non-interest expense during 2004. The remaining $32.2 million of prepayment penalties was deferred as an adjustment to the carrying value of the borrowings and are recognized in interest expense as an adjustment to the cost of the new borrowings over their remaining life.

     At December 31, 2007, the Company has a total of $1.6 million of deferred premium on the early extinguishment of debt remaining from the 2004 FHLB debt restructure. The increase in interest expense related to the remaining deferred premium is expected to be $1.4 million and $200,000 in the years ended December 31, 2008 and 2009, respectively.

     Interest expense on borrowed money totaled $11.9 million, $20.5 million and $25.9 million for the years ended December 31, 2007, 2006 and 2005, respectively. Included in interest expense was $4.5 million, $9.6 million and $14.4 million, respectively, of amortization of the deferred premium on the early extinguishment of debt for the years ended December 31, 2007, 2006 and 2005.

     At December 31, 2007, the Company had two lines of credit with a maximum of $40.0 million in unsecured overnight federal funds at the federal funds market rate at the time of any borrowing. At December 31, 2007, the Company borrowed $6.0 million on these lines at 4.50%. The maximum amount borrowed during the years ended December 31, 2007 and 2006 was $11.3 million and $9.8 million, respectively, and the weighted-average rate paid during the year was 5.17% and 5.26%, respectively.

     At December 31, 2007, the Company also had a $5.0 million revolving line of credit. Each borrowing under the line of credit carries an interest rate of either the Prime Rate minus 75 basis points or the three month London Interbank Offered Rate, at the Company’s option. The line of credit was obtained by the Company and is secured by all of the stock of the Bank owned by the Company. The Company has not borrowed any funds under this line of credit. The line of credit matures on March 21, 2008.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

8. EMPLOYEE BENEFIT PLANS

     The Company participates in an industry-wide, multi-employer, defined benefit pension plan, which covers full-time employees who have attained at least 21 years of age and completed one year of service. Benefits were frozen under this plan effective March 1, 2003. In addition, employees who would have been eligible after March 1, 2003 are not eligible to enter the plan. Although no further benefits will accrue while the freeze remains in place, the freeze does not reduce the benefits accrued to date.

     Calculations to determine full-funding status are made annually as of June 30. Pension expense for the years ended December 31, 2007, 2006 and 2005 was $455,000, $1.9 million and $840,000, respectively. The Company is currently reviewing its options including withdrawing from the multi-employer defined benefit plan. Asset and plan benefit information is not available for participating associations on an individual basis.

     The Company also participates in a single-employer defined contribution plan, which qualifies under Section 401(k) of the Internal Revenue Code. All full- and part-time employees who have attained at least 21 years of age are eligible to participate in this Plan after three months of employment and at least 250 hours worked during a three month period. Beginning in the 2008 Plan year, there is no requirement for hours worked to be eligible for the Plan once the employee has been employed for three months.

     This 401(k) plan allows for employee contributions up to 12% of their compensation, which are matched equal to 50% of the first 6% of the compensation contributed. The Company’s matching contribution for the 2007 Plan year will be made to the 401(k) plan directly in the form of a supplemental contribution during the first quarter of 2008. Plan expense for the year ended December 31, 2007 was $267,000. Effective January 1, 2005, the Company’s match under this Plan was no longer distributed as an addition to the employees’ contributions. The Plan was amended to allow for the Company match to be paid to eligible employees annually as shares distributed through the Company’s ESOP. Accordingly, the Company did not incur any expense under this Plan for the years ended December 31, 2006 and 2005. Effective January 1, 2008, the Company will match 100% of the employee’s contribution on the first 1% of the employee’s compensation, and also will match 50% of the employee’s contribution on the next 5% of the employee’s compensation. In addition, employees will be able to defer up to 100% of their compensation. Employees fully vest in the Company’s matching contribution after two years of service.

     The Company provides supplemental retirement benefits for certain senior officers in the form of payments upon retirement, death, or disability. The annual benefit is based on actuarial computations of existing plans without imposing Internal Revenue Service limits. This plan was frozen in 2003 along with the Company’s pension plan. There was no expense related to this plan in 2007, 2006 and 2005.

9. SHARE-BASED COMPENSATION

     Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123(R), Share-Based Payment (SFAS 123(R)). SFAS 123(R) addresses all forms of share-based payment awards, including shares under employee stock purchase plans, stock options, restricted stock and stock appreciation rights. SFAS 123(R) requires all share-based payments to be recognized as expense, based upon their fair values, in the financial statements over the vesting period of the awards. The Company has elected the modified prospective application.

     During 2005, the Company’s Compensation Committee of the Board of Directors approved the accelerated vesting of all then outstanding unvested stock options (Options) to purchase shares of common stock of the Company. Accordingly, all of the Options became vested as of September 30, 2005. The estimated future option expense associated with these options was $1.7 million, net of tax, and would have been required to be recorded in the Company’s income statement in future periods starting upon its adoption of SFAS 123(R) in January 2006. Since the Company accounted for these Options in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) at the time of acceleration, the Company reported this compensation expense

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CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

related to these Options for disclosure purposes only in 2005. Since all of the stock options granted by the Company vested prior to January 1, 2006, the Company did not record any compensation expense related to its stock options for the years ended December 31, 2007 and 2006.

     Prior to the adoption of SFAS 123(R), unearned compensation related to the Company’s Recognition and Retention Plan (RRP) was classified as a separate component of stockholders’ equity. In accordance with the provisions of SFAS 123(R), on January 1, 2006, the remaining balance of the Company’s unearned common stock related to the RRP was reclassified to additional paid-in capital on the Company’s statement of financial condition.

     Also prior to the adoption of SFAS 123(R), the Company accounted for its stock option plans under the recognition and measurement principles of APB 25 and related interpretations. No stock-based employee compensation cost was reflected in net income as all options granted under the plans had an exercise price equal to the market value of the underlying common stock on the grant date. Pursuant to SFAS No. 123, Accounting for Stock-Based Compensation (SFAS 123), pro forma net income and pro forma earnings per share for the year ended December 31, 2005 is presented in the following table as if the fair value method of accounting for stock-based compensation plans had been utilized.

	Year Ended
	December 31, 2005
	(Dollars in thousands
	except per share data)
Net income (as reported)	$	5,017
Stock-based compensation expense determined using fair value method, net of tax (1)		2,176
Pro forma net income	$	2,841
Basic earnings per share (as reported)	$	0.43
Pro forma basic earnings per share		0.24
Diluted earnings per share (as reported)		0.42
Pro forma diluted earnings per share		0.24

____________________

(1) A Black-Scholes option pricing model was used to determine the fair values of the options granted.

Stock Options

     The Company has stock option plans under which shares of Company common stock are reserved for the grant of both incentive and non-qualified stock options to directors, officers and employees. The dates the stock options are first exercisable and expire are determined by the Compensation Committee of the Company’s Board of Directors 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. All of the Company’s options were fully vested as of December 31, 2005.

     The Company did not grant any options during 2007 and 2006. On July 25, 2005, the Company granted stock options under its 1998 and 2003 Stock Option Plans to directors, officers and employees of the Company. The number of stock options granted in 2005 totaled 234,945 shares, all of which have an exercise price equal to the fair market value of the Company’s common stock on the day of grant of $13.48. The stock options originally were to vest ratably over five years. Subsequently, on September 30, 2005, the Company accelerated the vesting of all of its stock options. Accordingly, 622,705 stock options which would have otherwise vested from time to time over the next five years became immediately exercisable as a result of the accelerated vesting. The remaining terms for each of the stock options granted remain the same. Based on the Company’s closing stock price of $13.40 per share on the date of accelerated vesting, 95% of the total accelerated stock options had exercise prices above the closing market price at the time of acceleration. All of the accelerated stock options have exercise prices between $10.38 and $14.76 per share, with a total weighted average exercise price per share of $13.82 per share.

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CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

     The fair value of the stock options granted in 2005 was estimated using the Black-Scholes option value model with the following assumptions:

	2005
Dividend yield	3.6	%
Expected volatility	25.9
Risk-free interest	4.1
Original expected life	6 years

     The following table presents the activity related to options under the Company’s stock option plans for the years ended 2007, 2006 and 2005. The numbers of shares presented are in thousands.

	2007				2006				2005
			Weighted-				Weighted-				Weighted-
	Number of		Average		Number of		Average		Number of		Average
	Shares		Exercise Price		Shares		Exercise Price		Shares		Exercise Price
Outstanding at beginning of year	1,496		$	12.09	1,823		$	11.78	1,765		$	11.57
Granted	—			—	—			—	235			13.48
Exercised	(242	)		11.39	(321	)		10.29	(144	)		10.28
Forfeited	(1	)		14.00	(6	)		13.48	(33	)		13.67
Outstanding at end of year	1,253		$	12.23	1,496		$	12.09	1,823		$	11.78

     At December 31, 2007, there were 34,650 shares available for future grants under the Company’s stock option plans. There were no stock options granted during 2007 and 2006. The fair value of stock options granted during 2005 was $2.81.

     Options outstanding and exercisable at December 31, 2007 are presented in the table below. The number of shares is in thousands.

	As of December 31, 2007
	Outstanding and Exercisable
		Weighted
		Average	Weighted
		Remaining	Average
		Contractual	Exercise
Range of Exercise Prices:	Number	Life	Price
$8.19 — $8.99	67	2.3	$	8.47
$10.00 — $10.99	362	1.3		10.00
$11.00 — $11.99	145	3.3		11.25
$13.00 — $13.99	453	6.1		13.69
$14.00 — $14.76	226	6.0		14.59
Outstanding	1,253	4.1		12.23

     At December 31, 2007, the aggregate intrinsic value of options outstanding totaled $3.1 million. This value represents the difference between the Company’s closing stock price on the last day of trading for 2007 and the exercise price multiplied by the number of in-the-money options assuming all option holders had exercised their stock options on December 31, 2007.

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CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

     The aggregate intrinsic value of options exercised at the time of exercise during the years ended December 31, 2007, 2006 and 2005 was $813,000, $1.4 million and $514,000, respectively. Cash received from option exercises during the years ended December 31, 2007, 2006 and 2005 totaled $2.8 million, $3.3 million and $1.5 million, respectively. The actual tax benefit realized for the tax deduction from option exercises totaled $288,000, $463,000 and $179,000, respectively, for the years ended December 31, 2007, 2006 and 2005.

The Company reissues treasury shares to satisfy option exercises.

Recognition and Retention Plan

     In February 1999, the Company, with shareholder approval, established the RRP, which is a stock-based incentive plan, and a stock option plan. The Bank contributed $7.5 million to the RRP to purchase an aggregate total of 714,150 shares of Company common stock. On April 1, 1999, the Compensation Committee of the Board of Directors granted an aggregate of 707,000 shares under this plan to 92 participants. On April 1, 2003, the Compensation Committee made an additional grant of an aggregate of 21,000 shares to five participants. On April 1, 2004, the remaining 1,050 shares were granted to two participants. During 2007, 1,000 shares were forfeited and are available for future grants at December 31, 2007.

     The shares granted in the RRP vest to the participants at the rate of 20% per year. As a result, expense for this plan is being recorded over a 60-month period from the date of grant and is based on the market value of the Company’s stock as of the date of grant. The remaining unamortized cost of the RRP is reflected as a reduction in additional paid-in capital. At December 31, 2007, the remaining unamortized cost of the RRP totaled $38,000. The total grant date fair value of shares vested during 2007, 2006 and 2005 was $35,000, $48,000 and $48,000, respectively.

The following table presents the activity for the RRP during 2007.

	Number of		Weighted-Average
	Shares		Grant Date Fair Value
Unvested at December 31, 2006	7,115		$	13.84
Granted	—			—
Vested	(3,505	)		13.83
Forfeited	(1,000	)		13.80
Unvested as of December 31, 2007	2,610			13.87

Employee Stock Ownership Plan

     In 1998, the Company established an internally leveraged ESOP for the employees of the Company and the Bank. The ESOP is a qualified benefit plan under Internal Revenue Service guidelines. It covers all full-time employees who have attained at least 21 years of age and completed one year of service. Upon formation, the ESOP borrowed $14.3 million from the Company and purchased 1,428,300 shares of common stock. During March 2007, the Company renegotiated the terms of the loan to the ESOP with the plan’s trustee which reduced the interest rate from 8.50% to 4.64% and extended the term of the loan by an additional eight years from 2009 to 2017. The modification also includes event protection if the ESOP is terminated before the new maturity date of the loan due to a merger, sale or otherwise. In the event the ESOP is terminated due to one of these events, the unallocated stock will be distributed to the Plan participants instead of being applied to the repayment of the ESOP loan. The Bank made contributions to the ESOP plan in order to pay down the outstanding loan totaling $514,000, $1.4 million and $1.3 million during the years 2007, 2006 and 2005, respectively. Compensation expense related to the Company’s ESOP was $288,000, $1.4 million and $1.3 million, respectively, for the years ended December 31, 2007, 2006 and 2005.

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CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

The following table summarizes shares of Company common stock held by the ESOP:

	December 31,
	2007		2006
	(Dollars in thousands)
Shares allocated to participants		775,345		822,382
Unallocated and unearned shares		312,604		356,429
		1,087,949		1,178,811
Fair value of unallocated and unearned ESOP shares	$	4,592	$	5,222

     The Company also provides supplemental retirement benefits for certain senior officers under the ESOP. This benefit is also based on computations for the existing plan exclusive of Internal Revenue Service limits. Compensation expense related to this supplemental plan for the years ended December 31, 2007, 2006 and 2005, was $31,000, $31,000 and $22,000, respectively.

10. INCOME TAXES

The income tax provision consists of the following:

	Year Ended December 31,
	2007		2006			2005
	(Dollars in thousands)
Current tax expense:
Federal	$	1,338	$	948		$	1,487
State		—		—			—
Deferred tax expense (benefit):
Federal		942		(88	)		(190	)
State		30		(242	)		(121	)
	$	2,310	$	618		$	1,176

A reconciliation of the statutory federal income tax rate to the effective income tax rate is as follows:

	Year Ended December 31,
	2007		2006		2005
Statutory rate	34.0	%	34.0	%	34.0	%
State taxes	0.2		(2.7	)	(1.3	)
Bank-owned life insurance	(5.7	)	(9.4	)	(8.6	)
Low-income housing tax credits	(4.0	)	(5.6	)	(8.2	)
Reversal of allocated tax reserves	—		(8.8	)	—
Other	(1.0	)	2.9		3.1
Effective rate	23.5	%	10.4	%	19.0	%

     The increase in the Company’s effective tax rate for 2007 was mainly a result of a decrease in the percentage of permanent tax items to pre-tax income and the recognition in 2006 of tax benefits relating to certain tax positions taken on prior year tax returns that had not been recognized for financial reporting purposes. During 2006, tax liabilities established for these tax uncertainties were no longer required primarily as a result of favorable outcomes during the fourth quarter of 2006 in tax audits of other entities that had taken similar tax positions. The Company’s effective tax rate remains lower than the statutory tax rate primarily due to the Company’s investment in bank-owned life insurance and the application of available tax credits.

77

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Significant components of deferred tax assets and liabilities are as follows:

	December 31,
	2007			2006
	(Dollars in thousands)
Deferred tax assets:
Allowance for losses on loans	$	3,061		$	4,335
Deferred compensation		919			819
Deferred loan fees		625			773
Net operating loss carryforwards		817			1,378
Alternative minimum tax carryforwards		821			1,583
General business tax credit carryforwards		1,298			1,650
Other		226			153
		7,767			10,691
Deferred tax liabilities:
Unamortized deferred premium on early extinguishment of debt		608			2,378
FHLB stock dividends		1,030			1,063
Other		338			487
		1,976			3,928
Net deferred tax asset		5,791			6,763
Tax effect of adjustment related to unrealized depreciation on available-for-sale securities		(1,014	)		156
Net deferred tax assets including adjustments	$	4,777		$	6,919

     Based upon historical taxable income as well as projections of future taxable income, management believes that it is more likely than not that the deferred tax assets will be realized. Therefore, no valuation reserve was recorded at December 31, 2007 or 2006.

     Prior to 1988, the Bank qualified as a bank under provisions of the Internal Revenue Code which permitted it to deduct from taxable income an allowance for bad debts, which differed from the provision for such losses charged to income. Retained earnings at December 31, 2007 and 2006 included approximately $12.5 million, for which no provision for income taxes has been made. If in the future this portion of retained earnings is distributed, or the Bank no longer qualifies as a bank for tax purposes, income taxes may be imposed at the then applicable rates. The unrecorded deferred tax liability at December 31, 2007 and 2006 would have been approximately $4.9 million.

     At December 31, 2007, the Company had state net operating losses of $14.7 million which are being carried forward to reduce future taxable income. The carryforwards expire between 2016 and 2024.

11. RELATED PARTY DISCLOSURES

     The Company has no material related party transactions which would require disclosure. In compliance with applicable banking regulations, the Company may extend credit to certain officers and directors of the Company and its subsidiaries in the ordinary course of business under substantially the same terms as comparable third-party lending arrangements.

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CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

12. STOCKHOLDERS’ EQUITY AND REGULATORY CAPITAL

     During 2007, the Company completed its 600,000 share repurchase plan announced in June 2006 by repurchasing 188,283 shares remaining under this plan at an average price of $14.79. In February 2007, the Company announced a new share repurchase plan for an additional 600,000 shares. The Company plans to use existing funds to finance the repurchases. Total shares available for repurchase under this plan are 126,725 at December 31, 2007.

     The following table presents information with respect to the Company’s 2007 and 2006 share repurchase plans.

	2007 Repurchase Plan					2006 Repurchase Plan
	Shares	Cost of		Average		Shares	Cost of		Average
	Repurchased	Shares		Cost		Repurchased	Shares		Cost
	in Period	Repurchased		per Share		in Period	Repurchased		per Share
	(Dollars in thousands)
Years ended:
2006	—	$	—	$	—	411,717	$	6,119	$	14.86
2007	473,275		6,967		14.72	188,283		2,784		14.79
Plan to date	473,275	$	6,967	$	14.72	600,000	$	8,903	$	14.84

     OTS regulations impose limitations upon all capital distributions by a savings institution if the institution would not be “well-capitalized” after the distributions. Capital distributions include cash dividends, payments to repurchase or otherwise acquire its own stock, payments to shareholders of another institution in a cash-out merger and other distributions charged against capital. The regulations provide that an institution must submit an application to the OTS to receive approval of the capital distributions if the institution (i) is not eligible for expedited treatment; or (ii) for which its total amount of capital distributions for the applicable calendar year exceeds its net income for that year to date plus its retained income for the preceding two years; or (iii) would not be at least adequately capitalized following the distribution; or (iv) would violate a prohibition contained in a statute, regulation or agreement between the institution and the OTS by performing the capital distribution. Under any other circumstances, the institution would be required to provide a written notice to the OTS prior to the capital distribution. Based on its retained income for the preceding two years, the Bank is currently restricted from making any capital distributions without prior written approval from the OTS.

     The principal sources of cash flow for the Company are dividends from the Bank. Various federal banking regulations and capital guidelines limit the amount of dividends that may be paid to the Company by the Bank. Future payments of dividends by the Bank are dependent upon individual regulatory capital requirements and levels of profitability.

     The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to quantitative judgments by the regulators about components, risk weightings, and other factors.

     Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios, set forth in the table below of the total risk-based, tangible, and core capital, as defined in the regulations. As of December 31, 2007, the Bank met all capital adequacy requirements to which it is subject.

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CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

     As of December 31, 2007, the Bank is categorized as “well-capitalized” under the regulatory framework for prompt corrective action. To be categorized as “well-capitalized,” the Bank must maintain minimum total risk-weighted, tangible, and core ratios as set forth in the following table. There are no conditions or events since that date that management believes have changed the institution’s category. At December 31, 2007, the Bank’s adjusted total assets were $1.1 billion and its risk-weighted assets were $920.8 million.

										To Be Well-Capitalized
					For Capital Adequacy					Under Prompt Corrective
	Actual				Purposes					Action Provisions
	Amount		Ratio		Amount		Ratio			Amount		Ratio
	(Dollars in thousands)
As of December 31, 2007:
Total capital to risk-weighted assets	$	128,225	13.93	%	$	73,661	>	8.00	%	$	92,077	>	10.00	%
Tier 1 (core) capital to risk-weighted assets		120,227	13.06			36,831	>	4.00			55,246	>	6.00
Tier 1 (core) capital to adjusted total assets		120,227	10.50			45,782	>	4.00			57,227	>	5.00
Tangible capital to adjusted total assets		120,227	10.50			17,168	>	1.50			22,891	>	2.00
As of December 31, 2006:
Total capital to risk-weighted assets	$	132,762	14.10	%	$	75,332	>	8.00	%	$	94,165	>	10.00	%
Tier 1 (core) capital to risk-weighted assets		121,599	12.91			37,666	>	4.00		$	56,499	>	6.00
Tier 1 (core) capital to adjusted total assets		121,599	9.71			50,080	>	4.00			62,600	>	5.00
Tangible capital to adjusted total assets		121,599	9.71			18,780	>	1.50			25,040	>	2.00

13. COMMITMENTS

	December 31,
	2007		2006
	(Dollars in thousands)
Type of commitment
To originate retail loans:
Fixed rates (5.75% – 11.75% in 2007 and 5.625% – 9.00% in 2006)	$	6,443	$	4,807
Variable rates		968		2,402
To originate commercial real estate loans:
Fixed rates (6.25% – 8.38% in 2007 and 6.30% – 8.77% in 2006)		12,322		8,743
Variable rates		14,691		11,568
To originate commercial and industrial loans:
Fixed rates (4.85% – 9.00% in 2007 and 4.80% – 8.25% in 2006)		5,577		6,640
Variable rates		1,291		8,823
To purchase loans secured by commercial real estate:
Variable rates		—		18,000
Unused lines of credit and construction loans		155,345		141,815
Letters of credit:
Secured by cash		639		568
Real estate		6,892		11,777
Business assets		690		195
Other – Credit enhancements		31,257		42,465

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CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

     The commitments listed above do not necessarily represent future cash requirements, in that these commitments often expire without being drawn upon. All commitments to extend credit or to purchase loans expire within the following year. Letters of credit expire at various times through 2012. Credit enhancements expire at various times through 2010.

     The Company also has commitments to fund community investments through investments in 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 $1.2 million to be funded over seven 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 project. These commitments are not included in the commitment table above. See additional disclosures in Note 14.

     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 a triple-A rating, which provides for a lower interest rate, the FHLB-IN issues, in favor of the bond trustee, an Irrevocable Direct Pay Letter of Credit (IDPLOC) for the account of the Bank. Since the Bank, in accordance with the terms and conditions of a Reimbursement Agreement between the FHLB-IN and the Bank, would be required to reimburse the FHLB-IN for draws against the IDPLOC, these facilities are analyzed, appraised, secured by real estate mortgages, and monitored as if the Bank had funded the project initially.

     The letters of credit and credit enhancements provided by the Company are considered financial guarantees under FASB Interpretation 45 Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others and were carried at a fair value of $331,000 in the aggregate as of December 31, 2007.

14. VARIABLE INTEREST ENTITIES

     The Company has investments in nine low-income housing tax credit limited partnerships and one limited liability partnership for the development of shopping centers, for-sale housing, and the restoration of historic properties in low and moderate income areas. Although these partnerships generate operating losses, the Company realizes a return on its investment through reductions in income tax expense that result from tax credits and the deductibility of the entities’ operating losses. These investments were acquired at various times between 1996 and 2004 and are accounted for under the equity method. These entities are considered variable interest entities in accordance with FASB Interpretation No. 46 (Revised December 2003), Consolidation of Variable Interest Entities (FIN 46(R)). Since the Company is not considered the primary beneficiary of these entities, it is not required to consolidate these investments. The Company’s exposure is limited to its current recorded investment of $1.7 million plus $1.2 million that the Company is obligated to pay over the next seven years but has not yet funded.

15. FAIR VALUE OF FINANCIAL INSTRUMENTS

     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. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument.

     No fair value disclosure is required with respect to certain financial instruments and all nonfinancial instruments. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.

81

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

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

	December 31,
	2007				2006
	Carrying		Fair		Carrying		Fair
	Amount		Value		Amount		Value
	(Dollars in thousands)
Financial Assets
Cash and cash equivalents	$	38,909	$	38,909	$	67,167	$	67,167
Securities, available-for-sale		224,594		224,594		298,925		298,925
Securities, held-to-maturity		3,940		3,978		—		—
Federal Home Loan Bank stock		23,944		23,944		23,944		23,944
Loans receivable, net of allowance for losses on loans		785,110		788,681		791,199		784,192
Interest receivable		5,505		5,505		7,523		7,523
Total financial assets	$	1,082,002	$	1,085,611	$	1,188,758	$	1,181,751
Financial Liabilities
Deposits	$	863,272	$	864,437	$	907,095	$	906,148
Borrowed money		135,459		138,087		202,275		200,441
Interest payable		755		755		749		749
Total financial liabilities	$	999,486	$	1,003,279	$	1,110,119	$	1,107,338

     The carrying amount is the estimated fair value for cash and cash equivalents, Federal Home Loan Bank stock, and accrued interest receivable and payable. Securities fair values are based on quotes received from a third-party pricing source.

     The Company determined that for both variable-rate and fixed-rate loans, fair values are estimated using discounted cash flow analyses, with interest rates currently being offered for loans with similar terms and collateral to borrowers of similar credit quality.

     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 money 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-balance sheet instruments is nominal.

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CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

16. EARNINGS PER SHARE

     The following table sets forth the computation of basic and diluted earnings per share:

	Year Ended December 31,
	2007		2006		2005
	(Dollars in thousands except per share data)
Net income	$	7,525	$	5,340	$	5,017
Weighted-average common shares outstanding		10,547,853		11,045,857		11,728,073
Weighted-average common share equivalents (1)		294,929		348,006		236,941
Weighted-average common shares and common share equivalents
outstanding		10,842,782		11,393,863		11,965,014
Basic earnings per share	$	0.71	$	0.48	$	0.43
Diluted earnings per share		0.69		0.47		0.42

__________________

(1) Assumes exercise of dilutive stock options, a portion of the unearned awards under the RRP and treasury shares held in Rabbi Trust accounts.

     For the years ended December 31, 2007, 2006 and 2005, the Company had 105,000, 114,000 and 231,750 anti-dilutive options, respectively. The anti-dilutive options were not included in the above earnings per share calculations.

17. OTHER COMPREHENSIVE INCOME (LOSS)

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

	Year Ended December 31,
	2007			2006			2005
	(Dollars in thousands)
Unrealized holding gains (losses) arising during the period:
Unrealized net gains (losses)	$	3,780		$	2,744		$	(2,274	)
Related tax (expense) benefit		(1,370	)		(1,035	)		856
Net		2,410			1,709			(1,418	)
Less: reclassification adjustment for net gains realized during the period:
Realized net gains (losses)		536			750			(478	)
Related tax (expense) benefit		(200	)		(289	)		184
Net		336			461			(294	)
Total other comprehensive income (loss)	$	2,074		$	1,248		$	(1,124	)

18. LEGAL PROCEEDINGS

     The case of Betty and Raymond Crenshaw v. CFS Bancorp, et al. was filed in the United States District Court for the Northern District of Indiana sitting in Hammond, Indiana on December 6, 2005 under Cause No. 2:05 CV 440. The lawsuit names the Company, a police officer who was purportedly acting as the Bank’s security guard, along with three other police officers and the City of East Chicago as defendants. The lawsuit was brought in connection with an incident that occurred at a Bank branch on February 6, 2004. The complaint seeks compensation for alleged personal injuries, violations of civil rights, battery, false arrest, intentional infliction of emotional distress and loss of consortium. The plaintiffs also seek punitive damages and attorneys’ fees in this cause of action. The Company’s defense in this matter has been tendered to and accepted by the Company’s insurance carrier. An appearance has been filed on behalf of the Company by trial counsel retained by the Company’s insurance carrier. The case

83

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

remained in the discovery phase throughout 2006 and 2007. In the event that judgment is entered for the plaintiffs, insurance would not be available to indemnify the Company for punitive damages should they be assessed. The total potential exposure to the Company is not quantifiable at this stage of the proceedings insofar as the amount of damages being sought was not specifically set forth in the complaint and no other demand has been made by the plaintiffs to the Company.

     Other than the above-referenced matters, the Company is involved in routine legal proceedings occurring in the ordinary course of its business, which, in the aggregate, are believed to be immaterial to the financial condition of the Company.

19. CONDENSED PARENT COMPANY FINANCIAL STATEMENTS

     The following tables represent the condensed statement of financial condition as of December 31, 2007 and 2006 and condensed statement of income and cash flows for the three years ended December 31, 2007 for CFS Bancorp, Inc., the parent company.

Condensed Statements of Condition
(Parent Company Only)

	December 31,
	2007		2006
	(Dollars in thousands)
ASSETS
Cash on hand and in banks	$	3,011	$	5,364
Securities available-for-sale		134		180
Investment in subsidiary		125,956		124,160
Loan receivable from ESOP		4,299		4,813
Other assets		172		389
Total assets	$	133,572	$	134,906
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Accrued taxes and other liabilities	$	3,158	$	3,100
Total stockholders’ equity		130,414		131,806
Total liabilities and stockholders’ equity	$	133,572	$	134,906

Condensed Statements of Income
(Parent Company Only)

	Year Ended December 31,
	2007			2006			2005
	(Dollars in thousands)
Dividends from subsidiary	$	9,000		$	13,134		$	3,366
Interest income		251			490			639
Net realized gains (losses) on the sale available-for-sale investment securities		—			878			(32	)
Non-interest expense		(636	)		(728	)		(993	)
Net income before income taxes and equity in earnings of subsidiary		8,615			13,774			2,980
Income tax benefit (expense)		146			(244	)		152
Net income before equity in undistributed earnings of subsidiary		8,761			13,530			3,132
Equity in undistributed earnings (loss) of subsidiary		(1,236	)		(8,190	)		1,885
Net income	$	7,525		$	5,340		$	5,017

84

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Condensed Statements of Cash Flows
(Parent Company Only)

	Year Ended December 31,
	2007			2006			2005
	(Dollars in thousands)
Operating activities:
Net income	$	7,525		$	5,340		$	5,017
Adjustments to reconcile net income to net cash provided by operating
activities:
Impairment of securities		—			—			32
Equity in undistributed (earnings) loss of the Bank		1,236			8,190			(1,885	)
Net gains on the sale of available-for-sale investment securities		—			(878	)		—
Decrease in other assets		217			812			1,663
Increase in other liabilities		593			667			424
Net cash provided by operating activities		9,571			14,131			5,251
Investing activities:
Proceeds from paydowns and sales of securities					963			81
Net loan originations and principal payment on loans		514			1,364			1,252
Net cash provided by investing activities		514			2,327			1,333
Financing activities:
Purchase of treasury stock		(9,751	)		(15,730	)		(7,253	)
Net purchase of Rabbi Trust shares		(139	)		(18	)		—
Proceeds from exercise of stock options		2,763			3,300			1,484
Dividends paid on common stock		(5,311	)		(5,604	)		(5,783	)
Net cash used by financing activities		(12,438	)		(18,052	)		(11,552	)
Decrease in cash and cash equivalents		(2,353	)		(1,594	)		(4,968	)
Cash and cash equivalents at beginning of year		5,364			6,958			11,926
Cash and cash equivalents at end of year	$	3,011		$	5,364		$	6,958

20. QUARTERLY FINANCIAL DATA (UNAUDITED)

     The following table reflects summarized quarterly data for the periods presented (unaudited):

			Net				Earnings
	Interest		Interest		Net		per Share
	Income		Income		Income		Basic		Diluted
	(Dollars in thousands, except per share data)
2007
First quarter	$	18,651	$	8,524	$	1,313	$	0.12	$	0.12
Second quarter		18,484		8,638		2,281		0.22		0.21
Third quarter		17,866		8,550		1,896		0.18		0.18
Fourth quarter		17,240		8,395		2,035		0.20		0.19
2006
First quarter	$	17,957	$	8,236	$	1,309	$	0.12	$	0.11
Second quarter		18,962		8,732		1,621		0.15		0.14
Third quarter		18,905		7,853		780		0.07		0.07
Fourth quarter		19,723		8,082		1,630		0.15		0.15

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ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES 

None.

ITEM 9A. CONTROLS AND PROCEDURES

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

     Management evaluated, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, the effectiveness of its 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 by the Company in the reports that it files or submits 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.

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

     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 December 31, 2007 that has materially affected or is reasonable likely to materially affect, the Company’s internal control over financial reporting.

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

     The management of CFS Bancorp, Inc. (the Company) is responsible for establishing and maintaining adequate internal control over financial reporting.

     The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with United States generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with United States generally accepted accounting principles, and that receipts and expenditures of the Company are being made in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on its financial statements.

     Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. All internal control systems, no matter how well designed, have inherent limitations, including the possibility of human error and the circumvention of overriding controls. Accordingly, even effective internal control over financial reporting can provide only reasonable assurance with respect to financial statement preparation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies and procedures may deteriorate.

     The Company’s management assessed its internal control over financial reporting as of December 31, 2007, as required by Section 404 of the Sarbanes-Oxley Act of 2002, based on the criteria for effective internal control over financial reporting described in the Internal Control-Integrated Framework adopted by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, management concludes that, as of December 31, 2007, the Company’s internal controls over financial reporting are effective.

86

     The Company’s independent registered public accounting firm that audited the Company’s consolidated financial statements for the year ended December 31, 2007 has issued an attestation report on the effectiveness of the Company’s internal control over financial reporting. The report appears below.

/s/ THOMAS F. PRISBY	/s/ CHARLES V. COLE
THOMAS F. PRISBY	CHARLES V. COLE
Chairman and	Executive Vice President and
Chief Executive Officer	Chief Financial Officer

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Audit Committee, Board of Directors and Stockholders
CFS Bancorp, Inc.
Munster, Indiana

     We have audited CFS Bancorp, Inc.’s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

     We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

     A company’s internal control over financial reporting is a process designed 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. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.

     Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.

     In our opinion, CFS Bancorp, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

87

     We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of CFS Bancorp, Inc. and our report dated March 3, 2008, expressed an unqualified opinion thereon.

Indianapolis, Indiana
March 3, 2008

ITEM 9B. OTHER INFORMATION

Not applicable.

88

PART III.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

     The information required herein is incorporated by reference from the sections of the Registrant’s Proxy Statement which is expected to be filed on or about March 17, 2008 (Proxy Statement) titled Election of Directors, Information Concerning Continuing Directors and Executive Officers, Section 16(a) Beneficial Ownership Reporting Compliance and Report of the Audit Committee. Information related to the Company’s Code of Conduct and Ethics is incorporated by reference from the Proxy Statement under the heading Code of Conduct and Ethics.

ITEM 11. EXECUTIVE COMPENSATION

     The information required herein is incorporated by reference from the sections of the Registrant’s Proxy Statement titled Executive Compensation, Director Compensation, Compensation Committee Interlocks and Insider Participation and Report of the Compensation Committee.

ITEM 12.	SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
	STOCKHOLDER MATTERS

     The information required herein by Item 403 of Regulation S-K is incorporated by reference from the section of the Registrant’s Proxy Statement titled Beneficial Ownership of Common Stock by Certain Beneficial Owners and Management.

     Equity Compensation Plan Information. The following table sets forth certain information for all equity compensation plans and individual compensation arrangements (whether with employees or non-employees, such as directors), in effect as of December 31, 2007.

					Number of Shares
	Number of Shares to Be				Remaining Available
	Issued Upon the				for Future Issuance
	Exercise of Outstanding		Weighted-Average		(Excluding Shares
	Options, Warrants and		Exercise Price of		Reflected in the
Plan Category	Rights		Outstanding Options		First Column)
Equity Compensation Plans Approved by Security
Holders		1,253,295	$	12.23	34,650
Equity Compensation Plans Not Approved by Security
Holders		—		—	—
Total		1,253,295	$	12.23	34,650

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE 

     The information required herein is incorporated by reference from the sections of the Registrant’s Proxy Statement titled Director Independence and Related Party Transactions.

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

     The information required herein is incorporated by reference from the section of the Registrant’s Proxy Statement titled Fees Paid to the Independent Registered Public Accounting Firm.

89

PART IV.

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a) Documents filed as part of this Report:

     (1) All schedules for which provision is made in the applicable accounting regulation of the SEC are omitted because they are not applicable or the required information is included in the Consolidated Financial Statements or notes thereto.

     (2)(a) The following exhibits are filed with the SEC as part of this Form 10-K, and this list includes the Exhibit Index.

3.1	Certificate 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)
10.1*	Employment Agreement entered into between Citizens Financial Bank and Thomas F. Prisby (4)
10.2*	Employment Agreement entered into between CFS Bancorp, Inc. and Thomas F. Prisby (4)
10.3*	CFS Bancorp, Inc. Amended and Restated 1998 Stock Option Plan (5)
10.4*	CFS Bancorp, Inc. Amended and Restated 1998 Recognition and Retention Plan and Trust Agreement (5)
10.5*	CFS Bancorp, Inc. 2003 Stock Option Plan
10.6*	Employment Agreement entered into between Citizens Financial Bank and Charles V. Cole
10.7*	Employment Agreement entered into between CFS Bancorp, Inc. and Charles V. Cole
10.8*	Amended and Restated Supplemental ESOP Benefit Plan of CFS Bancorp, Inc. and Citizens Financial Services, FSB
10.9*	CFS Bancorp, Inc. Directors’ Deferred Compensation Plan
10.10*	Separation Agreement entered into between CFS Bancorp, Inc., Citizens Financial Bank and Zoran Koricanac
10.11*	Separation Agreement entered into between CFS Bancorp, Inc., Citizens Financial Bank and Thomas L. Darovic
23.0	Consent of BKD, LLP
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 by Reference from the Company’s Definitive Proxy Statement from the Annual Meeting of Stockholders filed on March 25, 2005.
(2)	Incorporated by Reference from the Company’s Form 8-K filed on October 25, 2007.
(3)	Incorporated by Reference from the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.
(4)	Incorporated by Reference from the Company’s Form 8-K filed on July 7, 2006.
(5)	Incorporated by Reference from the Company’s Definitive Proxy Statement for the Annual Meeting of Stockholders filed with the SEC on March 23, 2001.
(6)	Incorporated by Reference from the Company’s Definitive Proxy Statement for the Annual Meeting of Stockholders filed with the SEC on March 31, 2003.
(7)	Incorporated by Reference from the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.
(8)	Incorporated by Reference from the Company’s Form 8-K filed on November 16, 2007.
(9)	Incorporated by Reference from the Company’s Form 8-K filed on January 3, 2008.
*	Indicates management contract or compensatory plan or arrangement required to be filed as an exhibit to this report.

90

SIGNATURES

     In accordance with the requirements of Section 13 or 15(d) 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.
By:	/S/ THOMAS F. PRISBY
	THOMAS F. PRISBY
	Chairman of the Board and
	Chief Executive Officer

     Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

Name	Title	Date
/s/ THOMAS F. PRISBY	Chairman of the Board and Chief Executive Officer
THOMAS F. PRISBY	(principal executive officer)	March 7, 2008
/s/ CHARLES V. COLE	Executive Vice President and Chief Financial Officer
CHARLES V. COLE	(principal financial and accounting officer)	March 7, 2008
/s/ GREGORY W. BLAINE	Director	March 7, 2008
GREGORY W. BLAINE
/s/ GENE DIAMOND	Director	March 7, 2008
GENE DIAMOND
/s/ FRANK D. LESTER	Director	March 7, 2008
FRANK D. LESTER
/s/ ROBERT R. ROSS	Director	March 7, 2008
ROBERT R. ROSS
/s/ JOYCE M. SIMON	Director	March 7, 2008
JOYCE M. SIMON

91

EX-23

EXHIBIT 23

Consent of Independent Registered Public Accounting Firm

We consent to the incorporation by reference in the registration statements of CFS Bancorp, Inc. on Form S-8, as amended (File Nos. 333-62053, 333-62049, 333-84207, 333-105687), of our reports dated March 3, 2008 on the consolidated financial statements of CFS Bancorp, Inc. as of and for the three years ended December 31, 2007 and on our audit of internal control over financial reporting of CFS Bancorp, Inc. as of December 31, 2007, which reports are included in this Annual Report on Form 10-K.

/s/ BKD, LLP 

Indianapolis, Indiana
March 3, 2008

92

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 annual report on Form 10-K of CFS Bancorp, Inc. (the “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.

/s/ THOMAS F. PRISBY 

THOMAS F. PRISBY Chairman of the Board and Chief 

Executive Officer 

Date: March 7, 2008

93

EX-31.2

EXHIBIT 31.2

CERTIFICATION

I, Charles V. Cole, Executive Vice President and Chief Financial Officer certify that:

1. I have reviewed this annual report on Form 10-K of CFS Bancorp, Inc. (the “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.

/s/ CHARLES V. COLE 

CHARLES V. COLE Executive Vice President and Chief 

Financial Officer 

Date: March 7, 2008

94

EX-32.0

EXHIBIT 32.0

SECTION 1350 CERTIFICATIONS

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

     (1) The Annual Report on Form 10-K of the Company for the year ended December 31, 2007 (the “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); and

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

	By:	/s/ THOMAS F. PRISBY
		THOMAS F. PRISBY
		Chairman of the Board and
		Chief Executive Officer
Date: March 7, 2008
	By:	/s/ CHARLES V. COLE
		CHARLES V. COLE
		Executive Vice President and
		Chief Financial Officer

Date: March 7, 2008

     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.

95