CFS Bancorp (CITZ) 10-Q 2007 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2007.

OR

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

For the transition period from _________ to __________.

Commission file number: 0-24611

CFS Bancorp, Inc.

(Exact name of registrant as specified in its charter)

Indiana	35-2042093
(State or other jurisdiction	(I.R.S. Employer
of incorporation or organization)	Identification No.)

707 Ridge Road, Munster, Indiana 46321

(Address of principal executive offices)

(219) 836-5500

(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports 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 RNO £

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 £                                                                Accelerated filer R                                                      Non-accelerated filer £

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

The Registrant had 10,755,640 shares of Common Stock issued and outstanding as of October 24, 2007.

CFS BANCORP, INC.

TABLE OF CONTENTS

		Page
	PART I - FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)
	Condensed Consolidated Statements of Condition	3
	Condensed Consolidated Statements of Income	4
	Condensed Consolidated Statements of Changes in Stockholders’ Equity	5
	Condensed Consolidated Statements of Cash Flows	6
	Notes to Condensed Consolidated Financial Statements	7
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	11
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	33
Item 4.	Controls and Procedures	36
	PART II - OTHER INFORMATION
Item 1.	Legal Proceedings	37
Item 1A.	Risk Factors	37
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	37
Item 3.	Defaults upon Senior Securities	37
Item 4.	Submission of Matters to a Vote of Security Holders	38
Item 5.	Other Information	38
Item 6.	Exhibits	39
Signature Page		40
Certifications for Principal Executive Officer and Principal Financial Officer
	Exhibit 31.1
	Exhibit 31.2
	Exhibit 32.0

2

CFS BANCORP, INC.

Condensed Consolidated Statements of Condition

	September 30, 2007			December 31, 2006
	(Unaudited)
	(Dollars in thousands)
ASSETS
Cash and amounts due from depository institutions	$	15,934		$	33,194
Interest-bearing deposits		9,772			20,607
Federal funds sold		2,942			13,366
Cash and cash equivalents		28,648			67,167
Securities available-for-sale, at fair value		232,580			298,925
Investment in Federal Home Loan Bank stock, at cost		23,944			23,944
Loans receivable		820,832			802,383
Allowance for losses on loans		(11,277	)		(11,184	)
Net loans		809,555			791,199
Interest receivable		6,654			7,523
Other real estate owned		1,140			321
Office properties and equipment		19,177			17,797
Investment in bank-owned life insurance		36,052			35,876
Other assets		10,300			10,339
Goodwill and intangible assets		1,250			1,299
Total assets	$	1,169,300		$	1,254,390
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits	$	859,856		$	907,095
Borrowed money		161,208			202,275
Advance payments by borrowers for taxes and insurance		7,639			4,194
Other liabilities		10,995			9,020
Total liabilities		1,039,698			1,122,584
Stockholders’ equity:
Preferred stock, $0.01 par value; 15,000,000 shares authorized		–			–
Common stock, $0.01 par value; 85,000,000 shares authorized; 23,423,306 shares issued; 10,756,189 and 11,134,331 shares outstanding		234			234
Additional paid-in capital		191,086			190,825
Retained earnings		96,250			94,344
Treasury stock, at cost; 12,542,341 and 12,164,754 shares		(154,074	)		(148,108	)
Treasury stock held in Rabbi Trust, at cost; 124,776 and 124,221 shares		(1,636	)		(1,627	)
Unallocated common stock held by Employee Stock Ownership Plan		(3,204	)		(3,564	)
Accumulated other comprehensive income (loss), net of tax		946			(298	)
Total stockholders’ equity		129,602			131,806
Total liabilities and stockholders’ equity	$	1,169,300		$	1,254,390

See accompanying notes.

3

CFS BANCORP, INC.

Condensed Consolidated Statements of Income

	Three Months Ended September 30,						Nine Months Ended September 30,
	2007			2006			2007		2006
	(Unaudited)
	(Dollars in thousands, except share and per share data)
Interest income:
Loans	$	14,362		$	14,798		$	42,818	$	45,027
Securities		3,036			3,482			10,034		9,123
Other		468			625			2,149		1,674
Total interest income		17,866			18,905			55,001		55,824
Interest expense:
Deposits		6,516			5,752			19,829		15,309
Borrowed money		2,800			5,300			9,460		15,694
Total interest expense		9,316			11,052			29,289		31,003
Net interest income		8,550			7,853			25,712		24,821
Provision for losses on loans		884			413			1,197		971
Net interest income after provision for losses on loans		7,666			7,440			24,515		23,850
Non-interest income:
Service charges and other fees		1,786			1,730			5,025		5,042
Card-based fees		382			327			1,104		980
Commission income		40			32			107		149
Net realized gains (losses) on available-for-sale securities		(1	)		877			9		750
Net gains (losses) on sale of other assetsother assets		3			(1,339	)		13		(1,291	)
Income from bank-owned life insurance		404			401			1,212		1,189
Other income		228			241			674		716
Total non-interest income		2,842			2,269			8,144		7,535
Non-interest expense:
Compensation and employee benefits		4,343			5,027			14,005		15,246
Net occupancy expense		766			609			2,213		1,923
Data processing		540			559			1,669		1,910
Furniture and equipment expense		557			548			1,657		1,516
Professional fees		240			319			1,200		1,083
Marketing		214			442			615		1,031
Amortization of core deposit intangibles		16			16			49		49
Other general and administrative expenses		1,349			1,408			3,953		4,138
Total non-interest expense		8,025			8,928			25,361		26,896
Income before income taxes		2,483			781			7,298		4,489
Income tax expense		587			1			1,808		779
Net income	$	1,896		$	780		$	5,490	$	3,710
Per share data:
Basic earnings per share	$	0.18		$	0.07		$	0.52	$	0.33
Diluted earnings per share		0.18			0.07			0.50		0.32
Cash dividends declared per share		0.12			0.12			0.36		0.36
Weighted-average shares outstanding		10,460,716			10,899,012			10,591,832		11,134,491
Weighted-average diluted shares outstanding		10,741,093			11,248,382			10,892,853		11,491,605

See accompanying notes.

4

CFS BANCORP, INC.

Condensed Consolidated Statements of Changes in Stockholders' Equity

	Common Stock		Additional Paid-In Capital			Retained Earnings			Treasury Stock			Unallocated Common Stock Held By ESOP			Unearned Common Stock Acquired By RRP			Accumulated Other Compre-hensive Income/ (Loss)			Total
	(Unaudited)
	(Dollars in thousands, except per share data)
Balance at January 1, 2006	$	234	$	190,402		$	94,379		$	(136,229	)	$	(4,762	)	$	(111	)	$	(1,546	)	$	142,367
Net income		–		–			3,710			–			–			–			–			3,710
Other comprehensive income, net of tax: Change in unrealized loss on available-for-sale securities, net of reclassification adjustment																			922			922
Total comprehensive income																						4,632
Purchase of treasury stock		–		–			–			(14,705	)		–			–			–			(14,705	)
Cumulative effect of change in accounting for  Rabbi Trust shares		–		–			(92	)		(1,609	)		–			–			–			(1,701	)
Net purchases of Rabbi Trust shares		–		–			–			(11	)		–			–			–			(11	)
Shares earned under ESOP		–		424			–			–			898			–			–			1,322
Reclassification of unearned compensation to additional paid-in capital upon the adoption of SFAS 123(R)		–		(111	)		–			–			–			111			–			–
Amortization of award under RRP		–		48			–			–			–			–			–			48
Exercise of stock options		–		(474	)		–			3,417			–			–			–			2,943
Tax benefit related to stock options exercised		–		403			–			–			–			–			–			403
Dividends declared on common stock ($0.36 per share)		–		–			(3,988	)		–			–			–			–			(3,988	)
Balance at September 30, 2006	$	234	$	190,692		$	94,009		$	(149,137	)	$	(3,864	)	$	–		$	(624	)	$	131,310
Balance at January 1, 2007	$	234	$	190,825		$	94,344		$	(149,735	)	$	(3,564	)	$	–		$	(298	)	$	131,806
Net income		–		–			5,490			–			–			–			–			5,490
Other comprehensive income, net of tax: Change in unrealized loss on available-for-sale securities, net of reclassification adjustment																			1,244			1,244
Total comprehensive income																						6,734
Purchase of treasury stock		–		–			–			(7,837	)		–			–			–			(7,837	)
Net purchases of Rabbi Trust shares		–		–			–			(9	)		–			–			–			(9	)
Shares earned under ESOP		–		168			–			–			360			–			–			528
Amortization of award under RRP		–		48			–			–			–			–			–			48
Cumulative change in accounting principle under the adoption of FIN 48		–		–			240			–			–			–			–			240
Exercise of stock options		–		(161	)		–			1,871			–			–			–			1,710
Tax benefit related to stock options exercised		–		206			–			–			–			–			–			206
Dividends declared on common stock ($0.36 per share)		–		–			(3,824	)		–			–			–			–			(3,824	)
Balance at September 30, 2007	$	234	$	191,086		$	96,250		$	(155,710	)	$	(3,204	)	$	–		$	946		$	129,602

See accompanying notes. 

5

CFS BANCORP, INC.

Condensed Consolidated Statements of Cash Flows

	Nine Months Ended September 30,
	2007			2006
	(Unaudited)
	(Dollars in thousands)
Operating activities:
Net income	$	5,490		$	3,710
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for losses on loans		1,197			971
Depreciation and amortization		1,274			1,130
Premium amortization on the early extinguishment of debt		3,689			7,587
Net premium amortization on securities available-for-sale		(476	)		(361	)
Deferred income tax expense (benefit)		2,204			(493	)
Amortization of cost of stock benefit plans		576			1,370
Proceeds from sale of loans held-for-sale		8,973			7,809
Origination of loans held-for-sale		(8,850	)		(7,664	)
Net realized gains on sale of securities available-for-sale		(9	)		(750	)
Net realized (gains) losses on sale of other assets		(13	)		1,291
Increase in cash surrender value of bank-owned life insurance		(1,212	)		(1,189	)
Increase in prepaid expenses and other assets		(3,651	)		(4,849	)
Increase in other liabilities		4,484			4,659
Net cash provided by operating activities		13,676			13,221
Investing activities:
Securities:
Proceeds from sales		65,236			24,826
Proceeds from maturities and paydowns		78,884			17,064
Purchases		(75,315	)		(140,721	)
Net loan (fundings) and principal payments received		(33,327	)		66,457
Proceeds from sales of loans and loan participations		11,988			8,754
Proceeds from sale of other real estate owned		521			4,162
Proceeds from bank owned life insurance		1,036			604
Purchases of property and equipment		(2,605	)		(2,602	)
Disposal of property and equipment		–			84
Net cash provided by (used for) investing activities		46,418			(21,372	)
Financing activities:
Proceeds from exercises of stock options		1,710			2,943
Tax benefit from exercises of nonqualified stock options		206			403
Dividends paid on common stock		(4,006	)		(4,249	)
Purchase of treasury stock		(7,837	)		(14,705	)
Net purchase of Rabbi Trust shares		(9	)		(11	)
Net (decrease) increase in deposit accounts		(47,366	)		42,057
Net increase (decrease) in advance payments by borrowers for taxes and insurance		3,445			(2,248	)
Net (decrease) increase in other short-term borrowings		(9,559	)		20,322
Repayments of Federal Home Loan Bank debt		(35,197	)		(10,184	)
Net cash flows (used for) provided by financing activities		(98,613	)		34,328
Net (decrease) increase in cash and cash equivalents		(38,519	)		26,177
Cash and cash equivalents at beginning of period		67,167			24,177
Cash and cash equivalents at end of period	$	28,648		$	50,354
Supplemental disclosures:
Loans transferred to real estate owned	$	1,376		$	5,487
Cash paid for interest on deposits		19,805			15,259
Cash paid for interest on borrowed money		5,850			8,149
Cash paid for taxes		1,400			1,020

See accompanying notes.

6

CFS BANCORP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.  Basis of Financial Statements Presentation

The condensed consolidated financial statements of CFS Bancorp, Inc. (including its consolidated subsidiaries, the Company) as of September 30, 2007 and for the nine months ended September 30, 2007 and September 30, 2006 are unaudited; however, the financial information reflects all adjustments (consisting only of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the financial position, results of operations and cash flows of the Company for the interim periods.  The financial statements have been prepared in conformity with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.

The results of operations for the nine months ended September 30, 2007 are not necessarily indicative of the results expected for the full year ending December 31, 2007.  The accompanying condensed consolidated financial statements do not include information or footnotes necessary for a complete presentation of financial condition, results of operations or cash flows in accordance with U.S. generally accepted accounting principles.  The September 30, 2007 condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes for the year ended December 31, 2006 included in the Company’s Annual Report on Form 10-K.  The condensed consolidated statement of condition of the Company as of December 31, 2006 has been derived from the audited consolidated statement of condition as of that date.

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

Some items in the prior period financial statements were reclassified to conform to the current period’s presentation.

2.  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.

7

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 three or nine months ended September 30, 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.

Stock Options

Under the Company’s stock option plans, shares of Company common stock are reserved for grant in the form of 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 are fully vested.  The Company did not grant any options during the nine months ended September 30, 2007 and 2006.

The following table presents the activity related to options under the Company’s stock option plans for the nine months ended September 30, 2007.  The number of shares presented is in thousands.

	Number of Shares			Weighted-Average Exercise Price
Options outstanding at January 1, 2007		1,496		$	12.09
Granted		–			–
Exercised		(154	)		11.14
Forfeited		–			–
Options outstanding at September 30, 2007		1,342			12.20
Options exercisable at September 30, 2007		1,342			12.20

For stock options outstanding at September 30, 2007, the range of exercise prices was $8.19 to $14.76 and the weighted-average remaining contractual term was 4.4 years.

At September 30, 2007, the aggregate intrinsic value of options outstanding totaled $2.7 million.  This value represents the difference between the Company’s closing stock price on the last day of trading for the nine months ended September 30, 2007 and the exercise price multiplied by the number of in-the-money options assuming all option holders had exercised their stock options on September 30, 2007.

The aggregate intrinsic value of options exercised during the nine months ended September 30, 2007 and 2006 was $563,000 and $1.2 million, respectively.  The option exercises during the same periods resulted in cash receipts of $1.7 million and $2.9 million, respectively, and tax benefits of $206,000 and $403,000, respectively, that have been recorded as increases in equity.

The Company reissues treasury shares to satisfy option exercises.

8

Recognition and Retention Plan

In February 1999, the Company, with shareholder approval, established a stock-based incentive plan (RRP) 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.  At January 1, 2006, all shares had been granted under this plan.

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 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 that date.  The remaining unamortized cost of the RRP is reflected as a reduction in stockholders’ equity.  At September 30, 2007, the remaining unamortized cost of the RRP totaled $26,000.  The majority of the cost is expected to be recognized over the next nine months.  The total grant date fair value of shares vested during the nine months ended September 30, 2007 was $48,000.

The following table presents the activity for the RRP for the nine months ended September 30, 2007.

	Number of Shares			Weighted-Average Grant-Date Fair Value
Unvested at December 31, 2006		7,115		$	13.84
Granted		–			–
Vested		(3,505	)		13.83
Forfeited		–			–
Unvested as of September 30, 2007		3,610		$	13.85

3.  Other Comprehensive Income

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

	Nine Months Ended September 30,
	2007			2006
	(Dollars in thousands)
Unrealized holding gains arising during the period:
Unrealized net securities gains	$	1,984		$	2,229
Related tax expense		(735	)		(846	)
Net		1,249			1,383
Less:  reclassification adjustment for net gains     realized during the period:
Realized net securities gains		9			750
Related tax expense		(4	)		(289	)
Net		5			461
Total other comprehensive income	$	1,244		$	922

9

4.  Earnings Per Share

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

	Three Months Ended September 30,				Nine Months Ended September 30,
	2007		2006		2007		2006
	(Dollars in thousands, except per share data)
Net income	$	1,896	$	780	$	5,490	$	3,710
Weighted-average common shares outstanding		10,460,716		10,899,012		10,591,832		11,134,491
Weighted-average common share equivalents (1)		280,376		349,370		301,021		357,114
Weighted-average common shares and common share equivalents outstanding		10,741,093		11,248,382		10,892,853		11,491,605
Basic earnings per share	$	0.18	$	0.07	$	0.52	$	0.33
Diluted earnings per share		0.18		0.07		0.50		0.32

(1)  Assumes exercise of dilutive stock options and also a portion of the unearned awards under the RRP.

For the three and nine months ended September 30, 2007, the Company had 206,000 and 76,000 anti-dilutive options, respectively.  For the three months ended September 30, 2006, there were no anti-dilutive options.  For the nine months ended September 30, 2006, the Company had 79,000 anti-dilutive options.  The anti-dilutive options were not included in the above earnings per share calculations.

5.  Change in Accounting Principle 

The Company adopted the provisions of the Financial Accounting Standards Board (FASB) Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109, on January 1, 2007.  FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.  FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.  As a result of the implementation of FIN 48, no material reserves for uncertain income tax positions have been recorded; however, the Company reduced its reserves for certain tax positions by $240,000.  This reduction was recorded as a cumulative effect adjustment to equity.

The Company files income tax returns in the U.S. federal, Indiana, and Illinois jurisdictions.  With few exceptions, the Company is no longer subject to U.S. federal, state and local examinations by tax authorities for years before 2003.

The Company’s policy for recording interest and penalties associated with audits is to record these items as a component of income tax expense in the consolidated statement of income.  For the nine months ended September 30, 2007, the Company did not record any expense associated with interest or penalties.

10

6.  Recent Accounting Pronouncements

In September 2006, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements, 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 No. 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 No. 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 which will permit entities, if they so choose, 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 No. 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 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 No. 157, Fair Value Measurements.  The Company has not yet made a determination if it will elect to apply the options available in SFAS No. 159.

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

Forward Looking Statements

Certain statements contained in this Form 10-Q, 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

11

lending and investment activities, legislative changes, changes in the cost of funds, changes in the demand for loan products and financial services, unexpected legal developments, 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 “Part II. Item 1A.  Risk Factors” of this Form 10-Q as well as “Part I. Item 1A.  Risk Factors” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.  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.

Overview

The Company’s net income for the three and nine months ended September 30, 2007 increased 143% to $1.9 million and 48% to $5.5 million, respectively, from the comparable 2006 periods reflecting an improved net interest margin and reduced operating costs.  Diluted earnings per share for the 2007 periods increased to $0.18 and $0.50, respectively, when compared to $0.07 and $0.32, respectively, for the same 2006 periods.

The Company’s net interest margin expanded to 3.07% and 3.00%, respectively, for the three and nine months ended September 30, 2007 from 2.59% and 2.78% for the comparable 2006 periods.  The increases were 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 the cost of deposits.

The Company’s initiatives to improve operating efficiencies in 2007 reduced operating expenses by $903,000 to $8.0 million and $1.5 million to $25.4 million, respectively, for the three and nine months ended September 30, 2007 from $8.9 million and $26.9 million, respectively, for the comparable 2006 periods.  These reductions combined with increases in net interest income resulted in the improvement in the Company’s efficiency ratio to 70.4% and 74.9%, respectively, for the 2007 periods from 88.2% and 83.1% for the comparable 2006 periods.  The Company’s core efficiency ratios were 64.5% and 67.6% for the three and nine months ended September 30, 2007 and 68.4% and 66.4% for the comparable 2006 periods.  For the Company’s calculations of its efficiency and core efficiency ratios see the “Analysis of Statements of Income - Non-Interest Expense” below in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations”.

Total loans receivable increased 2.3% to $820.8 million at September 30, 2007 compared to $802.4 million at December 31, 2006.  During the nine months ended September 30, 2007, the Company had total loan fundings and purchases of $279.4 million which were offset by $258.7 million of loan repayments and sales.  The amount of loan repayments and sales for the 2007 period decreased from the higher level of repayments experienced during 2006.

During the third quarter of 2007, the Company increased its provision for losses on loans to $884,000 from $413,000 for the third quarter of 2006.  The Company’s provision for losses on

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loans was $1.2 million and $971,000, respectively, for the nine months ended September 30, 2007 and 2006.  The third quarter increase in the provision is the result of an increase in non-performing loans combined with a $425,000 increase in impairment reserves related to commercial real estate loans.  Non-performing assets increased during the third quarter due to the addition of two commercial real estate loans totaling $4.4 million in the aggregate.

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 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 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 its Annual Report on Form 10-K for the year ended December 31, 2006.  These policies, along with the disclosures presented in the notes to the Company’s unaudited financial statements included in Item 1 of this Form 10-Q 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

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loans and other classified loans; concentrations of credit within the commercial loan portfolios; volume and type of lending; and current and anticipated economic conditions.

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 of the allowance for losses on loans 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 an appropriate level.  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 provision 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 FIN 48 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.

Average Balances, Net Interest Income, Yields Earned and Rates Paid

The following tables provide 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

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average daily balances during the periods indicated.

	Three Months Ended September 30,
	2007							2006
	Average Balance		Interest		Average Yield/Cost			Average Balance		Interest		Average Yield/Cost
	(Dollars in thousands)
Interest-earning assets:
Loans receivable (1)	$	815,081	$	14,362		6.99	%	$	836,357	$	14,798		7.02	%
Securities (2)		251,463		3,036		4.72			316,459		3,482		4.31
Other interest-earning assets (3)		39,691		468		4.68			49,174		625		5.04
Total interest-earning assets		1,106,235		17,866		6.41			1,201,990		18,905		6.24
Non-interest earning assets		78,313							77,637
Total assets	$	1,184,548						$	1,279,627
Interest-bearing liabilities:
Deposits:
Checking accounts	$	97,737		218		0.88		$	99,450		262		1.05
Money market accounts		167,068		1,390		3.30			135,766		1,008		2.95
Savings accounts		139,438		245		0.70			157,105		194		0.49
Certificates of deposit		400,990		4,663		4.61			397,482		4,288		4.28
Total deposits		805,233		6,516		3.21			789,803		5,752		2.89
Borrowed money:
Other short-term borrowings (4)		19,139		200		4.15			24,633		294		4.74
FHLB debt (5)(6)		147,153		2,600		6.91			252,908		5,006		7.75
Total borrowed money		166,292		2,800		6.59			277,541		5,300		7.47
Total interest-bearing liabilities		971,525		9,316		3.80			1,067,344		11,052		4.11
Non-interest bearing deposits		66,043							61,173
Non-interest bearing liabilities		18,112							18,528
Total liabilities		1,055,680							1,147,045
Stockholders' equity		128,868							132,582
Total liabilities and stockholders' equity	$	1,184,548						$	1,279,627
Net interest-earning assets	$	134,710						$	134,646
Net interest income / interest rate spread			$	8,550		2.61	%			$	7,853		2.13	%
Net interest margin						3.07	%						2.59	%
Ratio of average interest-earning assets to average interest-bearing liabilities						113.87	%						112.62	%

(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 repurchase agreements (Repo Sweeps).

(5) The 2007 period includes an average of $150.2 million of contractual FHLB borrowings reduced by an average of $3.1 million of unamortized deferred premium on the early extinguishment of debt.  Interest expense on borrowed money includes $1.1 million of amortization of the deferred premium on the early extinguishment of debt.  The amortization of the deferred premium increased the average cost of borrowed money as reported to 6.59% compared to an average contractual rate of 4.02%.

(6) The 2006 period includes an average of $262.5 million of contractual FHLB borrowings reduced by an average of $9.6 million of unamortized deferred premium on the early extinguishment of debt.  Interest expense on borrowed money includes $2.5 million of amortization of the deferred premium on the early extinguishment of debt.  The amortization of the deferred premium increased the average cost of borrowed money as reported to 7.47% compared to an average contractual rate of 3.86%.

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	Nine Months Ended September 30,
	2007							2006
	Average Balance		Interest		Average Yield/Cost			Average Balance		Interest		Average Yield/Cost
	(Dollars in thousands)
Interest-earning assets:
Loans receivable (1)	$	805,831	$	42,818		7.10	%	$	863,874	$	45,027		6.97	%
Securities (2)		282,244		10,034		4.69			283,383		9,123		4.25
Other interest-earning assets (3)		57,435		2,149		5.00			45,845		1,674		4.88
Total interest-earning assets		1,145,510		55,001		6.42			1,193,102		55,824		6.26
Non-interest earning assets		77,897							73,411
Total assets	$	1,223,407						$	1,266,513
Interest-bearing liabilities:
Deposits:
Checking accounts	$	100,354		729		0.97		$	102,837		773		1.00
Money market accounts		178,252		4,549		3.41			133,275		2,647		2.66
Savings accounts		145,837		721		0.66			163,261		479		0.39
Certificates of deposit		402,156		13,830		4.60			383,416		11,410		3.98
Total deposits		826,599		19,829		3.21			782,789		15,309		2.61
Borrowed money:
Other short-term borrowings (4)		20,771		655		4.22			12,421		424		4.56
FHLB debt (5)(6)		165,940		8,805		7.00			256,152		15,270		7.86
Total borrowed money		186,711		9,460		6.68			268,573		15,694		7.71
Total interest-bearing liabilities		1,013,310		29,289		3.86			1,051,362		31,003		3.94
Non-interest bearing deposits		63,438							61,859
Non-interest bearing liabilities		16,723							17,276
Total liabilities		1,093,471							1,130,497
Stockholders' equity		129,936							136,016
Total liabilities and stockholders' equity	$	1,223,407						$	1,266,513
Net interest-earning assets	$	132,200						$	141,740
Net interest income / interest rate spread			$	25,712		2.56	%			$	24,821		2.32	%
Net interest margin						3.00	%						2.78	%
Ratio of average interest-earning assets to average interest-bearing liabilities						113.05	%						113.48	%

(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 repurchase agreements (Repo Sweeps).

(5) The 2007 period includes an average of $170.2 million of contractual FHLB borrowings reduced by an average of $4.3 million of unamortized deferred premium on the early extinguishment of debt.  Interest expense on borrowed money includes $3.7 million of amortization of the deferred premium on the early extinguishment of debt.  The amortization of the deferred premium increased the average cost of borrowed money as reported to 6.68% compared to an average contractual rate of 3.99%.

(6) The 2006 period includes an average of $268.3 million of contractual FHLB borrowings reduced by an average of $12.1 million of unamortized deferred premium on the early extinguishment of debt.  Interest expense on borrowed money includes $7.6 million of amortization of the deferred premium on the early extinguishment of debt.  The amortization of the deferred premium increased the average cost of borrowed money as reported to 7.71% compared to an average contractual rate of 3.84%.

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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).

	Three Months Ended September 30,
	2007 compared to 2006
	Increase (decrease) due to
	Rate			Volume			Rate/ Volume			Total Net Increase / (Decrease)
	(Dollars in thousands)
Interest-earning assets:
Loans receivable	$	(62	)	$	(376	)	$	2		$	(436	)
Securities		339			(715	)		(70	)		(446	)
Other interest-earning assets		(45	)		(121	)		9			(157	)
Total net change in income on interest- earning assets		232			(1,212	)		(59	)		(1,039	)
Interest-bearing liabilities:
Deposits:
Checking accounts		(40	)		(5	)		1			(44	)
Money market accounts		122			232			28			382
Savings accounts		82			(22	)		(9	)		51
Certificates of deposit		334			38			3			375
Total deposits		498			243			23			764
Borrowed money:
Other short-term borrowings		(36	)		(66	)		8			(94	)
FHLB debt		(538	)		(2,093	)		225			(2,406	)
Total borrowed money		(574	)		(2,159	)		233			(2,500	)
Total net change in expense on interest- bearing liabilities		(76	)		(1,916	)		256			(1,736	)
Net change in net interest income	$	308		$	704		$	(315	)	$	697

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	Nine Months Ended September 30,
	2007 compared to 2006
	Increase (decrease) due to
	Rate			Volume			Rate/ Volume			Total Net Increase / (Decrease)
	(Dollars in thousands)
Interest-earning assets:
Loans receivable	$	875		$	(3,025	)	$	(59	)	$	(2,209	)
Securities		951			(36	)		(4	)		911
Other interest-earning assets		40			425			10			475
Total net change in income on interest- earning assets		1,866			(2,636	)		(53	)		(823	)
Interest-bearing liabilities:
Deposits:
Checking accounts		(26	)		(19	)		1			(44	)
Money market accounts		754			893			255			1,902
Savings accounts		328			(51	)		(35	)		242
Certificates of deposit		1,775			558			87			2,420
Total deposits		2,831			1,381			308			4,520
Borrowed money:
Other short-term borrowings		(32	)		285			(22	)		231
FHLB debt		(1,678	)		(5,378	)		591			(6,465	)
Total borrowed money		(1,710	)		(5,093	)		569			(6,234	)
Total net change in expense on interest- bearing liabilities		1,121			(3,712	)		877			(1,714	)
Net change in net interest income	$	745		$	1,076		$	(930	)	$	891

Analysis of Statements of Income

Net Interest Margin.  The Company’s net interest margin for the three months ended September 30, 2007 increased 48 basis points to 3.07% from 2.59% for the comparable 2006 period.  The Company’s net interest margin for the nine months ended September 30, 2007 increased 22 basis points to 3.00% from 2.78% for the 2006 period.  The net interest margin was favorably impacted by increased weighted-average yields on interest-earning assets coupled with a reduction in the average balance 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 the cost of deposits.

Interest Income.  The Company’s interest income was $17.9 million for the three months ended September 30, 2007 compared to $18.9 million for the 2006 period.  For the nine months ended September 30, 2007, the Company’s interest income was $55.0 million compared to $55.8 million for the 2006 period.  The weighted-average yield on interest-earning assets increased 17 and 16 basis points to 6.41% and 6.42%, respectively, for the three and nine months ended September 30, 2007 from the comparable 2006 periods.  These increases reflect the Company’s reinvestment of proceeds from sales and maturities of relatively low rate securities into higher yielding securities.

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The Company’s average interest-earning assets were $1.1 billion for the third quarter and year to date periods of 2007, a decrease from $1.2 billion for the comparable 2006 periods.  The average balances of interest-earning assets were impacted as the Company utilized proceeds from security sales and maturities and other interest-earning assets to fund the repayment of maturing FHLB debt, Company stock repurchases during the 2007 periods and managed run-off of single-service, high-rate certificates.

           Interest Expense.  The Company’s total interest expense decreased to $9.3 million and $29.3 million, respectively, for the three and nine months ended September 30, 2007 from $11.1 million and $31.0 million, respectively, for the 2006 periods.  The Company’s average cost of interest-bearing liabilities decreased to 3.80% and 3.86%, respectively, for the three and nine months ended September 30, 2007 when compared to the comparable 2006 periods 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 $6.5 million and $19.8 million, respectively, for the three and nine months ended September 30, 2007 from $5.8 million and $15.3 million for the 2006 periods.  The average cost of interest-bearing deposits increased 32 basis points and 60 basis points, respectively, for the three and nine months ended September 30, 2007 from the comparable 2006 periods 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 and managing the run-off of single-service, high-rate certificates of deposit.

The Company’s total interest expense for the three and nine months ended September 30, 2007 was positively impacted by decreases in interest expense on borrowed money of $2.5 million and $6.2 million, or 47.2% and 39.7%, respectively, compared to the same 2006 periods.  These decreases were 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 $1.1 million and $3.7 million, respectively, for the three and nine months ended September 30, 2007 from $2.5 million and $7.6 million, respectively, for the comparable 2006 periods.  The Premium Amortization adversely impacted the Company’s net interest margin by 38 basis points and 82 basis points, respectively, for the three months ended September 30, 2007 and 2006.  For the nine months ended September 30, 2007 and 2006, the Premium Amortization adversely impacted net interest margin by 43 basis points and 85 basis points, respectively.  The interest expense related to the Premium Amortization is expected to be $851,000, $527,000, $449,000 and $270,000, respectively, before taxes in the quarters ended December 31, 2007, March 31, 2008, June 30, 2008 and September 30, 2008.

Provision for losses on loans.  The Company’s provision for losses on loans was $884,000 for the three months ended September 30, 2007 compared to $413,000 for the 2006 period.  The Company’s provision for losses on loans was $1.2 million and $971,000, respectively, for the nine months ended September 30, 2007 and 2006.  The increase in the provision for losses on loans for the 2007 periods is the result of an increase in non-performing loans combined with a $425,000 increase in impairment reserves identified during the third quarter of 2007 related to commercial real estate loans.  For additional information, see

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“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:

	Three Months Ended September 30,									Nine Months Ended September 30,
	2007			2006			% Change			2007		2006			% Change
	(Dollars in thousands)
Service charges and other fees	$	1,786		$	1,730			3.2	%	$	5,025	$	5,042			(0.3	)%
Card-based fees		382			327			16.8			1,104		980			12.7
Commission income		40			32			25.0			107		149			(28.2	)
Subtotal fee based revenues		2,208			2,089			5.7			6,236		6,171			1.1
Income from bank-owned life insurance		404			401			0.7			1,212		1,189			1.9
Other income		228			241			(5.4	)		674		716			(5.9	)
Subtotal		2,840			2,731			4.0			8,122		8,076			0.6
Securities gains (losses), net		(1	)		877		NM				9		750		NM
Other asset gains (losses), net		3			(1,339	)	NM				13		(1,291	)	NM
Total non-interest income	$	2,842		$	2,269			25.3	%	$	8,144	$	7,535			8.1	%

Non-interest income before securities and other asset gains and losses increased 4.0% and 0.6% for the three and nine months ended September 30, 2007 from the 2006 periods primarily due to increased income from card-based fees.  Card-based fees increased during the 2007 periods primarily 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 the 2007 periods as deposit customers continue to change their behavior patterns related to overdrafts and fees.  During the third quarter of 2007, the decrease in overdrafts was offset by the Company’s increase in the fee charged per overdraft.  Commission income from the Company’s third-party service provider for the sale of investment products was lower for the 2007 periods as rates offered on certificates of deposit have become more competitive relative to the yields available on non-deposit products.

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

	Three Months Ended September 30,							Nine Months Ended September 30,
	2007		2006		% Change			2007		2006		% Change
	(Dollars in thousands)
Compensation and mandatory benefits	$	3,784	$	3,916		(3.4	)%	$	12,396	$	11,691		6.0	%
Retirement and stock related compensation		289		733		(60.6	)		855		2,181		(60.8	)
Medical and life benefits		250		317		(21.1	)		675		1,167		(42.2	)
Other employee benefits		20		61		(67.2	)		79		207		(61.8	)
Subtotal compensation and employee benefits		4,343		5,027		(13.6	)		14,005		15,246		(8.1	)
Net occupancy expense		766		609		25.8			2,213		1,923		15.1
Data processing		540		559		(3.4	)		1,669		1,910		(12.6	)
Furniture and equipment expense		557		548		1.6			1,657		1,516		9.3
Professional fees		240		319		(24.8	)		1,200		1,083		10.8
Marketing		214		442		(51.6	)		615		1,031		(40.3	)
Other general and administrative expense		1,365		1,424		(4.1	)		4,002		4,187		(4.4	)
Total non-interest expense	$	8,025	$	8,928		(10.1	)%	$	25,361	$	26,896		(5.7	)%

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           The Company’s non-interest expense for the three and nine months ended September 30, 2007 when compared to the same 2006 periods were positively impacted by the following:

• reduced retirement and stock-related compensation expense pertaining to the Company’s 2007 ESOP loan modification totaling $280,000 and $571,000, respectively;

• reduced pension expense totaling $165,000 and $755,000, respectively;

• decreased medical and life benefits expense of $67,000 and $492,000, respectively, 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 $19,000 and $241,000, respectively, primarily as a result of bringing items processing in-house; and

• reduced marketing expenses totaling $228,000 and $416,000, respectively, 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 increased net occupancy expense and furniture and equipment expense primarily due to the opening of the Company’s Tinley Park, Illinois office during the first quarter of 2007 combined with the third quarter of 2007 implementation of the Company’s new digital phone system.

Non-interest expense for the nine months ended September 30, 2007 was impacted by an increase in compensation and mandatory benefits as a result of the hiring of additional commercial lenders since early 2006 combined with severance expense incurred during the first quarter of 2007 related to the Company’s reduction in force.  Professional fees for the year to date 2007 period also increased due to the first quarter of 2007 implementation of the Company’s customer-centric relationship management program and legal expenses relating to modifications to the Bank’s ESOP loan and 401(k) benefit plan, the reduction in the workforce and new SEC proxy disclosure requirements.

The Company’s efficiency and core efficiency ratios for the three months ended September 30, 2007 improved to 70.4% and 64.5%, respectively, from 88.2% and 68.4%, respectively, for the 2006 periods as a result of the Company’s cost initiatives previously discussed.  The Company’s efficiency and core efficiency ratios for the nine months ended September 2007 were 74.9% and 67.6%, respectively, compared to 83.1% and 66.4% for the 2006 periods.  The Company’s core efficiency ratio for the year to date period was negatively impacted by the lower Premium Amortization during 2007.  The efficiency and core efficiency ratios are presented in the following table for the dates indicated:

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	Three Months Ended September 30,						Nine Months Ended September 30,
	2007			2006			2007			2006
	(Dollars in thousands)
Efficiency ratio:
Non-interest expense	$	8,025		$	8,928		$	25,361		$	26,896
Net interest income plus non-interest income	$	11,392		$	10,122		$	33,856		$	32,356
Efficiency ratio		70.44	%		88.20	%		74.91	%		83.13	%
Core efficiency ratio:
Non-interest expense	$	8,025		$	8,928		$	25,361		$	26,896
Net interest income plus non-interest income	$	11,392		$	10,122		$	33,856		$	32,356
Adjustments:
Net realized (gains) losses on sale of securities    available-for-sale		1			(877	)		(9	)		(750	)
Net realized (gains) losses on sales of other            assets		(3	)		1,339			(13	)		1,291
Amortization of deferred premium on the early extinguishment of debt		1,062			2,465			3,689			7,587
Net interest income plus non-interest income – as adjusted	$	12,452		$	13,049		$	37,523		$	40,484
Core efficiency ratio		64.45	%		68.42	%		67.59	%		66.44	%

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.  

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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 for the third quarter of 2007 was $587,000 compared to $1,000 for the 2006 period.  The income tax expense for the nine months ended September 30, 2007 was $1.8 million compared to income tax expense of $779,000 for the comparable 2006 period.  The Company’s effective tax rates increased for the 2007 periods to 23.6% and 24.8% from 0.1% and 17.4% for the 2006 periods, respectively.  The increase in the effective tax rate was primarily due to a decreased percentage of tax credits and permanent differences to income before taxes for the 2007 periods compared to the 2006 periods resulting primarily from increased income before taxes for the 2007 periods.  Permanent tax differences, primarily related to the Company’s investment in bank-owned life insurance, and the application of available tax credits continue to have a favorable impact on income tax expense.

Changes in Financial Condition

Securities.  The amortized cost of the Company’s securities and their fair values were as follows at September 30, 2007 and December 31, 2006:

	Amortized  Cost		Gross Unrealized Gains		Gross  Unrealized Losses			Fair Value
	(Dollars in thousands)
At September 30, 2007:
Government sponsored entity (GSE) securities (1)	$	191,918	$	1,636	$	(84	)	$	193,470
Mortgage-backed securities		13,986		3		(120	)		13,869
Collateralized mortgage obligations		22,495		168		(33	)		22,630
Equity securities		2,660		-		(49	)		2,611
	$	231,059	$	1,807	$	(286	)	$	232,580
At December 31, 2006:
Government sponsored entity (GSE) securities (1)	$	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

(1)       At September 30, 2007 and December 31, 2006, the Company held $2.5 million and $15.3 million, respectively, of callable GSE securities.

During the nine months ended September 30, 2007, the Company purchased $75.3 million of available-for-sale securities which was more than offset by $78.9 million of maturities and paydowns and $65.2 million of sales.  The Company realized an aggregate net gain of $9,000 on the sales of the securities.  The proceeds from the sales and the maturities and paydowns were utilized to purchase additional available-for-sale securities and for general liquidity needs of the Company.

The Company evaluates all securities for determining if an other-than-temporary impairment (OTTI) exists pursuant to guidelines established in Financial Accounting Standards Board Staff Position (FSP) 115-1, The Meaning of Other-Than-Temporary Impairment and Its

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Application to Certain Investments on a quarterly basis, and more frequently when economic conditions warrant any additional evaluations.  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 within other comprehensive income in stockholders’ equity and not recognized in income until the security is ultimately sold.

At September 30, 2007, all securities available-for-sale with a loss position were issued by the federal government, its agencies or GSEs, including the Federal National Mortgage Association and Freddie Mac, and in management’s belief, the unrealized losses as of September 30, 2007 were attributable to changes in market interest rates and not the credit quality of the issuers.  Management does not believe any of these securities are other-than-temporarily impaired. As of September 30, 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.

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Loans.  Loans receivable, net of unearned fees, and the percentage of loans by category are presented in the following table at September 30, 2007 and December 31, 2006:

	September 30, 2007					December 31, 2006
	Amount		% of Total			Amount		% of Total			% Change
	(Dollars in thousands)
Commercial and construction loans:
Commercial real estate	$	346,361		42.2	%	$	339,110		42.2	%		2.1	%
Construction and land development		130,963		15.9			128,529		16.0			1.9
Commercial and industrial		62,304		7.6			35,743		4.5			74.3
Total commercial and construction loans		539,628		65.7			503,382		62.7			7.2
Retail loans:
Single-family residential		216,289		26.4			225,007		28.1			(3.9	)
Home equity lines of credit		61,805		7.5			70,527		8.8			(12.4	)
Other		3,110		0.4			3,467		0.4			(10.3	)
Total retail loans		281,204		34.3			299,001		37.3			(6.0	)
Total loans receivable, net of unearned fees	$	820,832		100.0	%	$	802,383		100.0	%		2.3	%

The Company’s total loans increased $18.4 million, or 2.3%, to $820.8 million at September 30, 2007 from $802.4 million at December 31, 2006.  The commercial and construction loan portfolio increased $36.2 million, or 7.2%, primarily as a result of fundings and purchases of commercial and industrial loans totaling $93.3 million which were partially offset by repayments of $63.5 million during 2007.  The increase in commercial and construction loans is a direct result of our 2007 initiatives to build relationships with businesses within our markets, including $14.0 million of short term loans to local municipalities.  The amount of loan repayments and sales for 2007 has decreased from the higher level of repayments experienced during 2006 which included $109.5 million during the fourth quarter of 2006.  At September 30, 2007, the Company had $40.7 million of commercial and construction loans approved but not yet closed.

Partially offsetting the commercial and construction loan increase is a decrease of $17.8 million, or 6.0%, in the retail loan portfolio.  This decrease is primarily the result of an $8.7 million, or 12.4%, decrease in home equity lines of credit and an $8.7 million, or 3.9%, decrease in single-family residential loans.  Due to the slowdown in the housing market and the increase in market interest rates, many borrowers have elected to reduce their outstanding balances either by increasing their principal payments or by paying off their loan balances.

Management continues to explore ways to reduce its risk relating to housing and speculative real estate loans and has decided to shift the Company’s loan origination focus from large commercial real estate loans 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 risk within the portfolio.

Allowance for Losses on Loans.  The Company maintains the allowance for losses on loans at a level that 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 balance

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sheet date and is based on its review of available and relevant information.  The Company believes that at September 30, 2007 the allowance for losses on loans was adequate.

The following is a summary of changes in the allowance for losses on loans for the periods presented:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2007			2006			2007			2006
	(Dollars in thousands)
Balance at beginning of period	$	10,624		$	11,690		$	11,184		$	12,939
Provision for losses on loans		884			413			1,197			971
Charge-offs		(246	)		(1,473	)		(1,281	)		(3,457	)
Recoveries		15			62			177			239
Balance at end of period	$	11,277		$	10,692		$	11,277		$	10,692

	September 30,  2007			December 31, 2006			September 30,  2006
Allowance for losses on loans to total loans		1.37	%		1.39	%		1.28	%
Allowance for losses on loans to non-performing loans		34.50			40.64			49.09

The increase in the provision for the losses on loans for the 2007 periods is the result of an increase in non-performing loans combined with a $425,000 increase in impairment reserves related to commercial real estate loans.  The Company’s realized net charge-offs through the allowance for losses on loans for the third quarter of 2007 included $200,000 as a result of a charge-off related to a non-performing commercial and industrial loan.

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 as of 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.  The Company had no loans past due 90 days or more still on interest accrual at either date presented.

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	September 30, 2007			December 31, 2006
	(Dollars in thousands)
Non-accrual loans:
Commercial and construction loans:
Commercial real estate	$	19,038		$	15,863
Construction and land development		9,395			7,192
Commercial and industrial		301			455
Total commercial and construction loans		28,734			23,510
Retail loans:
Single-family residential		2,906			3,177
Home equity lines of credit		966			772
Other		78			58
Total retail loans		3,950			4,007
Total non-accrual loans		32,684			27,517
Other real estate owned, net		1,140			321
Total non-performing assets		33,824			27,838
90 days past due and still accruing interest		–			–
Total non-performing assets plus 90 days past due loans still accruing interest	$	33,824		$	27,838
Asset Quality Ratios:
Non-performing assets to total assets		2.89	%		2.22	%
Non-performing loans to total loans		3.98	%		3.43	%

During the third quarter of 2007, the Company transferred two commercial real estate loans totaling $4.4 million into non-accrual status.  Partially offsetting this increase was the transfer of one non-accrual construction and land development loan totaling $500,000 during the third quarter to other real estate owned.

At September 30, 2007 and December 31, 2006, 23.7% and 29.6%, respectively, of the Company’s non-accrual loans consisted of two impaired commercial real estate loans secured by properties and assets utilized in the hotel industry.  Both of these loans have been on non-accrual status since 2004.  Included in non-performing assets are loans considered impaired.  Impaired loans totaled $24.2 million and $18.2 million with required impairment reserves of $4.4 million and $4.5 million, respectively, at September 30, 2007 and December 31, 2006.

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.

Potential Problem Assets.  The Company’s potential problem assets, defined as loans classified substandard, doubtful, or loss pursuant to the Company’s internal loan grading system that do not meet the definition of a non-performing loan, totaled $14.6 million at September 30, 2007, $13.6 million at June 30, 2007 and $5.6 million at December 31, 2006.  During the third quarter of 2007, the Company downgraded a $2.1 million commercial real estate loan secured by an apartment complex to substandard.  Although payments on this loan are current, the loan’s

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classification was revised due to decreased occupancy and reduced cash flow generated by the property.

Deposits and Borrowed Money.  The following table identifies the dollar amount and percentage of total deposits in each deposit category offered by the Company at the dates indicated:

	September 30, 2007					December 31, 2006
	Amount		% of Total			Amount		% of Total			% Change
	(Dollars in thousands)
Checking accounts:
Non-interest bearing	$	67,626		7.9	%	$	58,547		6.5	%		15.5	%
Interest-bearing		95,360		11.1			100,912		11.1			(5.5	)
Money market accounts		163,392		19.0			182,153		20.1			(10.3	)
Savings accounts		134,205		15.6			148,707		16.4			(9.8	)
Core deposits		460,583		53.6			490,319		54.1			(6.1	)
Certificates of deposit:
Less than $100,000		264,191		30.7			281,810		31.0			(6.3	)
$100,000 or greater		135,082		15.7			134,966		14.9			0.1
Time deposits		399,273		46.4			416,776		45.9			(4.2	)
Total deposits	$	859,856		100.0	%	$	907,095		100.0	%		(5.2	)

The Company’s total deposits decreased $47.2 million, or 5.2%, to $859.9 million at September 30, 2007 from $907.1 million at December 31, 2006.  Growth in the Company’s non-interest bearing deposits totaled $9.1 million, or 15.5%, and was driven by growth in non-interest bearing business accounts.  Core deposits decreased by $29.7 million, or 6.1%, primarily due to the decrease in money market and savings accounts.  Money market accounts decreased $18.8 million primarily due to the cyclical nature of municipal money market accounts which decreased by $28.8 million and were partially offset by increases in retail money market accounts of $9.7 million.  Total certificates of deposit accounts decreased $17.5 million due to the Company’s managed run-off of single-service high-rate certificates.

The Company offers specific deposit agreements to local municipalities and other public entities.  These public balances are included in the Company’s total deposits and were $42.8 million and $54.5 million, respectively, at September 30, 2007 and December 31, 2006.

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 considered and classified as other short-term borrowings which provide a lower-cost funding alternative for the Company as compared to FHLB advances.  At September 30, 2007, the Company had $13.6 million in Repo Sweeps which are not included in the above deposit totals, of which $10.1 million were Repo Sweeps with municipalities and other public entities.

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

	September 30, 2007						December 31, 2006
	Weighted Average Contractual Rate			Amount			Weighted Average Contractual Rate			Amount
	(Dollars in thousands)
Other short-term borrowings
Repo Sweeps		3.80	%	$	13,558			4.75	%	$	23,117
Secured advances from FHLB – Indianapolis:
Maturing in 2007 – fixed-rate		3.67			52,000			3.65			87,000
Maturing in 2008 – fixed-rate		3.89			72,000			3.89			72,000
Maturing in 2009 – fixed-rate		4.09			15,000			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			2,763			5.54			2,763
Maturing in 2019 – fixed-rate (1)		6.31			7,196			6.31			7,372
					150,128						185,325
Less:  deferred premium on early extinguishment of debt					(2,478	)					(6,167	)
Net FHLB – Indianapolis advances					147,650						179,158
Total borrowed money				$	161,208					$	202,275
Weighted-average contractual interest rate		3.99	%					4.02	%

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

The Company’s short-term borrowings include its Repo Sweeps which 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.

The decrease in the Company’s borrowed money from December 31, 2006 was due to repayment during the second quarter of 2007 of $35.0 million of matured FHLB debt.  The Company utilized proceeds from the sales of its available-for-sale security portfolio as well as its excess liquidity to repay the maturing debt.

At September 30, 2007, the Bank 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 September 30, 2007, the Bank had no borrowings outstanding under these lines.  During the third quarter of 2007, these lines were used for liquidity purposes.  The maximum amount borrowed pursuant to these lines was $5.3 million and the weighted-average rate paid during the quarter was 5.5%.

At September 30, 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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Capital Resources.  The Company’s stockholders’ equity at September 30, 2007 was $129.6 million compared to $131.8 million at December 31, 2006.  The decrease during the first nine months of 2007 was primarily due to:

•     repurchases of shares of the Company’s common stock during 2007 totaling $7.8

       million; and

•     cash dividends declared totaling $3.8 million.

The following increases in stockholders’ equity during the first nine months of 2007 partially offset the aforementioned decreases:

•     net income of $5.5 million;

•     proceeds from stock option exercises totaling $1.7 million; and

•     increased accumulated other comprehensive income of $1.2 million.

During the third quarter of 2007, the Company repurchased 93,777 shares of its common stock at an average price of $14.33 per share pursuant to the share repurchase plan approved in February 2007.  At September 30, 2007, the Company had 257,190 shares remaining to be repurchased under this plan.  Since its initial public offering, the Company has repurchased an aggregate of 13,715,582 shares of its common stock at an average price of $12.18 per share.  For additional information, see “Part II. Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds” of this Quarterly Report on Form 10-Q.

At September 30, 2007, the Bank’s regulatory capital was in excess of regulatory requirements set by the Office of Thrift Supervision (OTS).  The current requirements and the Bank's actual levels at September 30, 2007 and at December 31, 2006 are provided below:

	Actual					For Capital Adequacy Purposes				To Be Well-Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio		Amount		Ratio
	(Dollars in thousands)
As of September 30, 2007:
Risk-based	$	131,974		13.82	%	$	76,396	>8.00	%	$	95,495	>10.00	%
Tangible		120,733		10.36			17,487	>1.50			23,316	>2.00
Core		120,733		10.36			46,632	>4.00			58,290	>5.00
As of December 31, 2006:
Risk-based	$	132,762		14.10	%	$	75,332	>8.00	%	$	94,165	>10.00	%
Tangible		121,599		9.71			18,780	>1.50			25,040	>2.00
Core		121,599		9.71			50,080	>4.00			62,600	>5.00

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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 historically 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 September 30, 2007, the Company had cash and cash equivalents of $28.6 million, which was a decrease from $67.2 million at December 31, 2006.  The decrease was mainly the result of:

• purchases of available-for-sale securities totaling $75.3 million;

• repayments of borrowed money totaling $35.2 million;

• decreases in the balances of deposit accounts totaling $47.4 million;

• repurchases of the Company’s common stock totaling $7.8 million; and

• net loan fundings totaling $33.3 million.

The above cash outflows were partially offset by: 

• proceeds from sales, maturities and paydowns of securities aggregating $144.1 million;

• proceeds from sales of loans and loan participations totaling $12.0 million; and

• net cash provided by operating activities totaling $13.7 million.

The Company uses its sources of funds primarily to meet its ongoing commitments; fund loan commitments, maturing certificates of deposit and savings withdrawals; and maintain its 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 arrangement.  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 for prior distributions) of the prior two calendar years.  On a parent company-only basis, for the nine months ended September 30, 2007, the parent company received $7.3 million in dividends from the Bank.  At

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September 30, 2007, the parent company had $3.2 million in cash and cash equivalents and $164,000 in securities available-for-sale.

Contractual Obligations. The following table presents significant fixed and determinable contractual obligations to third parties by payment date at September 30, 2007:

	Payments Due By Period
	One Year Or Less		Over One Through Three Years		Over Three Through Five Years		Over Five Years		Total
	(Dollars in thousands)
FHLB advances (1)	$	92,268	$	47,593	$	679	$	9,588	$	150,128
Repo Sweeps (2)		13,558		-		-		-		13,558
Operating leases		617		572		152		-		1,341
Dividends payable on common stock		1,306		-		-		-		1,306
	$	107,749	$	48,165	$	831	$	9,588	$	166,333

(1)  Does not include interest expense at the weighted-average contractual rate of 4.00% for the periods presented.

(2)  Does not include interest expense at the weighted-average contractual rate of 3.80% for the periods presented.

See the “Deposits and Borrowed Money” section for further discussion surrounding the Company’s FHLB advances and Repo Sweeps.  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.

The Company also has commitments to fund certificates of deposit which are scheduled to mature within one year or less.  These deposits totaled $344.5 million at September 30, 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 Company.

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.

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The following table details the amounts and expected maturities of significant commitments at September 30, 2007:

	One Year or Less		Over One Through Three Years		Over Three Through Five Years		Over Five Years		Total
	(Dollars in thousands)
Commitments to extend credit:
Commercial	$	42,194	$	3,382	$	1,953	$	663	$	48,192
Retail		12,393		–		–		–		12,393
Commitments to fund unused construction loans		20,685		28,618		7,953		7,478		64,734
Commitments to fund unused lines of credit:
Commercial		22,133		12,157		–		247		34,537
Retail		12,675		–		260		57,097		70,032
Letters of credit		4,870		427		577		–		5,874
Credit enhancements		3,439		37,475		–		5,300		46,214
	$	118,389	$	82,059	$	10,743	$	70,785	$	281,976

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 2011.  Credit enhancements expire at various times through 2014.

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.

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.

Item 3.   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

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primarily the result of an imbalance 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 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). The 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 the 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 valuation, 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 June 30, 2007 and December 31, 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 (1%) increments up to 300 basis points and down 200 basis points in accordance with OTS regulations.  Information as of September 30, 2007 was not available prior to the filing of this Form 10-Q.  The Company does not believe the results as of September 30, 2007 would be materially different than the results presented as of June 30, 2007.  As illustrated in the table, the Bank’s NPV in the base case (0 basis point change) increased $0.3 million from $178.3 million at December 31, 2006 to $178.6 million at June 30, 2007.  The primary causes for this increase were changes in the composition of the Bank’s assets and liabilities along with changes in interest rates.

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		Net Portfolio Value
		At June 30, 2007								At December 31, 2006
		$ Amount		$ Change			% Change			$ Amount		$ Change			% Change
		(Dollars in thousands)
Assumed change in interest rates (basis points)
	+300	$	147,632	$	(30,940	)		(17.3	)%	$	145,688	$	(32,565	)		(18.3	)%
	+200		159,949		(18,622	)		(10.4	)		157,889		(20,364	)		(11.4	)
	+100		170,600		(7,972	)		(4.5	)		168,493		(9,760	)		(5.5	)
	0		178,572		–			–			178,253		–			–
	-100		185,574		(7,002	)		3.4			185,481		7,228			4.1
	-200		190,639		(12,067	)		6.8			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.  

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 Repricing In First Year
	September 30, 2007			December 31, 2006
Deposit category:
Business checking accounts		20	%		20	%
Interest checking accounts		20			20
High-yield checking accounts		95			95
Savings accounts		30			30
Money market accounts		50			50

The following table presents the Bank’s projected changes in net interest income over a twelve month period for the various interest rate change (rate shocks) scenarios at September 30, 2007 and December 31, 2006.

		Percentage Change in Net Interest Income Over a Twelve Month Time Period
		September 30, 2007			December 31, 2006
Assumed change in interest rates  (basis points):
	+200		0.1	%		(0.8	)%
	+100		0.3			(0.2	)
	-100		(0.8	)		(0.6	)
	-200		(2.3	)		(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 200 basis points, net interest income would be expected to increase 0.1% in year one; and if interest rates were to move down 200 basis points, net interest income would be expected to decrease 2.3% in year one.  The primary causes for the changes in net interest

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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 September 30, 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.

Item 4.   Controls and Procedures

No change in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) or 15(d)-15(f) under the Securities Exchange Act of 1934, as amended (the 1934 Act)) occurred during the third quarter of 2007 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

Management evaluated, with the participation of the 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 1934 Act) as of the end of the period covered by this report.  Based upon that 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 1934 Act 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.  Disclosure controls and procedures are the Company’s controls and other procedures that are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the 1934 Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and regulations.  Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the 1934 Act is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

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Part II.   OTHER INFORMATION

Item 1.   Legal Proceedings

Legal Proceedings

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 1A.   Risk Factors

Information regarding risk factors appears in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Forward Looking Statements,” of Part 1 - Item 2 of this Quarterly Report on Form 10-Q and in Part 1 - Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.  There have been no material changes from the risk factors disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

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

(a)           Not applicable.

(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:

Period	Total Number of Shares Purchased		Average Price Paid Per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs (1)
July 1-31, 2007		34,942	$	14.61		34,942		316,025
August 1-31, 2007		52,680		14.18		52,680		263,345
September 1-30, 2007		6,155		14.03		6,155		257,190
Total		93,777		14.33		93,777		257,190

(1) The Company publicly announced on February 27, 2007 a repurchase program for 600,000 shares.  Prior to July 1, 2007, 249,033 shares had been repurchased under that program.  From October 1, 2007 through October 29, 2007, the Company has not repurchased any shares under this program.

Item 3.   Defaults Upon Senior Securities

  (a)   None.

  (b)   Not applicable.

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Item 4.   Submission of Matters to a Vote of Security Holders

  (a)   Not applicable.

  (b)   Not applicable.

  (c)   Not applicable.

  (d)   Not applicable.

Item 5.   Other Information

  (a)   None.

  (b)   None.

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Item 6.   Exhibits

(a)	List of exhibits (filed herewith unless otherwise noted).
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 (6)
10.6	Employment Agreement entered into between Citizens Financial Bank and Charles V. Cole (4)
10.7	Employment Agreement entered into between Citizens Financial Bank and Thomas L. Darovic (4)
10.8	Employment Agreement entered into between CFS Bancorp, Inc. and Charles V. Cole (4)
10.9	Employment Agreement entered into between CFS Bancorp, Inc. and Thomas L. Darovic (4)
10.10	Employment Agreement entered into between Citizens Financial Services, FSB and Zoran Koricanac (7)
10.11	Employment Agreement entered into between CFS Bancorp, Inc. and Zoran Koricanac (7)
10.12	Amended and Restated Supplemental ESOP Benefit Plan of CFS Bancorp, Inc. and Citizens Financial Services, FSB (7)
10.13	CFS Bancorp, Inc. Directors’ Deferred Compensation Plan (7)
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
32.0	Section 1350 Certifications

_____________

(1) Incorporated by reference from the Company’s Definitive Proxy Statement from the Annual Meeting of Stockholders filed with the SEC 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, 2005.

(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.

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SIGNATURES

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

CFS BANCORP, INC.

Date:  October 30, 2007	By:	/s/ Thomas F. Prisby
		Thomas F. Prisby, Chairman and
		Chief Executive Officer
Date:  October 30, 2007	By:	/s/ Charles V. Cole
		Charles V. Cole, Executive Vice President and
		Chief Financial Officer

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