CFS Bancorp (CITZ) 10-Q 2012 Q1 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended March 31, 2012.

OR

o 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: 000-24611

CFS Bancorp, Inc.

(Exact name of registrant as specified in its charter)

Indiana	35-2042093
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
707 Ridge Road, Munster, Indiana	46321
(Address of principal executive offices)	(Zip code)
(219) 836-2960
(Registrant’s telephone number, including area code)

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

YES þ          NO o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

YES þ          NO o

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

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

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

The Registrant had 10,874,978 shares of Common Stock issued and outstanding as of April 30, 2012.

CFS BANCORP, INC.

Form 10-Q

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 Comprehensive Income	5
	Condensed Consolidated Statements of Changes in Shareholders’ Equity	6
	Condensed Consolidated Statements of Cash Flows	7
	Notes to Condensed Consolidated Financial Statements	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	39
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	69
Item 4.	Controls and Procedures	71
	PART II - OTHER INFORMATION
Item 1.	Legal Proceedings	72
Item 1A.	Risk Factors	72
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	72
Item 3.	Defaults Upon Senior Securities	72
Item 4.	Mine Safety Disclosures	72
Item 5.	Other Information	72
Item 6.	Exhibits	73
Signature Page		74
Certifications of Principal Executive Officer and Principal Financial Officer
	Exhibit 31.1
	Exhibit 31.2
	Exhibit 32.0

CFS BANCORP, INC.

Condensed Consolidated Statements of Condition

	March 31, 2012			December 31, 2011
	(Unaudited)
ASSETS	(Dollars in thousands)
Cash and amounts due from depository institutions	$	23,429		$	32,982
Interest-bearing deposits	89,718			59,090
Cash and cash equivalents	113,147			92,072
Investment securities available-for-sale, at fair value	239,247			234,381
Investment securities held-to-maturity, at cost	15,911			16,371
Federal Home Loan Bank stock, at cost	6,188			6,188
Loans receivable	706,938			711,226
Allowance for loan losses	(11,768		)	(12,424		)
Net loans	695,170			698,802
Loans held for sale	1,198			1,124
Bank-owned life insurance	36,273			36,275
Accrued interest receivable	2,841			3,011
Other real estate owned	19,429			19,091
Office properties and equipment	16,466			17,539
Net deferred tax assets	16,621			16,273
Other assets	8,051			7,823
Total assets	$	1,170,542		$	1,148,950
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits	$	1,004,441		$	977,424
Borrowed funds	51,935			54,200
Advance payments by borrowers for taxes and insurance	4,550			4,275
Other liabilities	6,281			9,803
Total liabilities	1,067,207			1,045,702
Commitments and contingencies
Shareholders’ equity:
Preferred stock, $.01 par value; 15,000,000 shares authorized	—			—
Common stock, $.01 par value; 85,000,000 shares authorized; 23,423,306 shares issued; 10,877,788 and 10,874,668 shares outstanding	234			234
Additional paid-in capital	186,995			187,030
Retained earnings	73,066			72,683
Treasury stock, at cost; 12,545,518 and 12,548,638 shares	(154,735		)	(154,773		)
Accumulated other comprehensive loss, net of tax	(2,225		)	(1,926		)
Total shareholders’ equity	103,335			103,248
Total liabilities and shareholders’ equity	$	1,170,542		$	1,148,950

See accompanying notes to the unaudited condensed consolidated financial statements.

3

CFS BANCORP, INC.

Condensed Consolidated Statements of Income

	Three Months Ended March 31,
	2012			2011
	(Unaudited)
	(Dollars in thousands, except share and per share data)
Interest income:
Loans receivable	$	8,386		$	8,811
Investment securities	2,130			2,045
Other interest-earning assets	93			157
Total interest income	10,609			11,013
Interest expense:
Deposits	1,390			1,894
Borrowed funds	296			262
Total interest expense	1,686			2,156
Net interest income	8,923			8,857
Provision for loan losses	1,050			903
Net interest income after provision for loan losses	7,873			7,954
Non-interest income:
Service charges and other fees	1,018			1,076
Card-based fees	533			475
Commission income	57			45
Net gain (loss) on sale of:
Investment securities	418			519
Loans held for sale	167			32
Other real estate owned	(47		)	(5		)
Income from bank-owned life insurance	540			206
Other income	138			103
Total non-interest income	2,824			2,451
Non-interest expense:
Compensation and employee benefits	4,713			5,239
Net occupancy expense	708			765
FDIC insurance premiums and regulatory assessments	488			653
Furniture and equipment expense	457			463
Data processing	438			442
Marketing	404			187
Professional fees	253			388
Other real estate owned related expense, net	618			592
Loan collection expense	118			120
Severance and early retirement expense	876			—
Other general and administrative expenses	1,134			1,118
Total non-interest expense	10,207			9,967
Income before income tax benefit	490			438
Income tax benefit	—			(34		)
Net income	$	490		$	472
Per share data:
Basic earnings per share	.05			.04
Diluted earnings per share	.05			.04
Cash dividends declared per share	.01			.01
Weighted-average common and common share equivalents outstanding:
Basic	10,697,892			10,650,743
Diluted	10,746,398			10,706,677

See accompanying notes to the unaudited condensed consolidated financial statements.

4

CFS BANCORP, INC.

Condensed Consolidated Statements of Comprehensive Income

	Three Months Ended March 31,
	2012			2011
	(Unaudited)
	(Dollars in thousands)
Net income	$	490		$	472
Other comprehensive income (loss):
Unrealized holding gains (losses) arising during the period:
Unrealized net gains (losses)	(318		)	1,250
Related income tax (expense) benefit	286			(449		)
Net unrealized gains (losses)	(32		)	801
Less:  reclassification adjustment for net gains realized during the period:
Realized net gains	418			519
Related income tax expense	(151		)	(189		)
Net realized gains	267			330
Other comprehensive income (loss)	(299		)	471
Comprehensive income	$	191		$	943

See accompanying notes to the unaudited condensed consolidated financial statements.

5

CFS BANCORP, INC.

Condensed Consolidated Statements of Changes in Shareholders’ Equity

	Common Stock		Additional Paid-In Capital			Retained Earnings			Treasury Stock			Accumulated Other Comprehensive Loss			Total
	(Unaudited) (Dollars in thousands)
Balance at January 1, 2011	$	234	$	187,164		$	83,592		$	(155,112	)	$	(2,950	)	$	112,928
Net income	—		—			472			—			—			472
Other comprehensive income	—		—			—			—			471			471
Forfeiture of restricted stock awards	—		437			2			(437		)	—			2
Grants of restricted stock awards	—		(672		)	—			672			—			—
Dividends declared on common stock ($.01 per share)	—		—			(109		)	—			—			(109		)
Balance at March 31, 2011	$	234	$	186,929		$	83,957		$	(154,877	)	$	(2,479	)	$	113,764
Balance at January 1, 2012	$	234	$	187,030		$	72,683		$	(154,773	)	$	(1,926	)	$	103,248
Net income	—		—			490			—			—			490
Other comprehensive loss	—		—			—			—			(299		)	(299		)
Forfeiture of restricted stock awards	—		552			2			(552		)	—			2
Grants of restricted stock awards	—		(587		)	—			590			—			3
Dividends declared on common stock ($.01 per share)	—		—			(109		)	—			—			(109		)
Balance at March 31, 2012	$	234	$	186,995		$	73,066		$	(154,735	)	$	(2,225	)	$	103,335

See accompanying notes to the unaudited condensed consolidated financial statements.

6

CFS BANCORP, INC.

Condensed Consolidated Statements of Cash Flows

	Three Months Ended March 31,
	2012			2011
	(Unaudited) (Dollars in thousands)
OPERATING ACTIVITIES:
Net income	$	490		$	472
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses	1,050			903
Depreciation and amortization	396			380
Net discount accretion on investment securities available-for-sale	(303		)	(83		)
Net premium amortization on investment securities held-to-maturity	33			40
Net (gain) loss on sale of:
Loans held for sale	(167		)	(32		)
Investment securities	(418		)	(519		)
Other real estate owned	47			5
Properties and equipment	(8		)	—
Writedowns on other real estate owned	485			21
Writedowns on transfer of future branch sites to other real estate owned	—			396
Writedown on construction in process	—			106
Deferred income tax expense	2			515
Proceeds from sale of loans held for sale	9,445			1,231
Origination of loans held for sale	(9,285		)	(899		)
Increase in cash surrender value of bank-owned life insurance	(540		)	(206		)
Decrease (increase) in other assets	84			(4,477		)
Decrease in other liabilities	(3,532		)	(125		)
Net cash flows used in operating activities	(2,221		)	(2,272		)
INVESTING ACTIVITIES:
Proceeds from sale of:
Investment securities, available-for-sale	13,458			6,405
Other real estate owned	674			402
Properties and equipment	26			—
Proceeds from maturities and pay downs of:
Investment securities, available-for-sale	11,053			21,086
Investment securities, held-to-maturity	427			397
Purchases of:
Investment securities, available-for-sale	(29,394		)	(68,070		)
Properties and equipment	(300		)	(43		)
Redemption of Federal Home Loan Bank stock	—			10,000
Net change in loans receivable	1,909			6,537
Proceeds from bank-owned life insurance	542			—
Net cash flows used in investing activities	(1,605		)	(23,286		)
FINANCING ACTIVITIES:
Net increase (decrease) in:
Deposit accounts	27,000			34,606
Advance payments by borrowers for taxes and insurance	275			167
Short-term borrowed funds	(2,211		)	2,158
Repayments of Federal Home Loan Bank advances	(54		)	(15,050		)
Dividends paid on common stock	(109		)	(109		)
Net cash flows provided by financing activities	24,901			21,772
Increase (decrease) in cash and cash equivalents	21,075			(3,786		)
Cash and cash equivalents at beginning of period	92,072			61,754
Cash and cash equivalents at end of period	$	113,147		$	57,968

CFS BANCORP, INC.

Condensed Consolidated Statements of Cash Flows (continued)

	Three Months Ended March 31,
	2012		2011
	(Unaudited) (Dollars in thousands)
Supplemental disclosures:
Loans and land transferred to other real estate owned	$	1,544	$	1,672
Cash paid for interest on deposits	1,395		1,890
Cash paid for interest on borrowed funds	297		289
Cash paid for income taxes	—		—

See accompanying notes to the unaudited condensed consolidated financial statements.

7

CFS BANCORP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information or footnotes necessary for a complete presentation of financial condition, results of operations, or cash flows in accordance with U.S. generally accepted accounting principles.  In our opinion, all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation have been included.  The results of operations for the three months ended March 31, 2012 are not necessarily indicative of the results expected for the year ending December 31, 2012.  The March 31, 2012 condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes for the year ended December 31, 2011 included in the Company’s Annual Report on Form 10-K.

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

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

Certain items in the condensed consolidated financial statements of prior periods have been reclassified to conform to the current period’s presentation.

2. Earnings Per Share

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

8

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

	Three Months Ended March 31,
	2012		2011
	(Dollars in thousands, except per share data)
Net income	$	490	$	472
Weighted-average common shares:
Outstanding	10,697,892		10,650,743
Equivalents (1)	48,506		55,934
Total	10,746,398		10,706,677
Earnings per share:
Basic	$	.05	$	.04
Diluted	.05		.04
Number of anti-dilutive stock options excluded from the diluted earnings per share calculation	451,995		647,995
Weighted-average exercise price of anti-dilutive option shares	$	14.06	$	13.46

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

3. Investment Securities

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

	Par Value		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(Dollars in thousands)
At March 31, 2012:
Available-for-sale investment securities:
U.S. Treasury securities	$	17,500	$	17,467	$	399	$	(1	)	$	17,865
Government sponsored entity (GSE) securities	44,800		44,947		1,280		—			46,227
Corporate bonds	5,420		5,046		89		—			5,135
Collateralized mortgage obligations	94,712		84,521		2,267		(707		)	86,081
Commercial mortgage-backed securities	61,654		62,464		1,600		—			64,064
Asset backed securities	4,811		4,407		8		(9		)	4,406
Pooled trust preferred securities	26,730		24,247		—		(8,780		)	15,467
GSE preferred stock	200		—		2		—			2
Total available-for-sale investment securities	$	255,827	$	243,099	$	5,645	$	(9,497	)	$	239,247
Held-to-maturity investment securities:
Asset backed securities	$	7,775	$	8,001	$	259	$	—		$	8,260
Municipal securities	7,910		7,910		50		—			7,960
Total held-to-maturity investment securities	$	15,685	$	15,911	$	309	$	—		$	16,220

9

	Par Value		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(Dollars in thousands)
At December 31, 2011:
Available-for-sale investment securities:
U.S. Treasury securities	$	15,000	$	14,967	$	447	$	—		$	15,414
Government sponsored entity (GSE) securities	46,800		46,967		1,415		—			48,382
Corporate bonds	5,420		5,022		9		(4		)	5,027
Collateralized mortgage obligations	79,006		71,073		1,178		(1,367		)	70,884
Commercial mortgage-backed securities	72,885		74,664		1,520		(66		)	76,118
Pooled trust preferred securities	27,398		24,804		—		(6,249		)	18,555
GSE preferred stock	200		—		1		—			1
Total available-for-sale investment securities	$	246,709	$	237,497	$	4,570	$	(7,686	)	$	234,381
Held-to-maturity investment securities:
Asset backed securities	$	8,201	$	8,461	$	285	$	—		$	8,746
Municipal securities	7,910		7,910		47		—			7,957
Total held-to-maturity investment securities	$	16,111	$	16,371	$	332	$	—		$	16,703

The Company’s investments in residential collateralized mortgage obligations consisted of $4.9 million and $5.2 million, respectively, of GSE issued investment securities and $81.2 million and $65.7 million, respectively, of non-agency (private issued) residential investment securities at March 31, 2012 and December 31, 2011, respectively.

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

	March 31, 2012
	Less than 12 Months					12 Months or More					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
	(Dollars in thousands)
U.S. Treasury securities	$	5,498	$	(1	)	$	—	$	—		$	5,498	$	(1	)
Collateralized mortgage obligations	25,910		(619		)	5,235		(88		)	31,145		(707		)
Commercial mortgage-backed securities	75		—			—		—			75		—
Asset backed securities	—		—			33		(9		)	33		(9		)
Pooled trust preferred securities	—		—			15,467		(8,780		)	15,467		(8,780		)
	$	31,483	$	(620	)	$	20,735	$	(8,877	)	$	52,218	$	(9,497	)

10

	December 31, 2011
	Less than 12 Months					12 Months or More					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
	(Dollars in thousands)
Corporate bonds	$	3,969	$	(4	)	$	—	$	—		$	3,969	$	(4	)
Collateralized mortgage obligations	34,504		(983		)	3,428		(384		)	37,932		(1,367		)
Commercial mortgage-backed securities	89		(1		)	4,154		(65		)	4,243		(66		)
Pooled trust preferred securities	—		—			18,555		(6,249		)	18,555		(6,249		)
	$	38,562	$	(988	)	$	26,137	$	(6,698	)	$	64,699	$	(7,686	)

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

In management’s belief, the decline in value of the Company’s investment in collateralized mortgage obligations is minimal and primarily attributable to changes in market interest rates and macroeconomic conditions affecting liquidity and not necessarily the expected cash flows of the individual investment securities.  The fair value of these investment securities is expected to recover as macroeconomic conditions improve, interest rates rise, and the investment securities approach their maturity date.

At March 31, 2012, the Company’s pooled trust preferred investment securities consisted of “Super Senior” securities backed by senior securities issued mainly by bank and thrift holding companies.  Due to the structure of the securities, as deferrals and defaults on the underlying collateral increase, cash flows are increasingly diverted from mezzanine and subordinate tranches to pay down principal on the “Super Senior” tranches.  In management’s belief, the decline in value is primarily attributable to macroeconomic conditions affecting liquidity of these securities and not necessarily the expected cash flows of the individual securities. The fair value of these securities is expected to recover as the securities approach their maturity date.

Unrealized losses on collateralized mortgage obligations and pooled trust preferred investment securities have not been recognized in income because management does not have the intent to sell these securities and has the ability to hold these securities for a period of time sufficient to allow for any anticipated recovery in fair value, which may be at maturity.  We may, from time to time, dispose of an impaired security in response to asset/liability management decisions, future market movements, business plan changes, or if the net proceeds could be reinvested at a rate of return that is expected to recover the loss within a reasonable period of time.  The Company concluded that the unrealized losses that existed at March 31, 2012 did not constitute other-than-temporary impairments.

The amortized cost and fair value of investment securities at March 31, 2012, by contractual maturity, are shown in the following tables.  Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.  Investment securities not due at a single maturity date are shown separately.

11

	Available-for-Sale
	Amortized Cost		Fair Value
	(Dollars in thousands)
U.S. Treasury securities:
Due in one year or less	$	5,499	$	5,498
Due after one year through five years	11,968		12,367
GSE securities:
Due in one year or less	799		814
Due after one year through five years	44,148		45,413
Corporate bonds — Due after one year through five years	5,046		5,135
Collateralized mortgage obligations — Due after five years	84,521		86,081
Commercial mortgage-backed securities — Due after five years	62,464		64,064
Asset backed securities — Due after five years	4,407		4,406
Pooled trust preferred securities — Due after ten years	24,247		15,467
GSE preferred stock	—		2
	$	243,099	$	239,247

	Held-to-Maturity
	Amortized Cost		Fair Value
	(Dollars in thousands)
Asset backed securities — Due after five years	$	8,001	$	8,260
Municipal securities:
Due in one year or less	2,970		2,987
Due after one year through five years	4,940		4,973
	$	15,911	$	16,220

The Company realized gross gains on the sale of available-for-sale investment securities totaling $418,000 and $519,000, respectively, for the three months ended March 31, 2012 and 2011.

The carrying value of investment securities pledged as collateral to secure public deposits and for other purposes at March 31, 2012 and December 31, 2011 was $53.8 million and $54.4 million, respectively.  Other than the U.S. Government, its agencies, and GSEs, there were no other holdings of investment securities of any one issuer in an amount greater than 10% of shareholders’ equity.

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4.   Loans Receivable

Loans receivable are summarized as follows:

	March 31, 2012			December 31, 2011
	(Dollars in thousands)
Commercial loans:
Commercial and industrial	$	86,807		$	85,160
Commercial real estate:
Owner occupied	95,110			93,833
Non-owner occupied	185,070			188,293
Multifamily	75,864			71,876
Commercial construction and land development	22,691			22,045
Commercial participations	7,089			12,053
Total commercial loans	472,631			473,260
Retail loans:
One-to-four family residential	179,980			181,698
Home equity lines of credit	50,496			52,873
Retail construction	1,282			1,022
Other	2,942			2,771
Total retail loans	234,700			238,364
Total loans receivable	707,331			711,624
Net deferred loan fees	(393		)	(398		)
Total loans receivable, net of deferred loan fees	$	706,938		$	711,226

5.   Allowance for Loan Losses

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

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

13

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

The second component of the Company’s allowance for loan losses contains allocations for probable incurred losses within various pools of loans with similar characteristics pursuant to ASC 450-10, Contingencies.  This component is based in part on certain loss factors applied to various stratified loan pools excluding loans evaluated individually for impairment.  In determining the appropriate loss factors for all portfolio segments, management considers historical charge-offs and recoveries; levels of and trends in delinquencies, impaired loans, and other classified loans; concentrations of credit within the commercial loan portfolios; volume and type of lending; and current and anticipated economic conditions.

Loan losses for all portfolio segments are charged-off against the allowance when the loan balance or a portion of the loan balance is no longer covered by the repayment capacity of the borrower based on an evaluation of available and projected cash resources and collateral value, while recoveries of amounts previously charged-off are credited to the allowance.  The Company assesses the appropriateness of the allowance for loan losses on a quarterly basis and adjusts the allowance for loan losses by recording a provision for loan losses in an amount sufficient to maintain the allowance at a level deemed appropriate by management.  The evaluation of the appropriateness of the allowance for loan losses is inherently subjective as it requires estimates that are susceptible to significant revision as additional information becomes available or as future events occur.  To the extent that actual outcomes differ from management’s estimates, an additional provision for loan losses could be required which could adversely affect earnings or the Company’s financial position in future periods.

The risk characteristics of each loan portfolio segment are as follows:

Commercial and Industrial Loans (C&I)

C&I loans are primarily based on the identified historic and/or the projected cash flows of the borrower and secondarily on the underlying collateral provided by the borrower.  The cash flows of borrowers, however, do fluctuate based on changes in the company’s internal and external environment including management, human and capital resources, economic conditions, competition, regulation, and product innovation/obsolescence.  The collateral securing these loans may also fluctuate in value and generally has advance rates between 50-80% of the collateral value.  Most C&I loans are secured by business assets being financed such as equipment, accounts receivable, and/or inventory and generally incorporate a secured or unsecured personal guarantee.  Occasionally, some short-term loans may be made on an unsecured basis.  In the case of loans secured by accounts receivable and/or inventory, the collateral securing the advances is generally monitored through a Borrowing Base Certificate submitted by the borrower which may identify deterioration in collateral value.  The ability of the borrower to collect amounts due from its customers may be affected by its customers’ economic and financial condition.  The availability of funds for the repayment of these loans may be substantially dependent on each of the factors described above.

14

Commercial Real Estate – Owner Occupied, Non-Owner Occupied, and Multifamily

These types of commercial real estate loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate.  Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally dependent upon the cash flows from the successful operation of the property securing the loan or the cash flows from the owner occupied business conducted on the property securing the loan.  A borrower’s business and/or the property securing the loan may be adversely affected by business conditions generally, and fluctuations in the real estate markets or in the general economy, which if adverse, can negatively affect the borrowers’ ability to repay the loan.  The value and cash flow of the property can be influenced by changes in market rental rates, changes in interest rates or investors’ required rates of return, the condition of the property, zoning, or environmental issues.  The properties securing the commercial real estate portfolio are diverse in terms of type and are generally located in the Chicagoland/Northwest Indiana market.  Owner occupied loans are generally a borrower purchased building where the borrower occupies at least 51% of the space with the primary source of repayment dependent on sources other than the underlying collateral.  Non-owner occupied and single tenant properties may have higher risk than owner occupied loans since the primary source of repayment is dependent upon the ability to lease out the collateral as well as the financial stability of the businesses occupying the collateral.  Multifamily loans can also be impacted by vacancy/collection losses and tenant turnover due to generally shorter term leases or even month-to-month leases.  Management monitors and evaluates commercial real estate loan portfolio concentrations based upon cash flow, collateral, geography, and risk grade criteria.  As a general rule, management avoids financing single purpose projects unless other underwriting factors mitigate the credit risk to an acceptable level.  The Company’s loan policy generally requires lower loan-to-value ratios against these types of properties.

Commercial Construction and Land Development Loans

Construction loans are underwritten utilizing feasibility studies, independent appraisals, sensitivity analysis of absorption and lease rates, presale or prelease/Letters of Intent analysis, and financial analysis of the developers and property owners.  Construction loans are generally based on the estimated cost to construct and cash flows associated with the completed project or stabilized value.  These estimates are subjective in nature and if erroneous, may preclude the borrower from being able to repay the loan.  Construction loans often involve the disbursement of substantial funds with repayment dependent on the success of the completed project.  These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions, the ability to sell the property, and the availability of long-term financing.

Commercial Participation Loans

Participation loans generally have larger principal balances, portions of which are sold to multiple participant banks in order to spread credit risk.  The collateral securing these loans is often real estate and is often located outside of the Company’s geographic footprint.  Loans outside of the Company’s geographical footprint pose additional risk due to the lack of knowledge of general economic conditions where the project is located along with various project specific risks regarding buyer demand and project specific risks regarding project competition risks.  The participant banks are required to underwrite these credits utilizing their own internal analysis techniques

and their own credit standards.  However, the participant banks are reliant upon the information about the borrowers and the collateral provided by the lead bank.  These loans carry higher levels of risk due to the participant banks being dependent on the lead bank for monitoring and managing the credit relationship, including the workout and/or foreclosure process should the borrower default.

15

Retail Loans

The Company’s retail loans include one-to-four family residential mortgage loans, home equity loans and lines of credit, retail construction, and other consumer loans.  Management has established a maximum loan-to-value ratio (LTV) of 80% for one-to-four family residential mortgages and home equity loans and lines of credit that are secured by a first or second mortgage on owner and non-owner occupied residences.  Loan applications exceeding 80% LTV require private mortgage insurance (PMI) from a mortgage insurance company deemed acceptable by management.  Residential construction loans are underwritten to the same standards and generally require an end loan financing commitment either from the Company or another financial institution acceptable to the Company.  Other consumer loans are generally small dollar auto and personal loans based on the credit score and income of the applicant.  These loans are very homogenous in nature and are rated in pools based on similar characteristics.

16

The following table presents the activity in the allowance for loan losses for the three months ended March 31, 2012 and 2011.

				Commercial Real Estate
	Commercial and Industrial			Owner Occupied			Non-Owner Occupied			Multifamily			Construction and Land Development			Commercial Participations			One-to-four Family Residential			HELOC			Retail Construction		Other			Total
	(Dollars in thousands)
Three months ended March 31, 2012
Balance, at beginning of quarter	$	1,236		$	2,129		$	3,935		$	370		$	1,198		$	1,467		$	1,521		$	442		$	3	$	123		$	12,424
Provision for loan losses	(67		)	67			818			608			115			(516		)	44			(17		)	1		(3		)	1,050
Loans charged-off:
Current year charge-offs	(119		)	—			(361		)	(378		)	—			—			(114		)	(52		)	—		(17		)	(1,041		)
Previously established specific reserves	—			—			(718		)	—			—			—			—			—			—		—			(718		)
Total loans charged-off	(119		)	—			(1,079		)	(378		)	—			—			(114		)	(52		)	—		(17		)	(1,759		)
Recoveries	13			—			23			—			—			—			8			1			—		8			53
Balance, at end of quarter	$	1,063		$	2,196		$	3,697		$	600		$	1,313		$	951		$	1,459		$	374		$	4	$	111		$	11,768
Three months ended March 31, 2011
Balance, at beginning of quarter	$	1,279		$	1,090		$	6,906		$	350		$	188		$	4,559		$	1,356		$	1,309		$	7	$	135		$	17,179
Provision for loan losses	(13		)	(78		)	(197		)	315			(30		)	863			(11		)	65			2		(13		)	903
Loans charged-off:
Current year charge-offs	—			—			—			(204		)	(4		)	(703		)	(23		)	(52		)	—		(28		)	(1,014		)
Previously established specific reserves	—			—			—			—			—			—			—			—			—		—			—
Total loans charged-off	—			—			—			(204		)	(4		)	(703		)	(23		)	(52		)	—		(28		)	(1,014		)
Recoveries	2			—			8			—			—			—			1			5			—		11			27
Balance, at end of quarter	$	1,268		$	1,012		$	6,717		$	461		$	154		$	4,719		$	1,323		$	1,327		$	9	$	105		$	17,095

17

The following tables provide other information regarding the allowance for loan and lease losses and balances by portfolio segment and impairment method at the dates indicated.

	At March 31, 2012
			Commercial Real Estate
	Commercial and Industrial		Owner Occupied		Non-Owner Occupied		Multifamily		Construction and Land Development		Commercial Participations		One-to-four Family Residential		HELOC		Retail Construction		Other		Total
	(Dollars in thousands)
Ending allowance balance:
Individually evaluated for impairment	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Collectively evaluated for impairment	1,063		2,196		3,697		600		1,313		951		1,459		374		4		111		11,768
Total evaluated for impairment	$	1,063	$	2,196	$	3,697	$	600	$	1,313	$	951	$	1,459	$	374	$	4	$	111	$	11,768
Loans receivable:
Individually evaluated for impairment	$	1,694	$	11,546	$	24,562	$	2,021	$	2,781	$	2,082	$	—	$	—	$	—	$	—	$	44,686
Collectively evaluated for impairment	85,113		83,564		160,508		73,843		19,910		5,007		179,980		50,496		1,282		2,942		662,645
Total loans receivable	$	86,807	$	95,110	$	185,070	$	75,864	$	22,691	$	7,089	$	179,980	$	50,496	$	1,282	$	2,942	$	707,331

	At December 31, 2011
			Commercial Real Estate
	Commercial and Industrial		Owner Occupied		Non-Owner Occupied		Multifamily		Construction and Land Development		Commercial Participations		One-to-four Family Residential		HELOC		Retail Construction		Other		Total
	(Dollars in thousands)
Ending allowance balance:
Individually evaluated for impairment	$	—	$	—	$	718	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	718
Collectively evaluated for impairment	1,236		2,129		3,217		370		1,198		1,467		1,521		442		3		123		11,706
Total evaluated for impairment	$	1,236	$	2,129	$	3,935	$	370	$	1,198	$	1,467	$	1,521	$	442	$	3	$	123	$	12,424
Loans receivable:
Individually evaluated for impairment	$	2,479	$	11,203	$	25,518	$	673	$	2,781	$	2,355	$	—	$	—	$	—	$	—	$	45,009
Collectively evaluated for impairment	82,681		82,630		162,775		71,203		19,264		9,698		181,698		52,873		1,022		2,771		666,615
Total loans receivable	$	85,160	$	93,833	$	188,293	$	71,876	$	22,045	$	12,053	$	181,698	$	52,873	$	1,022	$	2,771	$	711,624

18

The Company, as a matter of good risk management practices, utilizes objective loan grading matrices to assign risk ratings to all commercial loans.  The risk rating criteria is clearly supported by core credit attributes that emphasize debt service coverage, operating trends, collateral, and guarantor liquidity, and further removes subjective criteria and bias from the analysis.  Retail loans are rated pass until they become 90 days or more delinquent, put on non-accrual status, and generally rated substandard.  The Company uses the following definitions for risk ratings:

• Pass.  Loans that meet the conservative underwriting guidelines that include core credit attributes noted above as measured by the loan grading matrices at levels that are in excess of the minimum amounts required to adequately service the loans.

• Pass Watch.  Loans which are performing per their contractual terms and are not necessarily demonstrating signs of credit or operational weakness, including but not limited to delinquency.  Loans in this category are monitored by management for timely payments.  Current financial information may be pending or, based upon the most recent analysis of the loan, possess credit attributes that are sufficient to adequately service the loan, but are less than the parameters required for a pass risk rating.  This rating is considered transitional because management does not have current financial information to determine the appropriate risk grade or the quality of the loan appears to be changing.  Loans may be graded as pass watch when a single event may have occurred that could be indicative of an emerging issue or indicate trending that would warrant a change in the risk rating.

• Special Mention.  Loans that have a potential weakness that will be closely monitored by management.  A credit graded special mention does not expose the Company to elevated risk that would warrant an adverse classification.

• Substandard.  Loans that are inadequately protected by the current net worth and paying capacity of the borrower, guarantor, or the collateral pledged.  Loans classified as substandard have a well-defined weakness or weaknesses, characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

• Doubtful.  Loans that have the same weaknesses as those classified as substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

19

The Company’s loans receivable portfolio is summarized by risk rating category as follows:

	Risk Rating at March 31, 2012
	Pass		Pass Watch		Special Mention		Substandard		Doubtful		Total
	(Dollars in thousands)
Commercial loans:
Commercial and industrial	$	72,926	$	11,702	$	1,635	$	544	$	—	$	86,807
Commercial real estate:
Owner occupied	71,384		10,631		1,532		11,563		—		95,110
Non-owner occupied	146,037		9,356		6,901		22,776		—		185,070
Multifamily	70,539		2,872		600		1,853		—		75,864
Commercial construction and land development	17,070		793		1,450		3,378		—		22,691
Commercial participations	4,400		—		—		2,689		—		7,089
Total commercial loans	382,356		35,354		12,118		42,803		—		472,631
Retail loans:
One-to-four family residential	174,875		—		—		5,105		—		179,980
Home equity lines of credit	50,082		—		—		414		—		50,496
Retail construction	1,113		—		—		169		—		1,282
Other	2,942		—		—		—		—		2,942
Total retail loans	229,012		—		—		5,688		—		234,700
Total loans	$	611,368	$	35,354	$	12,118	$	48,491	$	—	$	707,331

	Pass		Pass Watch		Special Mention		Substandard		Doubtful		Total
	(Dollars in thousands)
Current	$	605,105	$	32,006	$	10,168	$	9,274	$	—	$	656,553
Delinquent:
30-59 days	5,142		2,651		1,646		281		—		9,720
60-89 days	1,121		697		223		1,284		—		3,325
90 days or more	—		—		81		37,652		—		37,733
Total loans	$	611,368	$	35,354	$	12,118	$	48,491	$	—	$	707,331

20

	Risk Rating at December 31, 2011
	Pass		Pass Watch		Special Mention		Substandard		Doubtful		Total
	(Dollars in thousands)
Commercial loans:
Commercial and industrial	$	76,554	$	6,534	$	1,476	$	596	$	—	$	85,160
Commercial real estate:
Owner occupied	69,029		12,036		1,540		11,228		—		93,833
Non-owner occupied	147,678		9,219		7,347		24,049		—		188,293
Multifamily	65,920		3,119		2,331		506		—		71,876
Commercial construction and land development	16,412		805		1,450		3,378		—		22,045
Commercial participations	9,698		—		—		2,355		—		12,053
Total commercial loans	385,291		31,713		14,144		42,112		—		473,260
Retail loans:
One-to-four family residential	176,763		—		—		4,935		—		181,698
Home equity lines of credit	52,332		—		—		541		—		52,873
Retail construction	853		—		—		169		—		1,022
Other	2,771		—		—		—		—		2,771
Total retail loans	232,719		—		—		5,645		—		238,364
Total loans	$	618,010	$	31,713	$	14,144	$	47,757	$	—	$	711,624

	Pass		Pass Watch		Special Mention		Substandard		Doubtful		Total
	(Dollars in thousands)
Current	$	610,129	$	29,528	$	11,670	$	9,310	$	—	$	660,637
Delinquent:
30-59 days	6,082		1,285		93		1,445		—		8,905
60-89 days	1,799		900		2,381		4,372		—		9,452
90 days or more	—		—		—		32,630		—		32,630
Total loans	$	618,010	$	31,713	$	14,144	$	47,757	$	—	$	711,624

For all loan categories, past due status is based on the contractual terms of the loan.  Interest income is generally not accrued on loans which are delinquent 90 days or more, or for loans which management believes, after giving consideration to a number of factors, including economic and business conditions and collection efforts, collection of interest is doubtful.  In all cases, loans are placed on non-accrual status or charged-off at an earlier date if collection of principal or interest is considered doubtful.  All interest accrued but not received for loans placed on non-accrual is reversed against interest income.  Interest subsequently received on non-accrual loans is accounted for using the cost-recovery basis for commercial loans and the cash-basis for retail loans until qualifying for return to accrual status.

21

Commercial loans are generally placed on non-accrual once they become 90 days past due.  Management reviews all current financial information of the borrower and guarantor(s) and action plans to bring the loan current before determining if the loan should be placed on non-accrual.  Management requires appropriate justification to maintain a commercial loan on accrual status once 90 days past due.  Occasionally commercial loans are placed on non-accrual status before the loan becomes significantly past due if current information indicates that future repayment of principal and interest may be doubtful.

Commercial loans are returned to accrual status only when the loan has been paid as agreed for a minimum of six months.  A detailed analysis of the borrower and guarantor’s ability to service the loan is completed and must meet the Company’s underwriting standards and conform to Company policy before the loan can be returned to accrual status.

Retail loans are returned to accrual status primarily based on the payment status of the loan.  A retail loan is automatically placed on non-accrual status immediately upon becoming 90 days past due.  The loan remains on non-accrual status, with interest income recognized on a cash basis when a payment is made, until the loan is paid current.  Once current, the loan is automatically returned to accrual status.  If management identifies other information to indicate that future repayment of the loan balance may still be questionable, the loan may be manually moved to non-accrual status until management determines otherwise.

The Company’s loan portfolio delinquency status is summarized as follows:

	Delinquency at March 31, 2012
	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Loans Receivable		Loans > 90 Days And Accruing
	(Dollars in thousands)
Commercial loans:
Commercial and industrial	$	125	$	48	$	82	$	255	$	86,552	$	86,807	$	—
Commercial real estate:
Owner occupied	2,290		—		10,700		12,990		82,120		95,110		—
Non-owner occupied	2,111		2,390		15,251		19,752		165,318		185,070		81
Multifamily	1,591		—		1,440		3,031		72,833		75,864		—
Commercial construction and land development	407		—		3,378		3,785		18,906		22,691		—
Commercial participations	—		—		2,689		2,689		4,400		7,089		—
Total commercial loans	6,524		2,438		33,540		42,502		430,129		472,631		81
Retail loans:
One-to-four family residential	2,791		617		3,674		7,082		172,898		179,980		—
Home equity lines of credit	405		270		350		1,025		49,471		50,496		—
Retail construction	—		—		169		169		1,113		1,282		—
Other	—		—		—		—		2,942		2,942		—
Total retail loans	3,196		887		4,193		8,276		226,424		234,700		—
Total loans receivable	$	9,720	$	3,325	$	37,733	$	50,778	$	656,553	$	707,331	$	81

22

	Delinquency at December 31, 2011
	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Loans Receivable		Loans > 90 Days And Accruing
	(Dollars in thousands)
Commercial loans:
Commercial and industrial	$	615	$	24	$	88	$	727	$	84,433	$	85,160	$	—
Commercial real estate:
Owner occupied	551		297		10,362		11,210		82,623		93,833		—
Non-owner occupied	1,622		5,197		12,153		18,972		169,321		188,293		5
Multifamily	1,856		1,732		91		3,679		68,197		71,876		—
Commercial construction and land development	—		502		3,378		3,880		18,165		22,045		—
Commercial participations	—		—		2,355		2,355		9,698		12,053		—
Total commercial loans	4,644		7,752		28,427		40,823		432,437		473,260		5
Retail loans:
One-to-four family residential	3,890		1,501		3,743		9,134		172,564		181,698		—
Home equity lines of credit	371		199		291		861		52,012		52,873		—
Retail construction	—		—		169		169		853		1,022		—
Other	—		—		—		—		2,771		2,771		—
Total retail loans	4,261		1,700		4,203		10,164		228,200		238,364		—
Total loans receivable	$	8,905	$	9,452	$	32,630	$	50,987	$	660,637	$	711,624	$	5

Non-accrual loans are summarized as follows:

	March 31, 2012		December 31, 2011
	(Dollars in thousands)
Commercial loans:
Commercial and industrial	$	544	$	596
Commercial real estate:
Owner occupied	11,258		11,228
Non-owner occupied	21,278		22,294
Multifamily	1,440		91
Commercial construction and land development	3,378		3,378
Commercial participations	2,689		2,355
Total commercial loans	40,587		39,942
Retail loans:
One-to-four family residential	5,105		4,935
Home equity lines of credit	414		541
Retail construction	169		169
Total retail loans	5,688		5,645
Total non-accrual loans	$	46,275	$	45,587

23

The Company’s impaired loans are summarized as follows with the majority of the interest income recognized on a cash basis at the time the payment is received. The below tables include impaired loans that are individually reviewed for impairment as well as impaired loans that are below management’s scope for individual reviews due to immateriality.

	At March 31, 2012								Three Months Ended March 31, 2012
	Recorded Investment		Unpaid Principal Balance		Partial Charge-offs to Date		Related Allowance		Average Recorded Investment		Interest Income Recognized
	(Dollars in thousands)
Loans without a specific valuation allowance:
Commercial loans:
Commercial and industrial	$	1,694	$	2,126	$	420	$	—	$	2,106	$	31
Commercial real estate:
Owner occupied	11,546		15,221		2,977		—		11,469		11
Non-owner occupied	24,562		31,233		5,724		—		25,643		82
Multifamily	2,021		2,402		378		—		2,395		13
Commercial construction and land development	2,781		2,781		—		—		2,781		—
Commercial participations	2,082		5,777		3,553		—		1,972		—
Retail loans:
One-to-four family residential	6,887		7,108		221		—		6,889		46
Home equity lines of credit	503		593		89		—		503		3
Retail construction	169		169		—		—		169		—
Total	$	52,245	$	67,410	$	13,362	$	—	$	53,927	$	186
Total impaired loans:
Commercial	$	44,686	$	59,540	$	13,052	$	—	$	46,366	$	137
Retail	7,559		7,870		310		—		7,561		49
Total	$	52,245	$	67,410	$	13,362	$	—	$	53,927	$	186

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	At December 31, 2011								Three Months Ended March 31, 2011
	Recorded Investment		Unpaid Principal Balance		Partial Charge-offs to Date		Related Allowance		Average Recorded Investment		Interest Income Recognized
	(Dollars in thousands)
Loans without a specific valuation allowance:
Commercial loans:
Commercial and industrial	$	2,479	$	2,700	$	216	$	—	$	3,697	$	—
Commercial real estate:
Owner occupied	11,203		14,557		2,694		—		9,641		—
Non-owner occupied	20,532		34,130		10,553		—		7,393		41
Multifamily	673		673		—		—		264		3
Commercial construction and land development	2,781		2,781		—		—		11,498		—
Commercial participations	2,355		1,796		1,189		—		7,881		—
Retail loans:
One-to-four family residential	7,202		7,504		302		—		6,887		48
Home equity lines of credit	540		630		89		—		610		2
Retail construction	169		169		—		—		169		—
Other	—		—		—		—		4		—
Total	$	47,934	$	64,940	$	15,043	$	—	$	48,044	$	94
Loans with a specific valuation allowance:
Owner occupied	$	—	$	—	$	—	$	—	$	2,778	$	—
Non-owner occupied	4,986		4,986		—		718		17,243		—
Commercial participations	—		—		—		—		5,443		—
Total	$	4,986	$	4,986	$	—	$	718	$	25,464	$	—
Total impaired loans:
Commercial	$	45,009	$	61,623	$	14,652	$	718	$	65,838	$	44
Retail	7,911		8,303		391		—		7,670		50
Total	$	52,920	$	69,926	$	15,043	$	718	$	73,508	$	94

The Company may grant a concession or modification for economic or legal reasons related to a borrower’s financial condition that it would not otherwise consider resulting in a modified loan which is then identified as a troubled debt restructuring (TDR).  The Company may modify loans through rate reductions, short-term extensions of maturity, interest only payments, or payment modifications to better match the timing of cash flows due under the modified terms with the cash flows from the borrowers’ operations.  Loan modifications are intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral.  TDRs are considered impaired loans for purposes of calculating the Company’s allowance for loan losses.

The Company identifies loans for potential restructure primarily through direct communication with the borrower and evaluation of the borrower’s financial statements, revenue projections, tax returns, and credit reports.  Even if the borrower is not presently in default, management will consider the likelihood that cash flow shortages, adverse economic conditions, and negative trends may result in a payment default in the near future.

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For one-to-four family residential and home equity lines of credit, a restructure often occurs with past due loans and may be offered as an alternative to foreclosure.  There are other situations where borrowers, who are not past due, experience a sudden job loss, become over-extended with credit obligations, or other problems, have indicated that they will be unable to make the required monthly payment and request payment relief.

When considering a loan restructure, management will determine if:  (i) the financial distress is short or long term; (ii) loan concessions are necessary; and (iii) the restructure is a viable solution.

When a loan is restructured, the new terms often require a reduced monthly debt service payment. For commercial loans, management completes an analysis of the operating entity’s ability to repay the debt.  If the operating entity is capable of servicing the new debt service requirements and the underlying collateral value is believed to be sufficient to repay the debt in the event of a future default, the new loan is generally placed on accrual status.  To date, there have been no commercial loans restructured and immediately placed on accrual status after the execution of the TDR.

For retail loans, an analysis of the individual’s ability to service the new required payments is performed.  If the borrower is capable of servicing the newly restructured debt and the underlying collateral value is believed to be sufficient to repay the debt in the event of a future default, the new loan is generally placed on accrual status.  The reason for the TDR is also considered, such as paying past due real estate taxes or payments caused by a temporary job loss, when determining whether a retail TDR loan could be returned to accrual status.  Retail TDRs remain on non-accrual status until sufficient payments have been made to bring the past due principal and interest current at which point the loan would be transferred to accrual status.

The following table summarizes the loans that have been restructured as TDRs during the three months ended March 31, 2012:

	Three Months Ended March 31, 2012
	Count	Balance prior to TDR		Balance after TDR
	(Dollars in thousands)
Commercial loans:
Commercial real estate:
Owner occupied	2	$	259	$	305
Non-owner occupied	1	66		83
Total commercial loans	3	325		388
Retail loans – one-to-four family residential	6	486		517
Total loans	9	$	811	$	905

Default occurs when a TDR is 90 days or more past due, transferred to non-accrual status, or transferred to other real estate owned within twelve months of restructuring.  The Company did not have any TDRs that defaulted during the three months ended March 31, 2012.

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The tables below summarize the Company’s TDRs by loan category and accrual status:

	March 31, 2012						December 31, 2011
	Accruing		Non-accruing		Total		Accruing		Non-accruing		Total
	(Dollars in thousands)
Commercial loans:
Commercial and industrial	$	1,392	$	250	$	1,642	$	2,167	$	259	$	2,426
Commercial real estate:
Owner occupied	671		2,253		2,924		369		2,272		2,641
Non-owner occupied	3,888		10,921		14,809		3,814		11,095		14,909
Multifamily	257		—		257		259		—		259
Commercial construction and land development	—		—		—		—		—		—
Commercial participations	—		2,083		2,083		—		1,748		1,748
Total commercial	6,208		15,507		21,715		6,609		15,374		21,983
Retail loans – one-to-four family residential	1,871		2,297		4,168		2,266		1,600		3,866
Total troubled debt restructurings	$	8,079	$	17,804	$	25,883	$	8,875	$	16,974	$	25,849

At March 31, 2012, TDRs totaled $25.9 million, of which $5.9 million were performing in accordance with their modified terms and accruing.  The Company’s TDRs which are performing in accordance with their agreements and on non-accrual status totaled $11.4 million at March 31, 2012.

Management monitors the TDRs based on the type of modification or concession granted to the borrower.  These types of modifications may include rate reductions, payment/term extensions, forgiveness of principal, forbearance, and other applicable actions.  Of the various noted concessions, management predominantly utilizes rate reductions and lower monthly payments, either from a longer amortization period or interest only repayment schedule, because these concessions provide needed payment relief without risking the loss of principal.  Management will also agree to a forbearance agreement when it is deemed appropriate to avoid foreclosure.

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The following tables set forth the Company’s TDRs by portfolio segment to quantify the type of modification or concession provided: 

	March 31, 2012
			Commercial Real Estate
	Commercial and Industrial		Owner Occupied		Non-Owner Occupied		Multifamily		Commercial Participations		One-to-four Family Residential		Total
	(Dollars in thousands)
Rate reduction	$	—	$	—	$	—	$	—	$	—	$	1,042	$	1,042
Payment extension	1,642		2,283		2,225		—		—		784		6,934
Rate reduction and payment extension	—		305		623		257		—		1,300		2,485
Rate reduction and interest only	—		—		3,041		—		—		1,042		4,083
Payment extension and interest only	—		289		—		—		—		—		289
Forbearance	—		—		2,956		—		2,083		—		5,039
Rate reduction, payment extension, interest only, and forbearance	—		46		—		—		—		—		46
A/B note structure	—		—		5,965		—		—		—		5,965
Total troubled debt restructurings	$	1,642	$	2,923	$	14,810	$	257	$	2,083	$	4,168	$	25,883

	December 31, 2011
			Commercial Real Estate
	Commercial and Industrial		Owner Occupied		Non-Owner Occupied		Multifamily		Commercial Participations		One-to-four Family Residential		Total
	(Dollars in thousands)
Rate reduction	$	—	$	—	$	—	$	—	$	—	$	805	$	805
Payment extension	2,426		2,297		2,210		—		—		948		7,881
Rate reduction and payment extension	—		—		542		259		—		1,858		2,659
Rate reduction and interest only	—		—		9,054		—		—		255		9,309
Payment extension and interest only	—		297		—		—		—		—		297
Forbearance	—		—		3,103		—		1,748		—		4,851
Rate reduction, payment extension, interest only, and forbearance	—		47		—		—		—		—		47
Total troubled debt restructurings	$	2,426	$	2,641	$	14,909	$	259	$	1,748	$	3,866	$	25,849

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At March 31, 2012, TDRs were relatively stable at $25.9 million from $25.8 million at December 31, 2011. The activity related to the Company’s TDRs is presented in the following table:

	Three Months Ended March 31,
	2012			2011
	(Dollars in thousands)
Beginning balance	$	25,849		$	39,581
Restructured loans identified as TDRs	872			1,307
Protective advances and miscellaneous	489			57
Repayments and payoffs	(1,327		)	(1,237		)
Ending balance	$	25,883		$	39,708

6.   Fair Value Measurements

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

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

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

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

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

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

			Fair Value Measurements at  March 31, 2012
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable  Inputs (Level 3)
	(Dollars in thousands)
Investment securities available-for-sale:
U.S. Treasury securities	$	17,865	$	—	$	17,865	$	—
GSE securities	46,227		—		46,227		—
Corporate bonds	5,135		—		5,135		—
Collateralized mortgage obligations	86,081		—		86,081		—
Commercial mortgage-backed securities	64,064		—		64,064		—
Asset backed securities	4,406		—		4,406		—
Pooled trust preferred securities	15,467		—		—		15,467
GSE preferred stock	2		2		—		—

			Fair Value Measurements at  December 31, 2011
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable  Inputs (Level 3)
	(Dollars in thousands)
Investment securities available-for-sale:
U.S. Treasury securities	$	15,414	$	—	$	15,414	$	—
GSE securities	48,382		—		48,382		—
Corporate bonds	5,027		—		5,027		—
Collateralized mortgage obligations	70,884		—		70,884		—
Commercial mortgage-backed securities	76,118		—		76,118		—
Pooled trust preferred securities	18,555		—		—		18,555
GSE preferred stock	1		1		—		—

Level 1 investment securities are valued using quoted prices in active markets for identical assets.  The Company uses Level 1 prices for its GSE preferred stock.

Level 2 investment securities are valued by a third party pricing service commonly used in the banking industry utilizing observable inputs.  The pricing provider utilizes evaluated pricing models that vary based on asset class.  These models incorporate available market information including quoted prices of investment securities with similar characteristics and, because many fixed-income investment securities do not trade on a daily basis, apply available information through processes such as benchmark yield curves, benchmarking of like investment

30

securities, sector groupings, and matrix pricing.  In addition, model processes, such as an option adjusted spread model, are used to develop prepayment estimates and interest rate scenarios for investment securities with prepayment features.

Management uses a recognized third-party pricing service to obtain market values for the Company’s fixed income securities portfolio.  Documentation is maintained as to the methodology and summary of inputs used by the pricing service for the various types of securities, and management notes that the servicer maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs.  Management does not have access to all of the individual specific assumptions and inputs used for each security.  The significant observable inputs include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data including market research publications.

Management validates the market values against fair market curves and other available pricing sources. Bloomberg pricing is used to compare the reasonableness of the third-party pricing service prices for U.S. Treasury securities and government sponsored entity (GSE) bonds.  For all securities, the Company’s Investment Officer, who is in the market on a regular basis, monitors the market and is familiar with where similar securities are trading and where specific bonds in specific sectors should be priced.  All monthly output from the third-party provider is reviewed against expectations as to pricing based on fair market curves, ratings, coupon, structure, and recent trade reports or offerings.

Based on management’s review of the methodology and summary of inputs used, management has concluded these assets are properly classified as Level 2 assets.

Fair value determinations for Level 3 measurements of securities are the responsibility of the Corporate Investment Officer with review and approval by the Asset/Liability Management Committee. Level 3 models are utilized when quoted prices are not available for certain investment securities or in markets where trading activity has slowed or ceased.  When quoted prices are not available and are not provided by third party pricing services, management judgment is necessary to determine fair value.  As such, fair value is determined by using discounted cash flow analysis models, incorporating default rate assumptions, estimations of prepayment characteristics, and implied volatilities.

The Company determined that Level 3 pricing models should be utilized for valuing its pooled trust preferred investment securities.  The markets for these securities and for similar securities at March 31, 2012 were illiquid.  There have been a limited number of observable transactions in the secondary market, however, a new issue market does not exist.  Management has determined a valuation approach that maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs will be more representative of fair value than the market approach valuation technique.

For its Level 3 pricing model, the Company uses externally produced fair values provided by a third party and compares them to other external pricing sources. Other external sources provided similar prices, both higher and lower, than those used by the Company.  The external model uses observed prices from limited transactions on similar securities to estimate liquidation values.

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

	Pooled Trust Preferred Securities
	Three Months Ended March 31,
	2012			2011
	(Dollars in thousands)
Beginning balance	$	18,555		$	18,125
Total realized and unrealized gains and losses:
Included in accumulated other comprehensive income (loss)	(2,531		)	1,224
Principal repayments	(557		)	(87		)
Ending balance	$	15,467		$	19,262

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

			Fair Value Measurements at  March 31, 2012
	Fair  Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(Dollars in thousands)
Impaired loans (collateral-dependent)	$	10,601	$	—	$	—	$	10,601
Other real estate owned	2,932		—		—		2,932

			Fair Value Measurements at  December 31, 2011
	Fair  Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(Dollars in thousands)
Impaired loans (collateral-dependent)	$	17,180	$	—	$	—	$	17,180
Other real estate owned	2,462		—		—		2,462

Loans for which it is probable that the Bank will not collect all principal and interest due according to contractual terms are measured for impairment.  Allowable methods for determining the amount of impairment include estimating fair value using the fair value of the collateral for collateral-dependent loans.  If the impaired loan is identified as collateral-dependent, then the fair value method of measuring the amount of impairment is utilized. Impaired loans that are collateral-dependent are classified within Level 3 of the fair value hierarchy.

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When the Bank determines a loan is collateral-dependent, the Bank’s Asset Management Committee (AMC) obtains appraisals on the underlying collateral securing the loan. The Senior Credit Officer (SCO) reviews the appraisals for accuracy and consistency. Appraisers are selected from the list of approved appraisers maintained by the SCO with input from the Bank’s Loan Committee. For purchased participation loans, management is dependent upon the lead bank to order and provide appraisals, which occasionally are broker’s opinions.

In determining the estimated fair value of the real estate, senior liens such as unpaid and current real estate taxes and any perfected liens are subtracted from the appraised value.  In addition, the Company generally applies a 10% discount to the current appraisal to allow for reasonable selling expenses, including sales commissions and closing costs.  

Fair value measurements for impaired loans are performed pursuant to ASC 310-10, Receivables, and are measured on a non-recurring basis.  Certain impaired loans were partially charged-off or re-evaluated during the first quarter of 2012.  These impaired loans were carried at fair value as estimated using current and prior appraisals, discounting factors, the borrowers’ financial results, estimated cash flows generated from the property, and other factors.  The change in the fair value of impaired loans that were valued based upon Level 3 inputs was approximately $811,000 and $779,000 for the three months ended March 31, 2012 and 2011, respectively.  These losses are not recorded directly as an adjustment to current earnings or other comprehensive income (loss), but rather as a component in determining the overall adequacy of the allowance for loan losses.  These adjustments to the estimated fair value of impaired loans may result in increases or decreases to the provision for loan losses recorded in future earnings.

The estimated fair value of other real estate owned is based on current or prior appraisals, less estimated costs to sell of 10%. Other real estate owned is classified within Level 3 of the fair value hierarchy. Appraisals of other real estate owned are obtained when the real estate is acquired and subsequently as deemed necessary by the AMC. The SCO reviews the appraisals for accuracy and consistency. Appraisers are selected from the list of approved appraisers maintained by the SCO with input from the Bank’s Loan Committee. The reduction in fair value of other real estate owned was $485,000 and $496,000 for the three months ended March 31, 2012 and 2011, respectively.  The changes were recorded as adjustments to current earnings through other real estate owned related expenses.

The following table sets forth quantitative information about unobservable inputs used in recurring and nonrecurring Level 3 fair value measurements at March 31, 2012 (dollars in thousands):

	Fair Value		Valuation Technique	Unobservable Inputs	Range (Weighted Averages)
Pooled trust preferred securities	$	15,467	Consensus pricing	Weighting of pricing	Varies by security 42.4% - 83.4% (57.9%)
Impaired loans	10,601		Market comparable properties	Marketability discount	10%
Other real estate owned	2,932		Market comparable properties	Marketability discount	10%

The value of the pooled trust preferred securities is determined using multiple pricing models or similar techniques from third-party sources as well as significant unobservable inputs such as judgment or estimations by the Company in the weighting of the models. The unobservable inputs used in the fair value measurement of the Company’s investment in pooled trust preferred securities are offered quotes and comparability adjustments.

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Significant increases (decreases) in any of those inputs in isolation would result in a significantly lower (higher) fair value measurement. Generally, changes in either of those inputs will not affect the other input.

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

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

	March 31, 2012
	Carrying Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(Dollars in thousands)
Financial Assets:
Cash and cash equivalents	$	113,147	$	113,147	$	—	$	—
Investment securities, available-for-sale	239,247		2		223,778		15,467
Investment securities, held-to-maturity	15,911		—		16,220		—
Federal Home Loan Bank stock	6,188		6,188		—		—
Loans receivable, net of allowance for loan losses	695,170		—		—		699,999
Loans held for sale	1,198		—		1,198		—
Interest receivable	2,841		—		2,841		—
Total financial assets	$	1,073,702	$	119,337	$	244,037	$	715,466
Financial Liabilities:
Deposits	$	1,004,441	$	627,236	$	—	$	379,105
Borrowed funds	51,935		—		54,786		—
Advance payments by borrowers	4,550		—		4,550		—
Interest payable	85		—		85		—
Total financial liabilities	$	1,061,011	$	627,236	$	59,421	$	379,105

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	December 31, 2011
	Carrying Amount		Fair Value
	(Dollars in thousands)
Financial Assets:
Cash and cash equivalents	$	92,072	$	92,072
Investment securities, available-for-sale	234,381		234,381
Investment securities, held-to-maturity	16,371		16,703
Federal Home Loan Bank stock	6,188		6,188
Loans receivable, net of allowance for loan losses	698,802		702,987
Loans held for sale	1,124		1,124
Interest receivable	3,011		3,011
Total financial assets	$	1,051,949	$	1,056,466
Financial Liabilities:
Deposits	$	977,424	$	979,483
Borrowed funds	54,200		57,241
Advance payments by borrowers	4,275		4,275
Interest payable	90		90
Total financial liabilities	$	1,035,989	$	1,041,089

The carrying amount is the estimated fair value for cash and cash equivalents, accrued interest receivable and payable, and advance payments by borrowers.  Investment securities fair values are based on quotes received from a third-party pricing source and discounted cash flow analysis models.  The fair value of Federal Home Loan Bank stock is based on its redemption value.  The fair values for loans receivable are estimated using discounted cash flow analyses. Cash flows are adjusted for estimated prepayments where appropriate and are discounted using interest rates currently being offered by the Bank for loans with similar terms and collateral to borrowers of similar credit quality. The carrying amount of loans held for sale is the amount funded and approximates fair value due to the insignificant time between origination and date of sale.

The fair value of checking, savings, and money market accounts is the amount payable on demand at the reporting date.  The fair value of fixed-maturity certificates of deposit is estimated by discounting the future cash flows using the rates currently offered by the Bank for deposits of similar remaining maturities.  The fair value of borrowed funds is estimated based on rates currently available to the Company for debt with similar terms and remaining maturities.  The fair value of the Company’s off-balance sheet instruments, including lending commitments, letters of credit, and credit enhancements, approximates their book value and is not included in the above table.

7. Share-Based Compensation

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

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For additional details on the Company’s share-based compensation plans and related disclosures, see “Note 9.  Share-Based Compensation” in the consolidated financial statements as presented in the Company’s 2011 Annual Report on Form 10-K.

Omnibus Equity Incentive Plan

The Company’s 2008 Omnibus Equity Incentive Plan (Equity Incentive Plan) authorized the issuance of 270,000 shares of its common stock.  In addition, there were 64,500 shares that had not yet been issued or were forfeited, canceled, or unexercised at the end of the option term under the 2003 Stock Option Plan when it was frozen.  These shares and any other shares that may be forfeited, canceled, or expired are available for any type of stock-based awards in the future under the Equity Incentive Plan.  At March 31, 2012, 166,728 shares were available for future grants under the Equity Incentive Plan.

Restricted Stock

During the first quarter of 2012, the Compensation Committee and Chief Executive Officer, under authority delegated by the Compensation Committee, granted awards under the Equity Incentive Plan. A total of 48,186 shares of restricted stock were granted to officers and key employees of the Company. The grants included 40,439 of performance-based and 7,746 of service-based shares awards. The Company reissued treasury shares to satisfy the granting of restricted stock awards.

The weighted-average fair market value of the restricted stock awards granted in the first quarter of 2012 was $5.96 per share and totaled $287,000. These awards vest 33%, 33%, and 34% on May 1, 2014, 2015, and 2016, respectively. The expense for these awards is being recorded over their requisite service period from the grant date. The Company estimates that the impact of forfeitures based on its historical experience with previously granted restricted stock awards and will consider the impact of the forfeitures when determining the amount of expense to record for the restricted stock granted.

During the first quarter of 2012, 41,142 shares of performance-based restricted stock granted during 2011 were deemed unearned by the Compensation Committee of the Board of Directors and, accordingly, were forfeited. At the time of forfeiture, the Company reversed $47,000 of compensation expense related to these awards.

The following table presents the activity for restricted stock for the three months ended March 31, 2012.

	Number of Shares		Weighted-Average Grant-Date Fair Value
Unvested at December 31, 2011	175,639		$	4.97
Granted	48,186		5.96
Vested	—		—
Forfeited	(45,096	)	5.42
Unvested as of March 31, 2012	178,729		$	5.12

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The compensation expense related to restricted stock for the three months ended March 31, 2012 and 2011 totaled $21,000 and $66,000, respectively.  At March 31, 2012, the remaining unamortized cost of the restricted stock awards was reflected as a reduction in additional paid-in capital and totaled $916,000.  This cost is expected to be recognized over a weighted-average period of 3.1 years which is subject to the actual number of shares earned and vested.

Stock Options

The Company’s 2008 Equity Incentive Plan allows for the grant of both incentive and non-qualified stock options to directors, officers, and employees.  The stock option vesting periods and exercise and expiration dates are determined by the Compensation Committee at the time of the grant.  The exercise price of the stock options is equal to the fair market value of the common stock on the grant date.

On January 3, 2012, the Compensation Committee granted 20,000 non-qualified options to purchase shares of the Company’s common stock at an exercise price of $4.40 per share, which was the closing price of the Company’s common stock on that date, to its President and Chief Executive Officer. The options vest ratably over four years on each anniversary date of the award and have a ten-year term. The fair value of the options granted was $2.42 and was estimated using the Black-Scholes option value model with the following assumptions:

	2012
Dividend yield	.91	%
Expected volatility %	57.33
Risk-free interest rate	1.58
Original expected life	7.9 years

The following table presents the activity under the Company’s stock option plans for the three months ended March 31, 2012.

	2012
	Number of Options		Weighted-Average Exercise Price
Options outstanding and exercisable at December 31, 2011	515,995		$	14.01
Granted	20,000		4.40
Exercised	—		—
Forfeited	(23,000	)	14.00
Expired unexercised	(41,000	)	13.49
Options outstanding at March 31, 2012	471,995		$	13.65

For stock options outstanding at March 31, 2012, the range of exercise prices was $4.40 to $14.76 and the weighted-average remaining contractual term was 2.3 years.  At March 31, 2012, 451,995 of the Company’s outstanding stock options were out-of-the-money, had no intrinsic value, and fully vested.  The remaining 20,000 were in-the-money with an intrinsic value of $26,000, which represents the difference between the Company’s closing stock price on the last day of trading for the first quarter of 2012 and the exercise price multiplied by the

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number of in-the-money options, assuming all option holders had exercised their stock options on the last day of trading for the same period. Stock option expense for the three months ended March 31, 2012 was $3,000. There was no stock option expense for the same 2011 period. There were no stock options exercised during the three months ended March 31, 2012 and 2011.  The Company reissues treasury shares to satisfy option exercises.

8. Adoption of New Accounting Standards

In December 2011, the FASB issued Accounting Standards Update (ASU) No. 2011-12, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. ASU 2011-12 effectively deferred only those changes in ASU 2011-05, Comprehensive Income (Topic 22): Presentation of Comprehensive Income, that relate to the presentation of reclassification adjustments out of accumulated other comprehensive income. The amendments will be temporary to allow the FASB time to redeliberate the presentation requirements for reclassifications out of accumulated other comprehensive income for annual and interim financial statements for public, private, and non-profit entities. All other requirements in ASU 2011-05 are not affected by this ASU. Effective January 1, 2012, the Company adopted the other requirements of ASU 2011-05 with the components of comprehensive income presented in a separate statement.

In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820):Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.  ASU 2011-04 is intended to result in convergence between United States Generally Accepted Accounting Principles (U.S. GAAP) and International Financial Reporting Standards (IFRS) requirements for measurement of and disclosures about fair value.  The amendments are not expected to have a significant impact on companies applying U.S. GAAP.  Key provisions of the amendment include:  a prohibition on grouping financial instruments for purposes of determining fair value, except when an entity manages market and credit risks on the basis of the entity’s net exposure to the group; an extension of the prohibition against the use of a blockage factor to all fair value measurements (that prohibition currently applies only to financial instruments with quoted prices in active markets); and a requirement that for recurring Level 3 fair value measurements, entities disclose quantitative information about unobservable inputs, a description of the valuation process used, and qualitative details about the sensitivity of the measurements.  In addition, for items not carried at fair value but for which fair value is disclosed, entities will be required to disclose the level within the fair value hierarchy that applies to the fair value measurement disclosed.  The Company adopted this ASU effective January 1, 2012 with no impact on the Company’s fair value measurements, financial condition, results of operations, or cash flows.

In April 2011, the FASB issued ASU No. 2011-03, Transfers and Servicing (Topic 860):  Reconsideration of Effective Control for Repurchase Agreements.  ASU 2011-03 amends the sale accounting requirement concerning a transferor’s ability to repurchase transferred financial assets even in the event of default by the transferee, which typically is facilitated in a repurchase agreement by the presence of a collateral maintenance provision.  Specifically, the level of cash collateral received by a transferor will no longer be relevant in determining whether a repurchase agreement constitutes a sale.  As a result of this amendment, more repurchase agreements will be treated as secured financings rather than sales.  The Company adopted this ASU effective January 1, 2012 for new transfers and existing transactions that are modified.  Because essentially all repurchase agreements entered into by the Company have historically been deemed to constitute secured financing transactions, this amendment had no impact on the Company’s characterization of such transactions and therefore did not have any impact on the Company’s financial condition, results of operation, or cash flows.

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

Cautionary Statement Regarding Forward Looking Statements

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

We wish to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made.  These forward-looking statements include but are not limited to statements regarding our ability to successfully execute our strategy and Strategic Growth and Diversification Plan, the level and sufficiency of our current regulatory capital and equity ratios, our ability to continue to diversify the loan portfolio, our efforts at deepening client relationships, increasing our levels of core deposits, lowering our non-performing asset levels, managing and reducing our credit-related costs, increasing our revenue growth and levels of earning assets, the effects of general economic and competitive conditions nationally and within our core market area, the sufficiency of the levels of provision for the allowance for loan losses and amounts of charge-offs, loan and deposit growth, interest on loans, asset yields and cost of funds, net interest income, net interest margin, non-interest income, non-interest expense, interest rate environment, and other factors.   For further discussion of risks and uncertainties that could cause actual results and events to differ materially from such forward-looking statements see “Part I. Item 1A.  Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2011.  Such forward-looking statements are not guarantees of future performance.  We do not undertake, and specifically disclaim any obligation, to update any forward-looking statements to reflect occurrences or unanticipated events or circumstances after the date of such statements unless required to do so under the federal securities laws.

Critical Accounting Policies

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

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

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We currently view the determination of the allowance for loan losses, valuations and impairments of investment securities, and the accounting for income taxes to be critical accounting policies.

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

The first component of the allowance for loan losses contains allocations for probable incurred losses that management has identified relating to impaired loans pursuant to Accounting Standards Codification (ASC) 310-10, Receivables. We individually evaluate for impairment all loans classified substandard and over $750,000. Loans are generally considered impaired when they are 90 days past due or when, based on current information and events, it is probable that the borrower will not be able to fulfill its obligation according to the contractual terms of the loan agreement and the guarantors have failed to provide evidence that they are willing and able to fulfill the obligations under their personal guarantees. The analysis on each loan involves a high degree of judgment in estimating the amount of the loss associated with the loan. Both borrower and guarantor factors may be taken into consideration to assist in determining the level of any impairment. Any impairment loss for non-collateral dependent loans is generally measured based on the present value of expected cash flows discounted at the loan’s effective interest rate. For a collateral-dependent loan, any impairment loss is generally the difference between the carrying value of the loan and the current appraisal value of the collateral securing the loan.

A loan is considered collateral-dependent when the repayment of the loan will be provided solely by the liquidation of the underlying collateral or the cash flow from the operations of the property and there are no other available and reliable sources of repayment. When current appraisals are not available, management estimates the fair value of the collateral using an appraisal-like methodology, giving consideration to several factors including the price at which individual unit(s) could be sold in the current market, the period of time over which the unit(s) would be sold, the estimated cost to complete the unit(s), the risks associated with completing and selling the unit(s), the required return on the investment a potential acquirer may have, and current market interest rates. If management determines a loan is collateral-dependent, any identified collateral shortfall is immediately charged-off against the allowance for loan losses. As such, each collateral-dependent impaired loan would not require a specific ASC 310-10 allowance as it would have already been charged-off.

The second component of our allowance for loan losses contains allocations for probable incurred losses within various pools of loans with similar characteristics pursuant to ASC 450-10, Contingencies. This component is based in part on certain loss factors applied to various stratified loan pools excluding loans evaluated individually for impairment. In determining the appropriate loss factors for these loan pools, we consider historical charge-offs and recoveries; levels of and trends in delinquencies, impaired loans, and other classified loans; concentrations of credit within the commercial loan portfolios; volume and type of lending; and current and anticipated economic conditions. Our historical charge-offs are determined by evaluating the net charge-offs over the most recent eight quarters, including the current quarter. Prior to the fourth quarter of 2010, we evaluated our net charge-offs by using the four calendar years preceding the current year.

Loan losses are charged-off against the allowance when the loan balance or a portion of the loan balance is no longer covered by the paying capacity of the borrower based on an evaluation of available cash resources and collateral value, while recoveries of amounts previously charged-off are credited to the allowance. We assess the appropriateness of the allowance for loan losses on a quarterly basis and adjust the allowance for loan losses by recording a provision for loan losses in an amount sufficient to maintain the allowance at a level deemed

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appropriate by management. The evaluation of the adequacy of the allowance for loan losses is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available or as future events occur. To the extent that actual outcomes differ from our estimates, an additional provision for loan losses could be required which could adversely affect earnings or our financial position in future periods.

Investment Securities.Under ASC 320-10, Investments – Debt and Equity Securities, investment securities must be classified as held-to-maturity, available-for-sale, or trading. We determine the appropriate classification at the time of purchase. The classification of investment securities is significant since it directly impacts the accounting for unrealized gains and losses on investment securities. Debt investment securities are classified as held-to-maturity and carried at amortized cost when we have the positive intent and the ability to hold the investment securities to maturity. Investment securities not classified as held-to-maturity are classified as available-for-sale and are carried at fair value, with the unrealized holding gains and losses, net of tax, reported in other comprehensive income and do not affect earnings until realized. Investment in FHLB stock is carried at cost. We have no trading account investment securities.

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

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

If we determine that an investment experienced an OTTI, we must then determine the amount of the OTTI to be recognized in earnings. If we do not intend to sell the investment security and it is more likely than not that we will not be required to sell the investment security before recovery of its amortized cost basis less any current period loss, the OTTI will be separated into the amount representing the credit loss and the amount related to all other factors. The amount of the OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings. The amount of the OTTI related to other factors will be recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings will become the new amortized cost basis of the investment. If we intend to sell the investment security or it is more likely than not we will be required to sell the investment security before recovery of its amortized cost basis less any current period credit loss, the OTTI will be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. Any

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recoveries related to the value of these investment securities are recorded as an unrealized gain (as other comprehensive income [loss] in shareholders’ equity) and not recognized in income until the investment security is ultimately sold. From time to time, we may dispose of an impaired investment security in response to asset/liability management decisions, future market movements, business plan changes, or if the net proceeds can be reinvested at a rate of return that is expected to recover the loss within a reasonable period of time.

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

Under U.S. GAAP, a valuation allowance is required to be recognized if it is more likely than not that a deferred tax asset will not be realized. The determination of the realizability of the deferred tax assets is highly subjective and dependent upon judgment concerning our evaluation of both positive and negative evidence, our forecasts of future income, applicable tax planning strategies, and assessments of current and future economic and business conditions. Positive evidence includes current positive earning trends, the existence of taxes paid in available carryback years, and the probability that taxable income will continue to be generated in future periods, while negative evidence includes any cumulative losses in the current year and prior two years and general business and economic trends.

During the first quarter of 2012, we recorded an income tax benefit of $166,000 primarily related to the lower pre-tax income and the tax sheltering impact of the increased income from bank-owned life insurance due to a benefit related to the death of an insured. In addition, we increased the deferred tax valuation allowance by $166,000 resulting in no income tax benefit for the first quarter. At March 31, 2012, based on the results of our regular assessment of the ability to realize our deferred tax assets, we concluded that, based on all available evidence, both positive and negative, approximately $6.5 million of our deferred tax assets did not meet the “more likely than not” threshold for realization. Although realization of the remaining net deferred tax assets of $16.6 million is not assured, we believe it is more likely than not that all of the recorded deferred tax assets will be realized based on available tax planning strategies and our projections of future taxable income. We believe the positive evidence considered in our analysis of the remaining deferred tax assets was our long-term history of generating taxable income; the industry in which we operate is cyclical in nature; the fact that a portion of the losses in the current year were partly attributable to syndicated/participation lending which we stopped investing in during 2007; our history of fully realizing net operating losses, including the federal net operating loss from a $45.0 million taxable loss in 2004; and the relatively long remaining tax loss carryforward periods (19 years for federal income tax purposes, ten years for the state of Indiana, and eight years for the state of Illinois). The amount of the deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income during tax loss carryforward periods are reduced. Any reduction in estimated future taxable income may require us to record an additional valuation allowance against our deferred tax assets, which would result in additional income tax expense in the period and could have a significant impact on our future earnings.

Positions taken in our tax returns may be subject to challenge by the taxing authorities upon examination. The benefit of an uncertain tax position is initially recognized in the financial statements only when it is more likely than not the position will be sustained upon examination by the tax authorities. Such tax positions are both

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initially and subsequently measured as the largest amount of tax benefit that is greater than 50% likely of being realized upon settlement with the tax authority, assuming full knowledge of the position and all relevant facts. Differences between our position and the position of tax authorities could result in a reduction of a tax benefit or an increase to a tax liability, which could adversely affect our future income tax expense.

We believe our tax policies and practices are critical accounting policies because the determination of our tax provision and current and deferred tax assets and liabilities have a material impact on our results of operations and the carrying value of our assets. We believe our tax liabilities and assets are adequate and are properly recorded in the consolidated financial statements at March 31, 2012.

Results of Operations for the Three Months Ended March 31, 2012 and 2011

Performance Overview

The following table provides selected financial information and performance information for the three months ended March 31, 2012 and March 31, 2011.

	Three Months Ended March 31,
	2012			2011
	(Dollars in thousands)
Net income	$	490		$	472
Diluted earnings per share	.05			.04
Pre-tax, pre-provision earnings, as adjusted (1)	2,781			1,539
Return on average assets (2)	.17		%	.17		%
Return on average equity (2)	1.89			1.69
Average interest-earning assets	$	1,045,778		$	1,012,431
Net interest income	8,923			8,857
Net interest margin	3.43		%	3.55		%
Non-interest income	$	2,824		$	2,451
Non-interest expense	10,207			9,967
Efficiency ratio (3)	90.10		%	92.38		%

(1) See “Non-U.S. GAAP Financial Information” on page 46.

(2) Annualized.

(3) The efficiency ratio is calculated by dividing non-interest expense by the sum of net interest income and non-interest income, excluding net gain on sales of investment securities.

	March 31, 2012			December 31, 2011			March 31, 2011
Book value per share	$	9.50		$	9.49		$	10.47
Shareholders’ equity to total assets	8.83		%	8.99		%	9.94		%
Tangible capital ratio (Bank only)	8.11			8.26			8.94
Core capital ratio (Bank only)	8.11			8.26			8.94
Risk based capital ratio (Bank only)	13.23			12.65			13.22

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The following discussion and analysis presents the more significant factors affecting our financial condition as of March 31, 2012 and results of operations for the three months ended March 31, 2012.  This discussion and analysis should be read in conjunction with our condensed consolidated financial statements and notes thereto included in this report.

During the first quarter of 2012, we recorded net income of $490,000, or $.05 per diluted share.  Our earnings were impacted by several cost cutting initiatives taken during the first quarter of 2012 which included the Voluntary Early Retirement Offering (VERO), the closing of our Bolingbrook and Orland Park, Illinois, branches, and the outsourcing of certain support functions. These initiatives required us to record $876,000 of severance and early retirement expense. In addition, we recorded a $1.05 million provision for loan losses. Partially offsetting these items, we recorded pre-tax gains on the sale of investment securities totaling $418,000 and gains on the sale of loans held for sale totaling $167,000. We also recognized $378,000 of income from bank-owned life insurance due to the death of an insured.

Our net interest margin decreased 12 basis points to 3.43% for the first quarter of 2012 from 3.55% for the first quarter of 2011.  Our net interest margin continued to be pressured by the higher levels of liquidity due to strong core deposit growth, modest loan demand, and the elevated level of non-performing assets. These factors resulted in a 33 basis point decline in our yield on average interest-earning assets, which was partially offset by a 24 basis point decrease in the cost of interest-bearing liabilities from the first quarter of 2011.

We remain focused on reducing non-interest expense. Non-interest expense for the first quarter of 2012 increased slightly to $10.2 million from $10.0 million for the first quarter of 2011. Excluding the severance and early retirement compensation expense recorded during the first quarter of 2012 related to our cost cutting initiatives, non-interest expense for the first quarter decreased to $9.3 million compared to $10.0 million for the first quarter of 2011. Through the above mentioned VERO, branch closings, and outsourcing, the number of full-time equivalent (FTE) employees decreased to 273 at March 31, 2012 from 303 at December 31, 2011 and 320 at March 31, 2011. The number of FTE employees is projected to further decrease to 262 at June 30, 2012 when all employees electing the VERO have retired, as well as normal attrition. Although these initiatives resulted in severance and early retirement expense of $876,000, these actions will generate future annual savings of approximately $1.1 million in compensation and employee benefits expense and approximately $115,000 in lower other non-interest expenses.

Improving credit quality also remains a priority in 2012.  We continue to focus our efforts on reducing the level of non-performing loans, seeking to either restructure specific non-performing credits or foreclose, obtain title, and transfer the loan to other real estate owned where management can take control of and liquidate the underlying collateral. Our non-performing loans increased modestly to $46.3 million at March 31, 2012 compared to $45.6 million at December 31, 2011 primarily due to the transfer of a $2.2 million commercial and multifamily real estate lending relationship to non-accrual status which were partially offset by $1.7 million of gross charge-offs.  The ratio of non-performing loans to total loans increased to 6.55% during the first quarter of 2012 compared to 6.41% at December 31, 2011 primarily due to an increase in non-performing loans combined with a decrease in total loans.

Our loan portfolio mix continues to improve as the higher risk, targeted contraction portfolios of commercial construction and land development and commercial participations decreased $4.3 million during the quarter.  Our targeted loan growth portfolio, including commercial and industrial, owner occupied commercial real estate, and multifamily loans, comprised 54.5% of the total commercial loan portfolio at March 31, 2012, up from 53.0% at December 31, 2011 and 51.0% from March 31, 2011.

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During the first quarter, we transferred our Bolingbrook banking center to other real estate owned. We also sold seven other real estate owned properties aggregating $722,000 and recognized a net loss of $47,000 on these sales. We continue to explore ways to reduce our overall exposure in our non-performing assets through various alternatives, including the potential sale of certain of these assets. We currently have contracts for the sale of five separate other real estate owned properties which will reduce non-performing assets by $1.0 million with no anticipated loss on sale, presuming the transactions close as scheduled and pursuant to the contract terms.

We continue to grow deposits through many channels including enhancing our brand recognition within our communities, offering attractive deposit products, bringing in new client relationships by meeting all of their banking needs, and holding our experienced sales team accountable for growing deposits and relationships. During the first quarter of 2012, we implemented our High Performance Checking (HPC) deposit acquisition marketing program that targets both retail and business clients. The program is designed to attract a younger demographic and enhance growth in core deposits and related fee income as well as to provide additional cross-selling opportunities. Our core deposits grew $29.9 million, or 5.0%, during the first quarter of 2012 and core deposits represent 62.4% of total deposits compared to 61.1% at December 31, 2011. The increase is primarily due to clients moving maturing certificates of deposit into money market accounts as a result of the current low interest rate environment, increased municipal deposits, and the impact of our new HPC program, which generated approximately $3.0 million in new core deposit growth during the quarter.

At March 31, 2012, our tangible common equity was $103.3 million, or 8.83% of assets, compared to $103.2 million, or 8.99% of assets at December 31, 2011. At March 31, 2012, the Bank’s Tier 1 core capital ratio was 8.11% and the total risk-based capital ratio was 13.23%, both of which exceeded “minimum” and “well capitalized” regulatory capital requirements.

Non-U.S. GAAP Financial Information

Our accounting and reporting policies conform to U.S. GAAP and general practice within the banking industry.  Management uses certain non-U.S. GAAP financial measures to evaluate our financial performance and has provided the non-U.S. GAAP financial measures of pre-tax, pre-provision earnings, as adjusted, and pre-tax, pre-provision earnings, as adjusted, to average assets.  In these non-U.S. GAAP financial measures, the provision for loan losses, other real estate owned related income and expense, loan collection expense, and certain other items, such as gains and losses on sales of investment securities and other assets, and severance and early retirement expense, are excluded.  Management believes that these measures are useful because they provide a more comparable basis for evaluating financial performance excluding certain credit-related costs and other non-recurring items period to period and allows management and others to assess our ability to generate pre-tax earnings to cover our provision for loan losses and other credit-related costs.  Although these non-U.S. GAAP financial measures are intended to enhance investors understanding of our business performance, these operating measures should not be considered as an alternative to U.S. GAAP.

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

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

	Three Months Ended March 31,
	2012			2011
	(Dollars in thousands)
Reconciliation of Income Before Income Taxes to Pre-Tax, Pre-Provision Earnings, as adjusted:
Income before income taxes	$	490		$	438
Provision for loan losses	1,050			903
Pre-tax, pre-provision earnings	1,540			1,341
Add back (subtract):
Net (gain) loss on sale of:
Investment securities	(418		)	(519		)
Other real estate owned	47			5
Other real estate owned related expense, net	618			592
Loan collection expense	118			120
Severance and early retirement expense	876			—
Pre-tax, pre-provision earnings, as adjusted	$	2,781		$	1,539
Pre-tax, pre-provision earnings, as adjusted, to average assets	.96		%	.55		%

Our pre-tax, pre-provision earnings, as adjusted, increased $1.2 million, or 80.7%, to $2.8 million for the first quarter of 2012 from $1.5 million for the first quarter of 2011 primarily due to increases in gains on sales of loans held for sale of $135,000 and income from bank-owned life insurance of $334,000 due to the death of an insured. In addition, the pre-tax, pre-provision earnings, as adjusted, also benefited from decreases in compensation and employee benefits expense of $526,000, FDIC insurance premiums and regulatory assessments of $165,000, and professional fees of $135,000. Partially offsetting these favorable variances was a $217,000 increase in marketing expense due to the HPC product promotion during the first quarter of 2012.

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Average Balances/Rates

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

	Three Months Ended March 31,
	2012						2011
	Average Balance		Interest		Average Yield/Cost		Average Balance		Interest		Average Yield/Cost
	(Dollars in thousands)
Interest-earning assets:
Loans receivable (1)	$	708,713	$	8,386	4.76	%	$	727,422	$	8,811	4.91	%
Investment securities (2)	258,882		2,130		3.25		239,070		2,045		3.42
Other interest-earning assets (3)	78,183		93		.48		45,939		157		1.39
Total interest-earning assets	1,045,778		10,609		4.08		1,012,431		11,013		4.41
Non-interest earning assets	113,419						117,646
Total assets	$	1,159,197					$	1,130,077
Interest-bearing liabilities:
Deposits:
Checking accounts	$	178,370	$	83	.19	%	$	157,782	$	112	.29	%
Money market accounts	196,117		171		.35		183,431		249		.55
Savings accounts	136,109		67		.20		124,096		76		.25
Certificates of deposit	378,047		1,069		1.14		404,475		1,457		1.46
Total deposits	888,643		1,390		.63		869,784		1,894		.88
Borrowed funds:
Other short-term borrowed funds	13,339		5		.15		14,199		18		.51
FHLB advances	39,821		291		2.89		25,657		244		3.80
Total borrowed funds	53,160		296		2.20		39,856		262		2.63
Total interest-bearing liabilities	941,803		1,686		.72		909,640		2,156		.96
Non-interest bearing deposits	101,645						95,596
Non-interest bearing liabilities	11,464						11,451
Total liabilities	1,054,912						1,016,687
Shareholders’ equity	104,285						113,390
Total liabilities and shareholders’ equity	$	1,159,197					$	1,130,077
Net interest-earning assets	$	103,975					$	102,791
Net interest income / interest rate spread			$	8,923	3.36	%			$	8,857	3.45	%
Net interest margin					3.43	%					3.55	%
Ratio of average interest-earning assets to average interest-bearing liabilities					111.04	%					111.30	%

(1) The average balance of loans receivable includes loans held for sale and non-performing loans, interest on which is recognized on a cash basis.

(2) Average balances of investment securities are based on amortized cost.

(3) Includes FHLB stock and interest-earning bank deposits.

47

Rate/Volume Analysis

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

	Three Months Ended March 31,
	2012 Compared to 2011
	Change due to Rate			Change due to Volume			Total Change
	(Dollars in thousands)
Interest income:
Loans receivable	$	(201	)	$	(224	)	$	(425	)
Investment securities	(80		)	165			85
Other interest-earning assets	(137		)	73			(64		)
Total	(418		)	14			(404		)
Interest expense:
Deposits:
Checking accounts	(43		)	14			(29		)
Money market accounts	(94		)	16			(78		)
Savings accounts	(16		)	7			(9		)
Certificates of deposit	(298		)	(90		)	(388		)
Total deposits	(451		)	(53		)	(504		)
Borrowed funds:
Other short-term borrowed funds	(12		)	(1		)	(13		)
FHLB advances	(66		)	113			47
Total borrowed funds	(78		)	112			34
Total	(529		)	59			(470		)
Net change in net interest income	$	111		$	(45	)	$	66

Net Interest Income

Net Interest Income.Netinterest income was stable at $8.9 million for the three months ended March 31, 2012 and 2011.  Thenet interest margin for the three months ended March 31, 2012 decreased 12 basis points to 3.43% from 3.55% for the comparable 2011 period.  Our net interest margin continued to be pressured by the higher levels of liquidity due to strong core deposit growth, modest loan demand, and elevated level of non-performing assets.

Interest Income.  Interest income decreased to $10.6 million for the three months ended March 31, 2012 compared to $11.0 million for the comparable 2011 period.  The weighted-average rate on interest-earning assets decreased to 4.08% for the three months ended March 31, 2012 from 4.41% for the comparable 2011 period.  The yield on investment securities declined during the first quarter of 2012 due to reinvesting maturing investment securities in lower yielding investments as market interest rates remained significantly low. The level of non-performing loans continues to negatively affect the yield on loans receivable.   

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Interest Expense.  Interest expense decreased 21.8% to $1.7 million for the three months ended March 31, 2012 from $2.2 million for the 2011 period.  The average cost of interest-bearing liabilities decreased 24 basis points to .72% for the three months ended March 31, 2012 from .96% for the 2011 period.  Interest expense continues to be positively affected by strong growth in low-cost core deposit balances and a reduction in higher cost certificates of deposit and FHLB advances.

Interest expense on interest-earning deposits decreased to $1.4 million for the three month period ended March 31, 2012 from $1.9 million for the comparable 2011 period.  The weighted-average cost of deposits decreased 25 basis points to .63% for the three month period ended March 31, 2012 from .88% for the comparable 2011 period as a result of disciplined pricing on deposits, the repricing of certificates of deposit at lower interest rates, and increases in the average balance of non-interest bearing deposits, which was partially offset by increases in the average balance of interest bearing deposits.

Interest expense on borrowed funds increased to $296,000 for the three months ended March 31, 2012 from $262,000 for the 2011 period primarily as a result of increases in the average balance of borrowed funds during the first quarter 2012 compared to the 2011 period.  The weighted-average cost of borrowed funds decreased 43 basis points during the three months ended March 31, 2012 to 2.20% from 2.63% for the same period 2011 due to a decrease of 36 basis points in the cost of Repo Sweeps and the schedule payments of higher cost FHLB advances.

Provision for Loan Losses

The Company’s provision for loan losses was $1.05 million for the three months ended March 31, 2012 compared to $903,000 for the 2011 period.  For more information, see “Changes in Financial Condition – Allowance for Loan Losses” below in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Non-Interest Income

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

	Three Months Ended March 31,
	2012			2011			$ Change			% Change
	(Dollars in thousands)
Service charges and other fees	$	1,018		$	1,076		$	(58	)	(5.4	)%
Card-based fees	533			475			58			12.2
Commission income	57			45			12			26.7
Subtotal fee based revenues	1,608			1,596			12			.8
Income from bank-owned life insurance	540			206			334			162.1
Other income	138			103			35			34.0
Subtotal	2,286			1,905			381			20.0
Net gain on sale of:
Investment securities	418			519			(101		)	(19.5	)
Loans receivable	167			32			135			421.9
Other real estate owned	(47		)	(5		)	(42		)	840.0
Total non-interest income	$	2,824		$	2,451		$	373		15.2	%

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Service charges and other fees were impacted by a lower volume of non-sufficient funds transactions which is an industry trend that is expected to continue due to regulatory changes affecting deposit account overdraft activity.  Service charges and other fees were also impacted by lower credit enhancement fee income related to non-owner occupied commercial real estate letters of credit as we continue to strategically reduce our exposure to these types of relationships.  The $334,000 increase in income from bank-owned life insurance was primarily due to a benefit related to the death of an insured. The increase in net gain on the sale of loans receivable in gains on the sale of loans held for sale related to our expanded residential loan origination and mortgage banking activities. We hired four additional seasoned mortgage loan originators in the last year to expand mortgage loan originations to generate additional income from our mortgage banking activities. For information related to net gains on sale of investment securities, see “Changes in Financial Condition – Investment Securities” below in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Non-Interest Expense

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

	Three Months Ended March 31,
	2012		2011		$ Change			% Change
	(Dollars in thousands)
Compensation and mandatory benefits	$	4,003	$	4,469	$	(466	)	(10.4	)%
Retirement and stock related compensation	272		213		59			27.7
Medical and life benefits	425		547		(122		)	(22.3	)
Other employee benefits	13		10		3			30.0
Subtotal compensation and employee benefits	4,713		5,239		(526		)	(10.0	)
Net occupancy expense	708		765		(57		)	(7.5	)
FDIC insurance premiums and regulatory assessments	488		653		(165		)	(25.3	)
Furniture and equipment expense	457		463		(6		)	(1.3	)
Data processing	438		442		(4		)	(.9	)
Marketing	404		187		217			116.0
Professional fees	253		388		(135		)	(34.8	)
Other real estate owned related expense, net	618		592		26			4.4
Loan collection expense	118		120		(2		)	(1.7	)
Severance and early retirement expense	876		—		876			NM
Other general and administrative expenses	1,134		1,118		16			1.4
Total non-interest expense	$	10,207	$	9,967	$	240		2.4	%

Compensation and employee benefits was positively impacted by lower incentive compensation, lower medical costs, and a reduction of 47, or 14.7%, FTE employees from March 31, 2011. FDIC insurance premiums and regulatory assessments expense decreased due to the FDIC premium assessment methodology implemented in April 2011. Professional fees were favorably impacted by lower legal fees, and marketing expense increased due to the implementation of our new HPC direct mail checking deposit acquisition program. Net other real estate owned related expense increased due to the higher valuation allowances of $464,000 partially offset by an increase in income on other real estate owned properties of $413,000.

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Income Tax Expense

During the current quarter, the Company recorded an income tax benefit of $166,000 primarily related to the lower pre-tax income and the tax sheltering impact of the increased income from bank-owned life insurance. In addition, the Company increased its deferred tax valuation allowance by $166,000 resulting in no income tax benefit for the first quarter. The Company’s deferred tax asset valuation allowance totaled $6.5 million at March 31, 2012. Although realization of the current net deferred tax assets of $16.6 million is not assured, management believes it is more likely than not that all of the recorded deferred tax assets will be realized. The amount of the deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income during tax loss carryforward periods are reduced.

Changes in Financial Condition

Our total assets increased to $1.17 billion at March 31, 2012 from $1.15 billion at December 31, 2011 primarily as a result of an increase in cash and cash equivalents which was funded by deposit growth.

	March 31, 2012		December 31, 2011		$ Change			% Change
	(Dollars in thousands)
Assets:
Cash and cash equivalents	$	113,147	$	92,072	$	21,075		22.9	%
Investment securities available-for-sale, at fair value	239,247		234,381		4,866			2.1
Investment securities held-to-maturity, at cost	15,911		16,371		(460		)	(2.8	)
Federal Home Loan Bank stock, at cost	6,188		6,188		—			—
Loans receivable, net	695,170		698,802		(3,632		)	(.5	)
Bank-owned life insurance	36,273		36,275		(2		)	—
Other real estate owned	19,429		19,091		338			1.8
Other assets	45,177		45,770		(593		)	(1.3	)
Total assets	$	1,170,542	$	1,148,950	$	21,592		1.9	%
Liabilities and Equity:
Deposits	$	1,004,441	$	977,424	$	27,017		2.8	%
Borrowed funds	51,935		54,200		(2,265		)	(4.2	)
Other liabilities	10,831		14,078		(3,247		)	(23.1	)
Total liabilities	1,067,207		1,045,702		21,505			2.1
Shareholders’ equity	103,335		103,248		87			.1
Total liabilities and equity	$	1,170,542	$	1,148,950	$	21,592		1.9	%

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Loans Receivable

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

	March 31, 2012					December 31, 2011
	Amount			% of Total		Amount			% of Total		% Change
	(Dollars in thousands)
Commercial loans:
Commercial and industrial	$	86,807		12.3	%	$	85,160		12.0	%	1.9	%
Commercial real estate:
Owner occupied	95,110			13.5		93,833			13.2		1.4
Non-owner occupied	185,070			26.2		188,293			26.5		(1.7	)
Multifamily	75,864			10.7		71,876			10.1		5.5
Commercial construction and land development	22,691			3.2		22,045			3.1		2.9
Commercial participations	7,089			1.0		12,053			1.7		(41.2	)
Total commercial loans	472,631			66.9		473,260			66.6		(.1	)
Retail loans:
One-to-four family residential	179,980			25.5		181,698			25.6		(.9	)
Home equity lines of credit	50,496			7.1		52,873			7.4		(4.5	)
Retail construction	1,282			.2		1,022			.1		25.4
Other	2,942			.4		2,771			.4		6.2
Total retail loans	234,700			33.2		238,364			33.5		(1.5	)
Total loans receivable	707,331			100.1		711,624			100.1		(.6	)
Net deferred loan fees	(393		)	(.1	)	(398		)	(.1	)	(1.3	)
Total loans receivable, net of deferred loan fees	$	706,938		100.0	%	$	711,226		100.0	%	(.6	)%

 Loan fundings during the three months ended March 31, 2012 totaled $32.7 million, stable compared to the three months ended December 31, 2011. Loan fundings during the first quarter of 2012 were offset by loan payoffs and amortization of $25.4 million, mortgage loan sales of $9.2 million, and transfers to other real estate owned totaling $586,000. In addition, loans decreased due to gross charge-offs of $1.8 million, including $718,000 that had been previously identified as a specific ASC 310-10 allowance.

Commercial participations decreased 41.2% compared to December 31, 2011 through net paydowns totaling $500,000 and the payoff of one non-owner occupied commercial real estate participation totaling $4.8 million. In addition, non-owner occupied commercial real estate loans decreased by $3.2 million, or 1.7%, since December 31, 2011 primarily due to gross charge-offs of $1.1 million and two loan payoffs aggregating $1.5 million. Partially offsetting this decrease, multifamily loans increased by $4.0 million, or 5.5%, since December 31, 2011 primarily due to fundings of $4.4 million partially offset by gross charge-offs of $377,000.

     As more fully discussed in our Annual Report on Form 10-K for the year ended December 31, 2011, we began a shift in mid-2007 to diversify our loan portfolio to reduce our focus on commercial real estate lending, including non-owner occupied, commercial construction and land development, and purchased participation and syndication loans. We have identified and segregated the remaining credit risk related to our deemphasized loan categories that were originated prior to our current risk tolerances, credit policy, and underwriting standards, by segregating our loan portfolio based upon each loan’s initial origination date. Loans that were renewed or modified

52

subsequent to their initial origination are included for disclosure purposes based on their initial loan origination date. The categories of the loan portfolio that we continue to focus on growing, which are commercial and industrial and commercial real estate - owner occupied and multifamily, comprised 54.5% of the commercial loan portfolio at March 31, 2012 compared to 51.0% at March 31, 2011. Over 74% of the loans outstanding at March 31, 2012 in these growth categories were originated after January 1, 2008 (Post-1/1/08). During 2012, these targeted growth categories grew by $6.9 million due to $9.5 million in new fundings which were partially offset by $2.3 million in loan payoffs. At March 31, 2012, our total loans outstanding originated prior to January 1, 2008 (Pre-1/1/08) decreased to 41.1% of our total loan portfolio primarily due to normal amortization, charge-offs, and repayments, including the full repayment of a $4.8 million performing participation loan.

The following tables present the categories of our commercial loan portfolio at the dates indicated segregated by the origination date of the lending relationship, and highlights the shift in our lending focus to those growth categories in accordance with our strategic plan.

	March 31, 2012
	Pre-1/1/08 Loans		Post-1/1/08 Loans		Total		% of Pre-1/1/08 to Total
	(Dollars in thousands)
Commercial loans:
Commercial and industrial	$	12,376	$	74,431	$	86,807	14.3	%
Commercial real estate:
Owner occupied	43,141		51,969		95,110		45.4
Non-owner occupied	115,158		69,912		185,070		62.2
Multifamily	10,333		65,531		75,864		13.6
Commercial construction and land development	6,191		16,500		22,691		27.3
Commercial participations	6,824		265		7,089		96.3
Total commercial loans	$	194,023	$	278,608	$	472,631	41.1	%

	December 31, 2011
	Pre-1/1/08 Loans		Post-1/1/08 Loans		Total		% of Pre-1/1/08 to Total
	(Dollars in thousands)
Commercial loans:
Commercial and industrial	$	11,878	$	73,282	$	85,160	13.9	%
Commercial real estate:
Owner occupied	43,510		50,323		93,833		46.4
Non-owner occupied	118,956		69,337		188,293		63.2
Multifamily	10,453		61,423		71,876		14.5
Commercial construction and land development	6,280		15,765		22,045		28.5
Commercial participations	11,537		516		12,053		95.7
Total commercial loans	$	202,614	$	270,646	$	473,260	42.8	%

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Total commercial participations by loan type and state where the collateral is located are presented in the following tables as of the dates indicated.

	March 31, 2012				December 31, 2011
	Amount		% of Total		Amount		% of Total		% Change
	(Dollars in thousands)
Commercial and industrial	$	139	2.0	%	$	151	1.3	%	(7.9	)%
Commercial real estate:
Owner occupied	100		1.4		102		.8		(2.0	)
Non-owner occupied	6,243		88.0		11,193		92.9		(44.2	)
Commercial construction and land development	607		8.6		607		5.0		—
Total commercial participations	$	7,089	100.0	%	$	12,053	100.0	%	(41.2	)%

	March 31, 2012				December 31, 2011
	Amount		% of Total		Amount		% of Total		% Change
	(Dollars in thousands)
Illinois	$	1,277	18.0	%	$	1,534	12.7	%	(16.8	)%
Indiana	2,530		35.7		2,203		18.3		14.8
Ohio	—		—		4,875		40.5		(100.0	)
Florida	607		8.6		607		5.0		—
Colorado	1,215		17.1		1,338		11.1		(9.2	)
Texas	1,460		20.6		1,496		12.4		(2.4	)
Total commercial participations	$	7,089	100.0	%	$	12,053	100.0	%	(41.2	)%

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Asset Quality and Allowance for Loan Losses

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

	March 31, 2012			December 31, 2011
	(Dollars in thousands)
Non-performing loans:
Commercial loans:
Commercial and industrial	$	544		$	596
Commercial real estate:
Owner occupied	11,258			11,228
Non-owner occupied	21,278			22,294
Multifamily	1,440			91
Commercial construction and land development	3,378			3,378
Commercial participations	2,689			2,355
Total commercial loans	40,587			39,942
Retail loans:
One-to-four family residential	5,105			4,935
Home equity lines of credit	414			541
Retail construction	169			169
Total retail loans	5,688			5,645
Total non-performing loans	46,275			45,587
Other real estate owned:
Commercial	18,022			17,688
Retail	1,407			1,403
Total other real estate owned	19,429			19,091
Total non-performing assets	65,704			64,678
90 days past due loans still accruing interest	81			5
Total non-performing assets plus 90 days past due loans still accruing interest	$	65,785		$	64,683
Accruing troubled debt restructurings	$	8,079		$	8,875
Non-performing assets to total assets	5.61		%	5.63		%
Non-performing loans to total loans, net of deferred fees	6.55			6.41

Total non-performing loans increased $688,000 to $46.3 million at March 31, 2012 from $45.6 million at December 31, 2011.  During the first quarter of 2012, non-performing loans increased primarily due to the transfer of one non-owner occupied and multifamily commercial real estate relationship totaling $2.2 million and 11 one-to-four family residential loans totaling $1.4 million to non-accrual status.  Non-performing commercial participation loans increased by $334,000 due to a protective advance for real estate taxes, that was reimbursed by the borrower subsequent to March 31, 2012. Partially offsetting these increases, 11 one-to-four family residential

55

loans totaling $475,000 and three home equity lines of credit totaling $233,000 became current and were returned to accrual status. Non-performing loans also decreased due to charge-offs for the quarter totaling $1.7 million, a $209,000 repayment of one non-owner occupied commercial real estate loan, a $200,000 repayment of a one-to-four family residential loan, and the transfer of two one-to-four family residential loans totaling $516,000 and one HELOC totaling $70,000 to other real estate owned.

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

	March 31, 2012			December 31, 2011			% change
	(Dollars in thousands)
Commercial real estate – non-owner occupied	$	2,082		$	1,748		19.1	%
Commercial construction and land development	607			607			—
Total non-performing commercial participations	$	2,689		$	2,355		14.2	%
Indiana	$	2,082		$	1,748		19.1	%
Florida	607			607			—
Total non-performing commercial participations	$	2,689		$	2,355		14.2	%
Percentage of total non-performing loans	5.81		%	5.17		%
Percentage of total commercial participations	37.93			19.54

The disclosure required with respect to impaired loans and troubled debt restructurings is contained in “Note 5. Allowance for Loan Losses” in the notes to the condensed consolidated financial statements in “Item 1. Financial Statements” of this Quarterly Report on Form 10-Q.

Non-performing assets increased to $65.7 million at March 31, 2012 from $64.7 million at December 31, 2011 primarily due to the aforementioned increases in new non-performing loans and transfers to other real estate owned. The activity for our other real estate owned is set forth in the following table.

	Three Months Ended March 31, 2012
	(Dollars in thousands)
Balance at beginning of period	$	19,091
Transfers to other real estate owned	1,545
Net repayments and improvements of properties	—
Sales of other real estate owned	(722		)
Valuation allowances for declines in net realizable value	(485		)
Balance at end of period	$	19,429

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The following table identifies our other real estate owned properties based on the loan category in which they were originated:

	March 31, 2012		December 31, 2011		% change
	(Dollars in thousands)
Commercial loans:
Commercial real estate:
Owner occupied	$	1,275	$	1,275	—	%
Non-owner occupied	2,963		2,193		35.1
Multifamily	477		557		(14.4	)
Commercial construction and land development	5,145		5,341		(3.7	)
Commercial participations:
Commercial real estate – non-owner occupied	2,673		2,673		—
Commercial construction and land development	5,489		5,649		(2.8	)
Total commercial loans	18,022		17,688		1.9
Retail loans:
One-to-four family residential	1,337		1,374		(2.7	)
Home equity lines of credit	70		29		141.4
Total retail loans	1,407		1,403		.3
Total other real estate owned	$	19,429	$	19,091	1.8	%

As more fully discussed in our Annual Report on Form 10-K for the year ended December 31, 2011, we believe that our loans that were originated Pre-1/1/08 have a higher degree of risk of loss due to the nature of the types of these loans and the credit environment under which they were originated, particularly given the downturn in the economic environment over the last four years. During the one year and five years ended December 31, 2011, $18.3 million and $53.3 million, respectively, or 87.8% and 95.5% of total commercial charge-offs were from the Pre-1/1/08 portfolio. The following tables illustrate that a large portion of our non-performing loans and other real estate owned were originated Pre-1/1/08 and that we have experienced a higher level of charge-offs and other real estate owned writedowns in the Pre-1/1/08 portfolios. As presented in the following tables, 76.7% of our non-performing commercial loans and our entire commercial other real estate owned portfolio at March 31, 2012 were originated Pre-1/1/08.

57

	March 31, 2012
	Pre-1/1/08 Loans			Post-1/1/08 Loans			Total			% of Pre-1/1/08 to Total
	(Dollars in thousands)
Non-performing commercial loans:
Commercial and industrial	$	510		$	34		$	544		93.8	%
Commercial real estate:
Owner occupied	9,570			1,688			11,258			85.0
Non-owner occupied	14,913			6,365			21,278			70.1
Multifamily	90			1,350			1,440			6.3
Commercial construction and land development	3,378			—			3,378			100.0
Commercial participations	2,689			—			2,689			100.0
Total non-performing commercial loans	$	31,150		$	9,437		$	40,587		76.7	%
Total commercial loans outstanding at March 31, 2012	$	194,023		$	278,608		$	472,631
Non-performing commercial loans to total commercial loans	16.05		%	3.39		%	8.59		%

	March 31, 2012
	Pre-1/1/08 Loans		Post-1/1/08 Loans		Total		% of Pre-1/1/08 to Total
	(Dollars in thousands)
Other real estate owned – commercial:
Commercial real estate:
Owner occupied	$	1,275	$	—	$	1,275	100.0	%
Non-owner occupied	2,963		—		2,963		100.0
Multifamily	477		—		477		100.0
Commercial construction and land development	5,145		—		5,145		100.0
Commercial participations:
Commercial real estate – non-owner occupied	2,673		—		2,673		100.0
Commercial construction and land development	5,489		—		5,489		100.0
Total other real estate owned – commercial	$	18,022	$	—	$	18,022	100.0	%

During 2012, we recorded gross loan charge-offs related to our commercial loan portfolio totaling $1.6 million, of which 73.5% were originated Pre-1/1/08. During 2012, we also recorded other real estate owned writedowns on commercial properties totaling $455,000, all of which were related to the Pre-1/1/08 loan portfolio. The breakdown of gross charge-offs of commercial loans and other real estate owned writedowns on commercial properties are identified in the following table.

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	For the Three Months Ended March 31, 2012
	Pre-1/1/08 Loans		Post-1/1/08 Loans		Total		% of Pre-1/1/08 to Total
	(Dollars in thousands)
Commercial loan charge-offs:
Commercial and industrial	$	120	$	—	$	120	100.0	%
Commercial real estate:
Non-owner occupied	1,038		41		1,079		96.2
Multifamily	—		377		377		—
Total commercial loan charge-offs	1,158		418		1,576		73.5
Writedowns on other real estate owned – commercial properties:
Commercial real estate:
Owner occupied	—		—		—		—
Non-owner occupied	157		—		157		100.0
Multifamily	80		—		80		100.0
Commercial construction and land development	196		—		196		100.0
Commercial participations – construction and land development	22		—		22		100.0
Total writedowns on other real estate owned – commercial properties	455		—		455		100.0
Total commercial loan charge-offs and writedowns on other real estate owned	$	1,613	$	418	$	2,031	79.4	%

Potential Problem Assets.Potential problem assets, defined as loans classified substandard pursuant to our internal loan grading system that do not meet the definition of a non-performing loan, were stable at $2.2 million at March 31, 2012 and December 31, 2011.

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

	Three Months Ended March 31,
	2012			2011
	(Dollars in thousands)
Balance at beginning of period	$	12,424		$	17,179
Loan charge-offs:
Current period loan charge-offs	(1,041		)	(1,014		)
Previously established specific reserves	(718		)	—
Total loan charge-offs	(1,759		)	(1,014		)
Recoveries of loans previously charged-off	53			27
Net loan charge-offs	(1,706		)	(987		)
Provision for loan losses	1,050			903
Balance at end of period	$	11,768		$	17,095

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	March 31, 2012			December 31, 2011			March 31, 2011
	(Dollars in thousands)
Allowance for loan losses	$	11,768		$	12,424		$	17,095
Total loans receivable, net of unearned fees	706,938			711,226			724,223
Allowance for loan losses to total loans	1.66		%	1.75		%	2.36		%
Allowance for loan losses to non-performing loans	25.43			27.25			28.65
Ratio of net loans charged-off to average loans outstanding for the quarter ended, annualized	.97			9.47			.54

The allowance for loan losses decreased $656,000 to $11.8 million at March 31, 2012 compared to $12.4 million at December 31, 2011 and $5.3 million from $17.1 million at March 31, 2011.  The ratio of the allowance for loan losses to total loans decreased to 1.66% at March 31, 2012 compared to 1.75% and 2.36%, respectively, at December 31, 2011 and March 31, 2011.

The provision for losses on loans increased to $1.05 million for the first quarter of 2012 from $903,000 for the prior year quarter.  The increase was primarily related to the higher level of net charge-offs in the current quarter.  Net charge-offs included $936,000 on a non-owner occupied commercial real estate loan and $418,000 on a non-owner occupied and multifamily commercial real estate lending relationship.

When we determine that a non-performing collateral dependent loan has a collateral shortfall, we will immediately charge off the collateral shortfall.  As a result, we are not required to maintain an allowance for loan losses on these loans as the loan balance has already been written down to its net realizable value (fair value less estimated costs to sell the collateral).  As such, the ratio of the allowance for loan losses to total loans and the ratio of the allowance for loan losses to non-performing loans has continued to be negatively affected by cumulative partial charge-offs of $13.7 million recorded through March 31, 2012 on $27.2 million (net of charge-offs) of non-performing collateral dependent loans. At March 31, 2012, the ratio of the allowance for loan losses to non-performing loans, excluding the $27.2 million of non-performing collateral dependent loans with partial charge-offs, was 61.6%.

Investment Securities

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

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

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	Par  Value		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair  Value
	(Dollars in thousands)
At March 31, 2012:
Available-for-sale investment securities:
U.S. Treasury securities	$	17,500	$	17,467	$	399	$	(1	)	$	17,865
Government sponsored entity (GSE) securities	44,800		44,947		1,280		—			46,227
Corporate bonds	5,420		5,046		89		—			5,135
Collateralized mortgage obligations	94,712		84,521		2,267		(707		)	86,081
Commercial mortgage-backed securities	61,654		62,464		1,600		—			64,064
Asset backed securities	4,811		4,407		8		(9		)	4,406
Pooled trust preferred securities	26,730		24,247		—		(8,780		)	15,467
GSE preferred stock	200		—		2		—			2
Total available-for-sale investment securities	$	255,827	$	243,099	$	5,645	$	(9,497	)	$	239,247
Held-to-maturity investment securities:
Asset backed securities	$	7,775	$	8,001	$	259	$	—		$	8,260
Municipal securities	7,910		7,910		50		—			7,960
Total held-to-maturity investment securities	$	15,685	$	15,911	$	309	$	—		$	16,220

	Par  Value		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair  Value
	(Dollars in thousands)
At December 31, 2011:
Available-for-sale investment securities:
U.S. Treasury securities	$	15,000	$	14,967	$	447	$	—		$	15,414
Government sponsored entity (GSE) securities	46,800		46,967		1,415		—			48,382
Corporate bonds	5,420		5,022		9		(4		)	5,027
Collateralized mortgage obligations	79,006		71,073		1,178		(1,367		)	70,884
Commercial mortgage-backed securities	72,885		74,664		1,520		(66		)	76,118
Pooled trust preferred securities	27,398		24,804		—		(6,249		)	18,555
GSE preferred stock	200		—		1		—			1
Total available-for-sale investment securities	$	246,709	$	237,497	$	4,570	$	(7,686	)	$	234,381
Held-to-maturity investment securities:
Asset backed securities	$	8,201	$	8,461	$	285	$	—		$	8,746
Municipal securities	7,910		7,910		47		—			7,957
Total held-to-maturity investment securities	$	16,111	$	16,371	$	332	$	—		$	16,703

The fair value of investment securities available-for-sale totaled $239.2 million at March 31, 2012 compared to $234.4 million at December 31, 2011.  Our investment securities portfolio increased since December 31, 2011 due to investing the proceeds from both our deposit growth and redemption of Federal Home Loan Bank stock as the demand for loans remains constrained by our local economic conditions.

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At March 31, 2012, our collateralized mortgage obligation portfolio totaled $86.1 million, with 98% of the portfolio maintaining a lowest credit rating of A or better.  The portfolio is mainly backed by residential mortgages originated prior to 2005.  Of our collateralized mortgage obligation portfolio, $67.3 million consists of floating-rate bonds with unaccreted discounts totaling $9.9 million.  The composition of this portfolio includes $4.9 million backed by Ginnie Mae.

Our commercial mortgage-backed investment securities portfolio consists mainly of senior tranches of issues originated prior to 2006 with extensive subordination.  All bonds were AAA-rated at March 31, 2012.  

Our corporate bond portfolio consists of three A-rated to AA-rated, floating-rate notes purchased at large discounts with maturities ranging from 2014 to 2016.

At March 31, 2012, management believed the unrealized losses in our investment securities portfolio are primarily attributable to macroeconomic conditions affecting the liquidity of these securities and not necessarily the expected cash flows of the individual securities.  The fair value of these securities is expected to recover as the economy recovers, as interest rates rise, and as the performance of the underlying collateral improves.

All of our pooled trust preferred investments were AAA-rated when they were purchased in late 2007 and early 2008 at discounts in excess of 10%.  In 2009, the market for this type of investment was severely impacted by the credit crisis leading to increased deferrals and defaults.  Credit ratings were also negatively affected in 2009, and all of these securities in our portfolio have at least one rating below investment grade.  One tranche with an amortized cost of $7.1 million holds recently updated ratings of both A and CCC-. One issue had one of its ratings upgraded to A3 in the first quarter of 2012. During the second quarter of 2012, the same issue had its other rating upgraded from CCC+ to BB+, which is now its lowest rating. The rating agency that places the lowest rating on all of our issues placed all of them on watch for upgrade in mid-April 2012.

We utilize extensive external and internal analysis on the pooled trust preferred holdings.  Our internal model stress tests all underlying issuers in the pools to project probabilities of deferral or default.  Management’s internal modeling runs multiple stress scenarios.  The high-stress scenario utilizes immediate defaults for all deferring collateral.  Any collateral that management believes may be at risk for deferring or defaulting, based upon its review of the underlying issuers’ most recent financial and regulatory information, is assumed to default immediately.  Despite a recent trend of recoveries from previously defaulted trust preferred collateral, the high-stress scenario assumes no recoveries on defaulted collateral.  All external and internal stress testing at March 31, 2012 currently projects no loss of principal or interest on any of our pooled trust preferred holdings.

All of our pooled trust preferred holdings are Super Senior tranches and were purchased at large discounts.  The Super Senior tranches are the most senior tranches.  Due to the structure of the securities, as deferrals and defaults on the underlying collateral increase, cash flows are increasingly diverted from mezzanine and subordinate tranches to pay down principal on the Super Senior tranches.  If certain senior coverage tests are not met, all interest is diverted from subordinate classes to pay down principal on the Super Senior tranche.  Four of the five issues we own are failing the senior coverage test.  This test is structured to protect the holders of the Super Senior tranches if deferrals or defaults exceed a specific threshold as a percent of the outstanding senior tranches.  As such, the proceeds of any early redemptions, successful tenders, or cures will be used to further pay down principal of the Super Senior tranches on these issues.  The annualized principal pay down rates on our pooled trust preferred

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holdings was 9.0% for the past four quarters.  Based on the pace of and success of planned capital raises by underlying issuers and confirmed acquisition announcements of underlying issuers, management expects additional cure and redemption announcements in the near term.  During the first quarter of 2012, the percentage of original collateral backing the pools deemed at risk by management declined.

An increasing number of previously deferring issuers of our pooled trust preferred holdings are resuming payments.  Of the previously deferring issues, 8.4% “cured,” or resumed payments, in the fourth quarter of 2011 and an additional 8.3% cured in the first quarter of 2012.  When a previously deferring company cures, all past interest and accrued interest on the past due interest is paid to the trust. 

Management is expecting redemption activity to remain strong this year as call windows open on the remaining securities, certain issuers reevaluate the impact of Dodd-Frank changes to Tier 1 capital treatment for these securities, and because of the high cost of this capital in the current low interest rate market.  The call window is open on four of our five pooled trust preferred holdings, and the call window on the remaining security we hold will open later this year.

Due to the current ratings on the pooled trust preferred securities being below investment grade, our investments in pooled trust preferred securities with an aggregate amortized cost of $28.4 million are classified as substandard in accordance with regulatory requirements.

Deposits

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

	March 31, 2012				December 31, 2011
	Amount		% of Total		Amount		% of Total		% Change
	(Dollars in thousands)
Checking accounts:
Non-interest bearing	$	105,177	10.5	%	$	96,321	9.9	%	9.2	%
Interest-bearing	179,366		17.8		175,150		17.9		2.4
Money market accounts	202,668		20.2		192,593		19.7		5.2
Savings accounts	140,025		13.9		133,292		13.6		5.1
Core deposits	627,236		62.4		597,356		61.1		5.0
Certificates of deposit accounts	377,205		37.6		380,068		38.9		(.8	)
Total deposits	$	1,004,441	100.0	%	$	977,424	100.0	%	2.8	%

We strive to grow deposits through many channels including enhancing our brand recognition within our communities, offering attractive deposit products, bringing in new client relationships by meeting all of their banking needs, and holding our experienced sales team accountable for growing deposits and relationships. During the first quarter of 2012, we implemented our HPC deposit acquisition marketing program that targets both retail and business clients. The program is designed to attract a younger demographic and enhance growth in core deposits and related fee income as well as to provide additional cross-selling opportunities. The $29.9 million increase in core deposits during the first quarter of 2012 is primarily related to clients moving maturing certificates of deposit into money market accounts due to the current low interest rate environment, increased municipal deposits, and the impact of the new HPC program which generated approximately $3.0 million in new core deposit growth during the quarter.

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In addition, we offer a repurchase sweep agreement (Repo Sweep) account which allows public entities and other business depositors to earn interest with respect to checking and savings deposit products offered.  The depositor’s excess funds are swept from a deposit account and are used to purchase an interest in investment securities that we own.  The swept funds are not recorded as deposits and instead are classified as other short-term borrowed funds which generally provide a lower-cost funding alternative as compared to FHLB advances.  At March 31, 2012, we had $12.1 million in Repo Sweeps compared to $14.3 million at December 31, 2011.  The Repo Sweeps are included in the table under “Borrowed Funds” and are treated as financings, and the obligations to repurchase investment securities sold are reflected as short-term borrowed funds.  The investment securities underlying these Repo Sweeps continue to be reflected as assets.

Borrowed Funds

Borrowed funds consisted of the following at the dates indicated:

	March 31, 2012				December 31, 2011
	Amount		Weighted-Average Contractual Rate		Amount		Weighted-Average Contractual Rate
	(Dollars in thousands)
Advances from FHLB of Indianapolis:
Fixed rate advances due in:
2013	$	15,000	2.22	%	$	15,000	2.22	%
2014 (1)	1,069		6.71		1,069		6.71
2015	15,000		1.42		15,000		1.42
2018 (1)	2,439		5.54		2,439		5.54
2019 (1)	6,304		6.30		6,358		6.29
Total FHLB advances	39,812		2.89		39,866		2.89
Short-term variable-rate borrowed funds - Repo Sweep accounts	12,123		.15		14,334		.20
Total borrowed funds	$	51,935	2.25	%	$	54,200	2.18	%

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

At March 31, 2012 and December 31, 2011, the Bank had a line of credit with a large commercial bank with a maximum of $15.0 million in secured overnight federal funds availability at the federal funds market rate at the time of any borrowing.  The Bank also has a borrowing relationship with the Federal Reserve Bank (FRB) discount window.  These lines were not utilized during the three months ended March 31, 2012.

Shareholders’ Equity

Shareholders’ equity at March 31, 2012 was relatively stable at $103.3 million compared to $103.2 million at December 31, 2011. The increase in shareholders’ equity during the first quarter of 2012 was primarily related to net income of $490,000 for the quarter, partially offset by a $299,000 increase in accumulated other comprehensive loss and dividends declared of $109,000.

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Liquidity and Capital Resources

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

• deposits and Repo Sweeps;

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

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

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

• funds provided from operations;

• federal funds line of credit; and

• borrowed funds from the FHLB and Federal Reserve Bank.

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

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

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

At March 31, 2012, we had cash and cash equivalents of $113.1 million, an increase from $92.1 million at December 31, 2011.  The increase was mainly the result of proceeds from sales, maturities, and paydowns of investment securities aggregating $24.5 million and increases in deposit accounts totaling $27.0 million. These cash inflows were partially offset by purchases of investment securities totaling $29.4 million.

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

The parent company’s liquidity needs consist primarily of operating expenses and dividend payments to shareholders.  The primary sources of liquidity are cash and cash equivalents and dividends from the Bank.  We are prohibited from repurchasing shares and incurring any debt at the parent company without the prior approval of the Office of the Comptroller of the Currency (OCC) under our informal regulatory agreement.

We are currently prohibited from paying dividends to our shareholders without the prior approval of the Federal Reserve Bureau (FRB) pursuant to our informal regulatory agreement we previously entered into with the Office of Thrift Supervision (OTS).  Additionally, the Bank requires the prior approval of the OCC before paying dividends to the Company under its informal regulatory agreement. Absent such restriction, OCC regulations provide various standards under which the Bank may declare and pay dividends to the parent company without

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prior approval. The dividends from the Bank are limited to the extent of its cumulative earnings for the year plus the net earnings (adjusted by prior distributions) of the prior two calendar years.  At March 31, 2012, under current regulations, the Bank had no net earnings available for dividend declarations.  At March 31, 2012, the parent company had $2.1 million in cash and cash equivalents.  We do not anticipate that these restrictions will have a material adverse impact on our liquidity in the short-term.

Contractual Obligations

The following table presents our contractual obligations to third parties at March 31, 2012 by maturity:

	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)
Certificates of deposit	$	276,520	$	82,753	$	16,784	$	1,148	$	377,205
FHLB advances (1)	360		16,770		15,837		6,845		39,812
Short-term borrowed funds (2)	12,123		—		—		—		12,123
Service bureau contract	1,639		3,278		3,278		—		8,195
Operating leases	423		553		259		1,838		3,073
Dividends payable on common stock	109		—		—		—		109
	$	291,174	$	103,354	$	36,158	$	9,831	$	440,517

(1) Does not include interest expense at the weighted-average contractual rate of 2.89% for the periods presented.

(2) Does not include interest expense at the weighted-average contractual rate of .15% for the periods presented.

See the “Borrowed Funds” section for further discussion surrounding FHLB advances.  The 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.

Off-Balance-Sheet Obligations

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

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The following table details the amounts and expected maturities of significant commitments at March 31, 2012:

	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 and industrial	$	7,654	$	159	$	—	$	350	$	8,163
Commercial real estate:
Owner occupied	11,094		285		—		—		11,379
Non-owner occupied	1,510		4,000		—		—		5,510
Multifamily	5,750		21		—		—		5,771
Commercial construction and land development	2,621		—		—		—		2,621
Commercial participations	48		—		—		—		48
Retail	3,927		—		—		—		3,927
Commitments to fund unused:
Equity lines of credit	24		—		—		39,984		40,008
Commercial business lines	46,541		3,060		—		—		49,601
Construction loans	—		—		28		—		28
Credit enhancements	2,328		—		4,514		8,512		15,354
Letters of credit	1,535		137		—		—		1,672
	$	83,032	$	7,662	$	4,542	$	48,846	$	144,082

The commitments listed above do not necessarily represent future cash requirements, in that these commitments often expire without being drawn upon.  Credit enhancements expire at various dates through 2018.  Letters of credit expire at various dates through 2013.

We also have commitments to fund community investments through investments in various limited partnerships, which represent future cash outlays for the construction and development of properties for low-income housing, small business real estate, and historic tax credit projects that qualify under the Community Reinvestment Act.  These commitments include $376,000 to be funded over two 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 AAA ratings, which provide for a lower interest rate, the FHLB issues, in favor of the bond trustee, an Irrevocable Direct Pay Letter of Credit (IDPLOC) for our account.  Since we, in accordance with the terms and conditions of a Reimbursement Agreement between the FHLB, would 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 we had funded the project initially.

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Regulatory Capital

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

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios set forth in the below table of total risk-based, tangible, and core capital, as defined in the regulations. The Bank met all capital adequacy requirements to which it is subject as of March 31, 2012 and December 31, 2011.

At March 31, 2012, the Bank was deemed to be “well-capitalized” and in excess of regulatory requirements set by the OCC. The total amount of deferred tax assets not included for regulatory capital purposes was $9.6 million and $8.6 million, respectively, at March 31, 2012 and December 31, 2011. Determining the amount of deferred tax assets included or excluded in periodic regulatory capital calculations requires significant judgment when assessing a number of factors. In assessing the amount of the deferred tax assets includable in capital, management considers a number of relevant factors including the amount of deferred tax assets dependent on future taxable income, the amount of taxes that could be recovered through loss carrybacks, the reversal of temporary book tax differences, projected future taxable income within one year, tax planning strategies, and OCC limitations. Using all information available to management at each statement of condition date, these factors are reviewed and can and do vary from period to period.

The current regulatory capital requirements and the actual capital levels of the Bank at March 31, 2012 and December 31, 2011 are presented in the following table. There are no conditions or events since March 31, 2012 that management believes have changed the Bank’s category. At March 31, 2012, the Bank’s adjusted total assets were $1.2 billion and its risk-weighted assets were $786.6 million.

	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 March 31, 2012:
Tangible capital to adjusted total assets	$	94,224	8.11	%	$	17,435	>= 1.5	$	23,246	>= 2.0
Tier 1 (core) capital to adjusted total assets	94,224		8.11		46,492		>= 4.0	58,115		>= 5.0
Tier 1 (core) capital to risk-weighted assets	94,224		11.98		31,464		>= 4.0	47,196		>= 6.0
Total capital to risk-weighted assets	104,081		13.23		62,928		>= 8.0	78,660		>= 10.0
As of December 31, 2011:
Tangible capital to adjusted total assets	$	94,502	8.26	%	$	17,151	>= 1.5	$	22,868	>= 2.0
Tier 1 (core) capital to adjusted total assets	94,502		8.26		45,737		>= 4.0	57,171		>= 5.0
Tier 1 (core) capital to risk-weighted assets	94,502		11.40		33,168		>= 4.0	49,752		>= 6.0
Total capital to risk-weighted assets	104,892		12.65		66,336		>= 8.0	82,920		>= 10.0

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The following table reflects the adjustments required to reconcile the Bank’s shareholders’ equity to the Bank’s regulatory capital at March 31, 2012:

	Tangible			Core			Risk-Based
	(Dollars in thousands)
Shareholders’ equity of the Bank	$	102,379		$	102,379		$	102,379
Disallowed deferred tax asset	(9,552		)	(9,552		)	(9,552		)
Adjustment for unrealized losses on certain available-for-sale  securities	2,227			2,227			2,227
Other	(830		)	(830		)	(830		)
General allowance for loan losses	—			—			9,857
Regulatory capital of the Bank	$	94,224		$	94,224		$	104,081

The increase in the Bank’s risk-based capital ratio from December 31, 2011 is primarily a result of an increase in the Bank’s shareholders’ equity from net income for the quarter ended March 31, 2012 coupled with an increase in other interest earning deposits that are in the 0% risk-weighting category. In addition, during the first quarter of 2012, the Bank began calculating its risk-based capital ratio in accordance with OCC standards which could vary from the former OTS standards. As such, management identified specific multifamily commercial real estate loans that it deemed to be more appropriately included in the 50% risk-weighting category rather than the 100% risk-weighting category.

Determining the amount of deferred tax assets included or excluded in periodic regulatory capital calculations requires significant judgment when assessing a number of factors.  In assessing the amount of the disallowed deferred tax asset, we consider a number of relevant factors including the amount of deferred tax assets dependent on future taxable income, the amount of taxes that could be recovered through loss carrybacks, the reversal of temporary book tax differences, projected future taxable income within one year, available tax planning strategies, and OCC limitations.  Using all information available to us at each statement of condition date, these factors are reviewed and vary from period to period.

Item 3.          Quantitative and Qualitative Disclosures about Market Risk

Our primary market risk is considered to be interest rate risk.  Interest rate risk on our balance sheet arises from the maturity mismatch of interest-earning assets versus interest-bearing liabilities, as well as the potential for maturities to shorten or lengthen on our interest-earning assets, and to a lesser extent on our interest-bearing liabilities due to the exercise of options.  The most common of these are prepayment options on mortgage loans, and commercial mortgage-backed securities, and to a lesser extent jump-rate features in certain of our certificates of deposit.  Management’s goal, through policies established by the Asset/Liability Management Committee of the Board of Directors (ALCO), is to maximize net interest income while achieving adequate returns on equity capital and managing our balance sheet within the established interest rate risk policy limits prescribed by the ALCO.

We maintain a written Asset/Liability Management Policy that establishes written guidelines for the asset/liability management function, including the management of net interest margin, interest rate risk (IRR), and liquidity.  The Asset/Liability Management Policy falls under the authority of the Board of Directors which in turn assigns its formulation, revision, and administration to the ALCO.  The ALCO schedules monthly meetings and consists of certain senior officers and one outside director.  The results of the meetings are reported to the Board of Directors.  The primary duties of the ALCO are to develop reports and establish procedures to measure and

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monitor IRR, verify compliance with Board approved IRR tolerance limits, take appropriate actions to mitigate those risks, monitor and discuss the status and results of implemented strategies and tactics, monitor our capital position, review the current and prospective liquidity positions, and monitor alternative funding sources.  The policy requires management to measure overall IRR exposure using Net Present Value analysis and earnings-at-risk analysis.

We use Net Portfolio Value Analysis as the primary measurement of our interest rate risk.  Under prior OTS regulations in Thrift Bulletin 13a, we are required to measure our interest rate risk assuming various increases and decreases in general interest rates and their effect on our market value of portfolio equity.  The Board of Directors has established limits to changes in Net Portfolio Value (NPV), (including limits regarding the change in net interest income discussed below), across a range of hypothetical interest rate changes.  If estimated changes to NPV and net interest income are not within these limits, the Board may direct management to adjust its asset/liability mix to bring its interest rate risk within Board limits.  NPV is computed as the difference between the market value of assets and the market value of liabilities, adjusted for the value of off-balance-sheet items.

Net Portfolio Value Analysis measures our interest rate risk by calculating the estimated change in NPV of our cash flows from interest-sensitive assets and liabilities, as well as certain off-balance-sheet items, in the event of a shock in interest rates ranging down 200 to up 300 basis points.  The following table shows the change in NPV applying the various instantaneous rate shocks to the Bank’s interest-earning assets and interest-bearing liabilities as of March 31, 2012 and December 31, 2011. 

		Net Portfolio Value
		At March 31, 2012								At December 31, 2011
		$ Amount		$ Change			% Change			$ Amount		$ Change			% Change
		(Dollars in thousands)
Assumed Change in Interest Rates (Basis Points):
+	300	$	134,112	$	20,648		18.2	%		$	128,623	$	18,838		17.2	%
+	200	130,032		16,568			14.6			125,450		15,665			14.3
+	100	123,840		10,376			9.1			119,804		10,019			9.1
	0	113,464		—			—		��	109,785		—			—
-	100	98,452		(15,012		)	(13.2	)		95,325		(14,460		)	(13.2	)
-	200	93,911		(19,553		)	(17.2	)		91,269		(18,516		)	(16.9	)

Our reported earnings at risk analysis models the impact of instantaneous parallel shifts in yield curve changes in interest rates (assuming interest rates rise and fall in increments of 100 basis points), on anticipated net interest income over a twelve-month horizon.  These models are modeling underlying cash flows in each of our interest-sensitive portfolios under these changing rate environments.  This includes adjusting anticipated prepayments, changing expected business volumes and mix as well as modeling anticipated changes in interest rates paid on core deposit accounts, whose rates do not necessarily move in any relationship to movements in U.S. Treasury rates.  We compare these results to our results assuming flat interest rates.

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The following table presents the projected changes in net interest income over a twelve-month period for the various interest rate change (rate shocks) scenarios at March 31, 2012 and December 31, 2011, respectively.

		Change in Net Interest Income Over a Twelve Month Period
		March 31, 2012					December 31, 2011
		$ Change			% Change		$ Change		% Change
		(Dollars in thousands)
Assumed Change in Interest Rates (Basis Points):
+	300	$	2,153		6.1	%	$	1,008	2.8	%
+	200	1,383			3.9		678		1.9
+	100	430			1.2		297		.8
-	100	(454		)	(1.3	)	155		.4
-	200	(550		)	(1.6	)	1		—

The table above indicates that if interest rates were to move up 200 basis points, net interest income would be expected to increase 3.9% in year one; and if interest rates were to move down 100 basis points, net interest income would be expected to decrease 1.3% in year one.  The primary causes for the changes in net interest income over the twelve-month period were a result of the changes in the composition of interest-earning assets and interest-bearing liabilities, their repricing characteristics and frequencies, and related interest rates.  The net interest income projections for rising rates have improved since December 31, 2011 as the Bank has been growing low-cost core deposits, shifting the investment securities portfolio from fixed-rate bonds to floating-rate bonds, and growing interest-earning bank deposit assets. Actual results will differ from the above model results due to timing, magnitude, and frequency of interest rate changes, as well as changes in market conditions and management strategies.  The above table does not reflect any actions we might take in response to changes in interest rates.

We manage our IRR position by holding assets with various desired IRR characteristics, implementing certain pricing strategies for loans and deposits, and implementing various investment securities portfolio strategies.  On a quarterly basis, the ALCO reviews the calculations of all IRR measures for compliance with the Board approved tolerance limits.  At March 31, 2012, we were in compliance with all of our tolerance limits.

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

Item 4.        Controls and Procedures

No change in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) or 15d-15(f) under the Securities Exchange Act of 1934, as amended) occurred during the quarter ended March 31, 2012 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

Management evaluated, with the participation of the Chief Executive Officer and Chief Financial Officer, the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) or 15(d)-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report.  Based on such evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s

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disclosure controls and procedures are designed to ensure that information required to be disclosed in the reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and regulations and are operating in an effective manner as of such date.

Part II.         OTHER INFORMATION

Item 1.          Legal Proceedings

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

Item 1A.       Risk Factors

In addition to the other information set forth in this report, you should carefully consider the factors discussed in “Item 1A. Risk Factors” contained in our Annual Report on Form 10-K for the year ended December 31, 2011 (the 2011 Form 10-K), which could materially affect our business, financial condition, or future results.  There have been no material changes from the risk factors as disclosed in the 2011 Form 10-K.

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

(a) Not applicable.

(b) Not applicable.

(c) We did not repurchase any shares of our common stock during the quarter ended March 31, 2012.  Under our repurchase plan publicly announced on March 20, 2008 for 530,000 shares, we have 448,612 shares that may yet be purchased.  We are currently prohibited from repurchasing our common stock without prior approval pursuant to an informal regulatory agreement.

Item 3.          Defaults Upon Senior Securities

(a) None.

(b) Not applicable.

Item 4.          Mine Safety Disclosures

Not applicable.

Item 5.           Other Information

(a) Not applicable.

(b) None.

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Item 6.           Exhibits

(a)	List of exhibits (filed herewith unless otherwise noted).
3.1	Articles of Incorporation of CFS Bancorp, Inc. (1)
3.2	Amended and Restated Bylaws of CFS Bancorp, Inc. (2)
4.0	Form of Stock Certificate of CFS Bancorp, Inc. (3)
31.1	Rule 13a-14(a) Certification of Chief Executive Officer
31.2	Rule 13a-14(a) Certification of Chief Financial Officer
32.0	Section 1350 Certifications
101.0	The following financial statements from the CFS Bancorp, Inc. Quarterly Report on Form 10-Q for the quarter ended March 31, 2012, filed on May 15, 2012, formatted in Extensive Business Reporting Language (XBRL):  (i) condensed consolidated statements of condition, (ii) condensed consolidated statements of income, (iii) condensed consolidated statements of comprehensive income, (iv) condensed consolidated statements of changes in shareholders’ equity, (v) condensed consolidated statements of cash flows, and (vi) the notes to condensed consolidated financial statements (4)

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

(2) Incorporated herein by Reference to the Company’s Form 8-K filed with the SEC on December 17, 2010.

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

(4) As provided in Rule 406T of Regulation S-T, this information is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1033 and Section 18 of the Securities Exchange Act of 1934.

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SIGNATURES

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

CFS BANCORP, INC.

Date:	May 15, 2012	By:	/s/ Daryl D. Pomranke
			Daryl D. Pomranke, Chief Executive Officer and President
Date:	May 15, 2012	By:	/s/ Jerry A. Weberling
			Jerry A. Weberling, Executive Vice President and Chief Financial Officer

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