UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION
 Washington,
D.C.  20549
 
 Form
10-Q
 
 (Mark
One)
 
 x
              QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF
      1934
 
 For the
quarterly period ended September 30,
2009
 
  ̈
              TRANSITION
      REPORT PURSUANT TO 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934
 
 For the
transition period from ____________ to ____________
 
 Commission
file number 000-25287
 
 TOWER
FINANCIAL CORPORATION
 (Exact
name of Registrant as specified in its charter)
 
 INDIANA
              
              35-2051170(State
      or other jurisdiction of incorporation or
    organization)
              
              (I.R.S.
      Employer Identification No.)
 
 116 East
Berry Street, Fort Wayne, Indiana 46802
 (Address
of principal executive offices)
 
 
 (260)
427-7000
 (Registrant’s
telephone number)
 
 Indicate
      by check whether the Registrant (1) has filed all reports required to be
      filed by Section 13 or 15(d) of the 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
      x  No
       ̈
 
 Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer a non-accelerated filer, or a smaller reporting company. See
the definition of "large accelerated filer," "accelerated filer" and "smaller
reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
 
 Large accelerated filer  ̈
              Accelerated filer  ̈Non-accelerated filer  ̈
                  (Do
      not check if a smaller reporting company.)
              Smaller reporting company x
 
 
 Indicate
by check mark whether the Registrant is a shell company (as defined in Rule
12b-2of the Exchange Act).
  Yes  ̈   No
x
 
 Number of
shares of the issuer’s common stock, without par value, outstanding as of
September 30, 2009: 4,090,432.
  
 1
 
 Forward-Looking
Statements
 This
report, including the section on “Management’s Discussion and Analysis of
Financial Condition and Results of Operations”, includes "forward-looking
statements." All statements regarding our anticipated results or expectations,
including our financial position, business plan and strategies, are intended to
be forward-looking statements within the meaning of the safe harbor provisions
for forward-looking statements contained in the Private Securities Litigation
Reform Act of 1995. These statements are not guarantees of future performance
and involve certain risks, uncertainties and assumptions that are difficult to
predict.
 
 Typically,
forward-looking statements are predictive and are not statements of historical
fact, and the words "anticipate," "believe," "estimate," "seek," "expect,"
"plan," "intend," “think” and similar conditional expressions, as they relate to
us or to management, are intended to identify forward-looking statements.
Although we believe that the expectations reflected in these forward-looking
statements are reasonable, and although we have based these expectations upon
beliefs and assumptions we believe to be reasonable, these expectations may
prove to be incorrect. Important factors that could cause actual results to
differ materially from our expectations include, without limitation, the
following:
 
 ·
                our
      dependence on a favorable local economy in the Bank’s primary service
      area;
 ·
                the
      effect of general economic and monetary conditions on the Bank’s ability
      to attract deposits, make loans and achieve satisfactory interest
      spreads;
 ·
                the
      risk of losses due to loan defaults by both commercial loan customers or a
      significant number of other
borrowers;
 ·
                general
      changes in real estate, business and general property valuations
      underlying secured loans;
 ·
                the
      effect of banking regulation on the Bank’s ability to grow and
      compete;
 ·
                restrictions
      imposed on us by regulators; and
 ·
                our
      dependence on key banking and management
  personnel.
  We also
refer you to a discussion of the many other risks and uncertainties described
under “Risk Factors” in our Annual Report on Form 10-K, in our Quarterly Reports
on Form 10-Q, or in other reports we file from time to time with the Securities
and Exchange Commission, which are available on the Commission’s website at
www.sec.gov.
  2
  INDEX
 
 PART
I.   FINANCIAL INFORMATION
 
 Item
      1. Financial Statements
                  
                  page
      no.Consolidated
      Condensed Balance Sheets atSeptember 30, 2009 (unaudited) and
      December 31, 2008
                  
                  4Consolidated
      Condensed Statements of Operations for the three andnine months
      ended September 30, 2009 and September 30, 2008
    (unaudited)
                  
                  5Consolidated
      Condensed Statements of Changes in Stockholders’ Equity forthe
      nine months ended September 30, 2009 and September 30, 2008
      (unaudited)
                  
                  6Consolidated
      Condensed Statements of Cash Flows for the nine months endedSeptember 30, 2009 and September 30, 2008
      (unaudited)
                  
                  7Notes to Consolidated Condensed Financial Statements
      (unaudited)
                  
                  8Item
      2.   Management’s Discussion and Analysis of
      Financial Condition and Results of Operations
                  
                  24Item
      4.   Controls and
      Procedures
                  
                  33PART
      II.   OTHER INFORMATIONItem
      1.   Legal Proceedings
                  
                  34Item
      1a. Risk Factors
                  
                  34Item
      4.   Submission of Matters to a Vote of
      Security Holders
                  
                  34Item
      6.   Exhibits
                  
                  34SIGNATURES
                  
                  34
  3
 Index
  PART
I.  FINANCIAL INFORMATION
  Item
1.  FINANCIAL STATEMENTS
 Tower
Financial Corporation
 Consolidated
Condensed Balance Sheets
 At
September 30, 2009 and December 31, 2008
 (unaudited)September
      30,
                
                
                December
      31,2009
                
                
                2008ASSETSCash
      and due from banks
                
                $
                23,597,889
                
                
                $
                19,418,905Short-term
      investments and interest-earning deposits
                
                
                3,253,798
                
                
                
                9,525,414Federal
      funds sold
                
                
                3,088,130
                
                
                
                2,632,054Total
      cash and cash equivalents
                
                
                29,939,817
                
                
                
                31,576,373Securities
      available for sale, at fair value
                
                
                81,277,417
                
                
                
                77,792,255Securities
      held to maturity, at cost
                
                
                4,628,873
                
                
                
                -FHLB
      and FRB stock
                
                
                4,032,446
                
                
                
                4,032,446Loans
      held for sale
                
                
                1,387,958
                
                
                
                151,614Loans
                
                
                536,073,868
                
                
                
                561,011,675Allowance
      for loan losses
                
                
                (14,905,393
                )
                
                
                (10,654,879
                )Net
      loans
                
                
                521,168,475
                
                
                
                550,356,796Premises
      and equipment, net
                
                
                8,000,452
                
                
                
                8,010,596Accrued
      interest receivable
                
                
                2,511,735
                
                
                
                2,615,260Bank
      owned life insurance
                
                
                12,927,275
                
                
                
                12,589,699Other
      Real Estate Owned
                
                
                3,990,126
                
                
                
                2,660,310Other
      assets
                
                
                9,529,328
                
                
                
                6,798,774Total
      assets
                
                $
                679,393,902
                
                
                $
                696,584,123LIABILITIES
      AND STOCKHOLDERS' EQUITYLIABILITIESDeposits:Noninterest-bearing
                
                $
                98,858,989
                
                
                $
                82,107,483Interest-bearing
                
                
                493,871,633
                
                
                
                504,129,631Total
      deposits
                
                
                592,730,622
                
                
                
                586,237,114Federal
      Home Loan Bank (FHLB) advances
                
                
                16,200,000
                
                
                
                39,200,000Junior
      subordinated debt
                
                
                17,527,000
                
                
                
                17,527,000Accrued
      interest payable
                
                
                501,328
                
                
                
                658,956Other
      liabilities
                
                
                3,893,457
                
                
                
                3,342,913Total
      liabilities
                
                
                630,852,407
                
                
                
                646,965,983STOCKHOLDERS'
      EQUITYPreferred
      stock, par value of $100 per share, 4,000,000 shares authorized; 18,300
      and 0 shares issued and outstanding at September 30, 2009 and December 31,
      2008
                
                
                1,780,000
                
                
                
                -Common
      stock and paid-in-capital, no par value, 6,000,000   shares
      authorized; 4,155,432 and 4,149,432 shares issued;
      and     4,090,432 and 4,084,432 shares
      outstanding at at September 30, 2009 and December 31, 2008
                
                
                39,821,770
                
                
                
                39,766,742Treasury
      stock, at cost, 65,000 shares at September 30, 2009 and December 31,
      2008
                
                
                (884,376
                )
                
                
                (884,376
                )Retained
      earnings
                
                
                6,488,315
                
                
                
                10,895,724Accumulated
      other comprehensive income(loss), net of tax of $688,132 at September 30,
      2009 and ($82,399) at December 31, 2008
                
                
                1,335,786
                
                
                
                (159,950
                )Total
      stockholders' equity
                
                
                48,541,495
                
                
                
                49,618,140Total
      liabilities and stockholders' equity
                
                $
                679,393,902
                
                
                $
                696,584,123
 
 The
following notes are an integral part of the financial
statements.
  4
 Index
 
 Tower
Financial Corporation
 Consolidated
Condensed Statements of Operations
 For the
three and nine months ended September 30, 2009 and 2008
  (unaudited)
                
                
                (unaudited)Three
      Months ended
                
                
                Nine
      Months endedSeptember
      30
                
                
                September
      302009
                
                
                2008
                
                
                2009
                
                
                2008Interest
      income:Loans,
      including fees
                
                $
                6,959,860
                
                
                $
                8,303,686
                
                
                $
                21,107,524
                
                
                $
                25,919,244Securities
      - taxable
                
                
                824,234
                
                
                
                734,502
                
                
                
                2,240,516
                
                
                
                1,997,272Securities
      - tax exempt
                
                
                242,924
                
                
                
                220,715
                
                
                
                710,768
                
                
                
                658,061Other
      interest income
                
                
                1,951
                
                
                
                59,938
                
                
                
                11,504
                
                
                
                331,924Total
      interest income
                
                
                8,028,969
                
                
                
                9,318,841
                
                
                
                24,070,312
                
                
                
                28,906,501Interest
      expense:Deposits
                
                
                2,491,713
                
                
                
                3,322,465
                
                
                
                8,138,297
                
                
                
                11,397,623Short-term
      borrowings
                
                
                583
                
                
                
                2,776
                
                
                
                1,573
                
                
                
                2,776FHLB
      advances
                
                
                176,749
                
                
                
                284,982
                
                
                
                643,777
                
                
                
                857,759Junior
      subordinated debt
                
                
                283,072
                
                
                
                283,071
                
                
                
                846,369
                
                
                
                847,791Total
      interest expense
                
                
                2,952,117
                
                
                
                3,893,294
                
                
                
                9,630,016
                
                
                
                13,105,949Net
      interest income
                
                
                5,076,852
                
                
                
                5,425,547
                
                
                
                14,440,296
                
                
                
                15,800,552Provision
      for loan losses
                
                
                1,995,000
                
                
                
                1,999,000
                
                
                
                9,505,000
                
                
                
                3,174,000Net
      interest income after provision for loan losses
                
                
                3,081,852
                
                
                
                3,426,547
                
                
                
                4,935,296
                
                
                
                12,626,552Noninterest
      income:Trust
      and brokerage fees
                
                
                818,838
                
                
                
                936,689
                
                
                
                2,492,794
                
                
                
                2,769,715Service
      charges
                
                
                285,662
                
                
                
                288,186
                
                
                
                826,978
                
                
                
                923,540Loan
      broker fees
                
                
                218,870
                
                
                
                65,075
                
                
                
                552,551
                
                
                
                192,945Gain
      on sale of securities
                
                
                14,880
                
                
                
                6,004
                
                
                
                209,892
                
                
                
                65,841Impairment
      on available-for-sale securities (includes gains (losses) of $4,425 and
      ($165,474), net of $481,769 and $359,526 recognized in other comprehensive
      income, pretax for the three and nine months ended September 30,
      2009)
                
                
                (477,344
                )
                
                
                -
                
                
                
                (525,000
                )
                
                
                -Other
      fees
                
                
                348,939
                
                
                
                516,267
                
                
                
                1,040,881
                
                
                
                969,423Total
      noninterest income
                
                
                1,209,845
                
                
                
                1,812,221
                
                
                
                4,598,096
                
                
                
                4,921,464Noninterest
      expense:Salaries
      and benefits
                
                
                2,651,713
                
                
                
                2,813,399
                
                
                
                8,019,122
                
                
                
                8,951,643Occupancy
      and equipment
                
                
                779,044
                
                
                
                719,498
                
                
                
                2,170,446
                
                
                
                2,209,401Marketing
                
                
                87,660
                
                
                
                131,147
                
                
                
                366,532
                
                
                
                505,363Data
      processing
                
                
                257,974
                
                
                
                246,198
                
                
                
                879,426
                
                
                
                747,128Loan
      and professional costs
                
                
                445,546
                
                
                
                326,588
                
                
                
                1,140,686
                
                
                
                956,656Office
      supplies and postage
                
                
                87,003
                
                
                
                92,452
                
                
                
                257,549
                
                
                
                288,431Courier
      services
                
                
                58,048
                
                
                
                64,858
                
                
                
                177,955
                
                
                
                229,393Business
      development
                
                
                87,842
                
                
                
                140,317
                
                
                
                354,604
                
                
                
                469,149Communication
      Expense
                
                
                43,219
                
                
                
                90,856
                
                
                
                131,458
                
                
                
                242,579FDIC
      Insurance Premiums
                
                
                357,138
                
                
                
                180,036
                
                
                
                1,315,936
                
                
                
                547,791Write-down
      on Other Real Estate Owned
                
                
                -
                
                
                
                -
                
                
                
                950,000
                
                
                
                -Other
      expense
                
                
                612,700
                
                
                
                237,450
                
                
                
                1,155,325
                
                
                
                994,474Total
      noninterest expense
                
                
                5,467,887
                
                
                
                5,042,799
                
                
                
                16,919,039
                
                
                
                16,142,008Income
      (Loss) before income taxes
                
                
                (1,176,190
                )
                
                
                195,969
                
                
                
                (7,385,647
                )
                
                
                1,406,008Income
      tax expense (benefit)
                
                
                (455,615
                )
                
                
                (133,632
                )
                
                
                (2,979,817
                )
                
                
                22,528Net
      income (loss)
                
                $
                (720,575
                )
                
                $
                329,601
                
                
                $
                (4,405,830
                )
                
                $
                1,383,480Less:
      Preferred stock dividends
                
                
                1,579
                
                
                
                -
                
                
                
                1,579
                
                
                
                -Net
      income (loss) available to common stockholders
                
                $
                (722,154
                )
                
                $
                329,601
                
                
                $
                (4,407,409
                )
                
                $
                1,383,480
 
 The
following notes are an integral part of the financial
statements
  5
 Index
 
 Tower
Financial Corporation
 Consolidated
Condensed Statements of Changes in Stockholders’ Equity
 For the
nine months ended September 30, 2009 and 2008
  Preferred
      Stock
                  
                  
                  Common
      Stock, and Paid-in Capital
                  
                  
                  Retained
      Earnings
                  
                  
                  Accumulated
      Other Comprehensive Income (Loss)
                  
                  
                  Treasury
      Stock
                  
                  
                  TotalBalance,
      January 1, 2008
                  
                  $
                  -
                  
                  
                  $
                  39,482,669
                  
                  
                  $
                  9,208,719
                  
                  
                  $
                  274,993
                  
                  
                  $
                  (758,827
                  )
                  
                  $
                  48,207,554Net
      income for 2008
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  1,383,480
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  1,383,480Other
      Comprehensive Income (See Note 5)
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (1,113,456
                  )
                  
                  
                  
                  
                  
                  
                  (1,113,456
                  )Total
      Comprehensive Income
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  270,024Cash
      dividends paid ($0.044 per share)
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (179,104
                  )
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (179,104
                  )Issuance
      of 22,127 shares of common stock for stock options exercised, including
      tax benfit
                  
                  
                  
                  
                  
                  
                  220,639
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  220,639Stock
      based compensation expense
                  
                  
                  
                  
                  
                  
                  55,205
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  55,205Repurchase
      of 11,964 shares ofcommon
      stock
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (125,549
                  )
                  
                  
                  (125,549
                  )Balance,
      September 30, 2008
                  
                  $
                  -
                  
                  
                  $
                  39,758,513
                  
                  
                  $
                  10,413,095
                  
                  
                  $
                  (838,463
                  )
                  
                  $
                  (884,376
                  )
                  
                  $
                  48,448,769Balance,
      January 1, 2009
                  
                  $
                  -
                  
                  
                  $
                  39,766,742
                  
                  
                  $
                  10,895,724
                  
                  
                  $
                  (159,950
                  )
                  
                  $
                  (884,376
                  )
                  
                  $
                  49,618,140Net
      income(loss) for 2009
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (4,405,830
                  )
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (4,405,830
                  )Other
      Comprehensive Income (Loss) (SeeNote
      5)
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  1,495,736
                  
                  
                  
                  
                  
                  
                  
                  1,495,736Total
      Comprehensive Income (Loss)
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (2,910,094
                  )Issuance
      of Covertible Series A Preferred Stock (18,300 shares)
                  
                  
                  1,780,000
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  1,780,000Stock
      based compensation expense
                  
                  
                  
                  
                  
                  
                  55,028
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  55,028Preferred
      Stock Dividends Paid
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (1,579
                  )
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (1,579
                  )Balance,
      September 30, 2009
                  
                  $
                  1,780,000
                  
                  
                  $
                  39,821,770
                  
                  
                  $
                  6,488,315
                  
                  
                  $
                  1,335,786
                  
                  
                  $
                  (884,376
                  )
                  
                  $
                  48,541,495
  The
following notes are an integral part of the financial
statements
  6
 Index
  Tower
Financial Corporation
 Consolidated
Condensed Statements of Cash Flows
 For the
nine months ended September 30, 2009 and 2008
 (unaudited)
                
                
                (unaudited)Nine
      Months ended
                
                
                Nine
      Months endedSeptember
      30, 2009
                
                
                September
      30, 2008Cash
      flows from operating activities:Net
      income (loss)
                
                $
                (4,405,830
                )
                
                $
                1,383,480Adjustments
      to reconcile net income (loss) to net cash from operating
      activities:Depreciation
      and amortization
                
                
                1,012,154
                
                
                
                1,043,847Provision
      for loan losses
                
                
                9,505,000
                
                
                
                3,174,000Stock
      based compensation expense
                
                
                55,028
                
                
                
                55,205Earnings
      on life insurance
                
                
                (337,576
                )
                
                
                (320,983
                )Gain
      on sale of securities AFS
                
                
                (209,892
                )
                
                
                (65,841
                )Impairment
      on available-for-sale securities
                
                
                525,000
                
                
                
                -Gain
      on settlement of interest rate floor
                
                
                (364,766
                )
                
                
                (312,656
                )(Gain)Loss
      on disposal of premises and equipment
                
                
                231
                
                
                
                (36,697
                )Loans
      originated for sale
                
                
                (26,308,704
                )
                
                
                (6,475,527
                )(Gain)Loss
      on sale of other real estate owned
                
                
                68,970
                
                
                
                -Proceeds
      on sale of other real estate owned
                
                
                702,317
                
                
                
                -Write-down
      on other real estate owned
                
                
                950,000
                
                
                
                -Proceeds
      from sale of loans
                
                
                25,072,360
                
                
                
                8,966,173Change
      in accrued interest receivable
                
                
                103,525
                
                
                
                444,573Change
      in other assets
                
                
                (3,492,536
                )
                
                
                796,797Change
      in accrued interest payable
                
                
                (157,628
                )
                
                
                (936,925
                )Change
      in other liabilities
                
                
                498,965
                
                
                
                131,843Net
      cash from operating activities
                
                
                3,216,618
                
                
                
                7,847,289Cash
      flows from investing activities:Net
      change in loans
                
                
                16,623,666
                
                
                
                17,060,268Purchase
      of securities AFS
                
                
                (20,093,141
                )
                
                
                (29,907,366
                )Purchase
      of securities HTM
                
                
                (4,720,914
                )
                
                
                -Proceeds
      from calls and maturities of securities HTM
                
                
                92,041
                
                
                
                -Proceeds
      from calls and maturities of securities AFS
                
                
                12,021,820
                
                
                
                9,910,750Proceeds
      from settlement of interest rate floor
                
                
                -
                
                
                
                833,750Proceeds
      from sale of securities AFS
                
                
                6,738,302
                
                
                
                5,184,945Purchase
      of FHLB and FRB Stock
                
                
                -
                
                
                
                (442,746
                )Purchase
      of premises and equipment, net
                
                
                (838,456
                )
                
                
                487,404Net
      cash from investing activities
                
                
                9,823,318
                
                
                
                3,127,005Cash
      flows from financing activities:Net
      change in deposits
                
                
                6,493,508
                
                
                
                (27,468,190
                )Cash
      dividends paid
                
                
                -
                
                
                
                (179,104
                )Proceeds
      from issuance of common stock from exercise of stock
    options
                
                
                -
                
                
                
                220,639Proceeds
      from issuance of preferred stock
                
                
                1,830,000
                
                
                
                -Proceeds
      from FHLB advances
                
                
                -
                
                
                
                82,950,000Repayment
      of FHLB advances
                
                
                (23,000,000
                )
                
                
                (65,350,000
                )Repurchase
      of common stock
                
                
                -
                
                
                
                (125,549
                )Net
      cash from (used in) financing activities
                
                
                (14,676,492
                )
                
                
                (9,952,204
                )Net
      change in cash and cash equivalents
                
                
                (1,636,556
                )
                
                
                1,022,090Cash
      and cash equivalents, beginning of period
                
                
                31,576,373
                
                
                
                33,830,389Cash
      and cash equivalents, end of period
                
                $
                29,939,817
                
                
                $
                34,852,479Supplemental
      disclosures of cash flow informationCash
      paid during the year for:Interest
                
                $
                9,787,644
                
                
                $
                14,042,874Income
      taxes
                
                
                1,265,000
                
                
                
                -Noncash
      items:Transfer
      of loans to other real estate owned
                
                
                3,059,655
                
                
                
                1,819,306
 
 The
following notes are an integral part of the financial
statements.
  7
 Index
  Tower
Financial Corporation
 Notes
to Consolidated Condensed Financial Statements
 
 
 Note
1 – Basis of Presentation
 
 The
accompanying unaudited consolidated financial statements are filed for Tower
Financial Corporation and its wholly-owned subsidiaries, Tower Bank & Trust
(or the “Bank” or “Tower Bank”), Tower Trust Company (or the “Trust Company”),
and two unconsolidated subsidiary guarantor trusts, Tower Capital Trust 2, and
Tower Capital Trust 3.  Also included is the Bank’s wholly-owned
subsidiary, Tower Capital Investments, which owns Tower Funding Corporation, a
real estate investment trust.
 
 The
accompanying unaudited consolidated condensed financial statements were prepared
in accordance with generally accepted accounting principles for interim periods
and with instructions for Form 10-Q and, therefore, do not include all
disclosures required by generally accepted accounting principles for complete
presentation of the Company’s financial statements.  In the opinion of
management, the unaudited consolidated condensed financial statements contain
all adjustments necessary to present fairly its consolidated financial position
at September 30, 2009 and its consolidated results of operations, comprehensive
income, changes in stockholders’ equity and cash flows for the nine-month
periods ended September 30, 2009 and September 30, 2008.  The results
for the period ended September 30, 2009 should not be considered as indicative
of results for a full year.  These consolidated condensed financial
statements should be read in conjunction with the audited financial statements
for the years ended December 31, 2008, 2007, and 2006 and related notes included
in the Company’s Annual Report on Form 10-K for the year ended December 31,
2008.
 
 Note
2 – Summary of Critical Accounting Policies
 
 A
comprehensive discussion of our critical accounting policies is disclosed in
Note 1 of our Annual Report on Form 10-K for the year ended December 31,
2008.  Certain accounting policies require management to use estimates
and make assumptions based on available information.  These estimates
and assumptions affect the amounts reported in the financial statements and
disclosures provided, and actual results could differ.  There were no
material changes in the information regarding our critical accounting policies
since December 31, 2008.
 
 The
following policies affect our reported earnings and financial condition and
require significant estimates and assumptions:
 
 Allowance for Loan Losses: Our
allowance for loan losses represents management’s estimate of probable incurred
credit losses in the loan portfolio at the balance sheet date. Additions to the
allowance may result from recording provision for loan losses and recoveries,
while charge-offs are deducted from the allowance. Allocation of the allowance
is made for analytical purposes only, and the entire allowance is available to
absorb probable and estimated credit losses inherent in the loan
portfolio.
  We have
an established process for determining the adequacy of the allowance for loan
losses that relies on various procedures and pieces of information to arrive at
a range of probable outcomes. First, management allocates specific portions of
the allowance for loan losses to identified problem loans. Problem loans are
identified through a loan risk rating system and monitored through watchlist
reporting. Specific reserves are determined for each identified credit based on
delinquency rates, collateral and other risk factors identified for that credit.
Second, management’s evaluation of the allowance for different loan groups is
based on consideration of actual loss experience, the present and prospective
financial condition of borrowers, industry concentrations within the loan
portfolio and general economic conditions, and absent the ability of some of
those factors, as well as peer industry data of comparable banks.
 
 The
determination of the level of allowance and, correspondingly, the provision for
loan losses, rests upon estimates and assumptions, including past loan loss
experience, the nature and volume of the portfolio, information about specific
borrower situations and estimated collateral values, economic conditions and
other factors. Loan losses are charged against the allowance when management
believes the uncollectibility of a loan is confirmed.
 
 A loan is
impaired when full payment under the loan terms is not expected. Large groups of
smaller balance homogeneous loans, such as consumer and residential real estate
loans, are collectively evaluated for impairment, and accordingly, they are not
identified for impairment disclosures. Commercial loans and mortgage loans
secured by other properties are evaluated individually for impairment. When
analysis of a borrower's operating results and financial condition indicates
that underlying cash flows of the borrower's business are not adequate to meet
its debt service requirements, the loan is evaluated for impairment. If a loan
is impaired, a portion of the allowance is allocated so that the loan is
reported, net, at the present value of estimated future cash flows using the
loan's existing interest rate or at the fair value of collateral if repayment is
expected solely from the collateral.
  8
 Index
  Income Taxes:Income tax
expense is the sum of the current year income tax due or refundable and the
change in deferred tax assets and liabilities.  Deferred tax assets
and liabilities are the expected future tax consequences of the temporary
differences between carrying amounts and tax bases of assets and liabilities,
computed using enacted tax rates.  A valuation allowance, if needed,
reduces deferred tax assets to the amount expected to be
realized.  Deferred tax assets are recognized for net operating losses
that expire primarily in 2023 because the benefit is more likely than not to be
realized. We adopted Income Taxes (Topic 740), Accounting for Uncertainty in
Income Taxes, as of January 1, 2007.  A tax position is recognized as
a benefit only if it is "more likely than not" that the tax position would be
sustained in a tax examination, with a tax examination being presumed to
occur.  The amount recognized is the largest amount of tax benefit
that is greater than 50% likely of being realized on examination.  For
tax positions not meeting the "more likely than not" test, no tax benefit is
recorded.  If required, we would recognize interest and/or penalties
related to income tax matters in income tax expense.  The adoption had
no affect on the Company’s financial statements.
 
 We are
subject to U.S. federal income tax as well as income tax of the state of
Indiana.  We are no longer subject to examination by taxing
authorities for years before 2004.  We do not expect the total amount
of unrecognized tax benefits to significantly increase in the next twelve
months.
 
 Fair Values of Financial
Instruments:Effective January 1, 2008, we determined the fair
value of our financial instruments based on a fair value hierarchy which
requires an entity to maximize the use of observable inputs and minimize the use
of unobservable inputs when measuring fair value.  When available, we
use quoted market prices to determine fair value, and classify such items within
Level 1 of the fair value hierarchy.  If quoted market prices are not
available, we attempt to find quoted market prices for similar instruments or
inputs that are observable and may be corroborated.  These would
qualify as Level 2.  If no observable market prices or inputs are
available, management uses unobservable inputs and documents the rationale to
support such assumptions.  These instruments qualify as Level
3.  In all cases changes in market conditions or assumptions could
significantly affect the estimated fair value of an instrument.  The
fair value estimates of existing on- and off-balance-sheet financial instruments
do not include the value of anticipated future business or the value of assets
and liabilities not considered financial instruments.
 
 Note
3 – New Accounting Pronouncements
 
 In June
2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards Codification
and the Hierarchy of Generally Accepted Accounting Principles,” which was
primarily codified into FASB ASC Topic 105 “Generally Accepted Accounting
Standards.” FASB ASC Topic 105 provides for the FASB Accounting Standards
Codification to be the official source of authoritative, nongovernmental U.S.
generally accepted accounting principles (“GAAP”). The provisions of FASB ASC
Topic 105 are effective for interim and annual periods ending after September
15, 2009 and, accordingly, are effective for the Company for the current
reporting period. The adoption of this pronouncement did not have an impact on
the Company’s financial condition or results of operations, but will impact our
financial reporting process by eliminating all references to pre-codification
standards. On the effective date of this Statement, the FASB ASC superseded all
then-existing non-SEC accounting and reporting standards, and all other
non-grandfathered non-SEC accounting literature not included in the FASB ASC
became non-authoritative.
 
 Recently
issued and not yet effective:
 In August
2009, the FASB issued ASU No. 2009-05, “Fair Value Measurements and Disclosures
(Topic 820) – Measuring Liabilities at Fair Value”.  This ASU provides
amendments for fair value measurements of liabilities.  It provides
clarification that in circumstances in which a quoted price in an active market
for the identical liability is not available, a reporting entity is required to
measure fair value using one or more techniques.  ASU 2009-05 also
clarifies that when estimating a fair value of a liability, a reporting entity
is not required to include a separate input or adjustment to other inputs
relating to the existence of a restriction that prevents the transfer of the
liability.  ASU 2009-05 is effective for the first reporting period
(including interim periods) beginning after issuance or fourth quarter
2009.  The Company is assessing the impact of ASU 2009-05 on our
financial condition, results of operations, and disclosures.
  9
 Index
  Note
4 – Securities Available for Sale
 The
following table summarizes the amortized cost and fair value of the available
for sale and held to maturity investment securities portfolio at September 30,
2009 and December 31, 2008 and the corresponding amounts of unrealized gains and
losses therein:
 
 September
      30, 2009Amortized
                  
                  
                  Gross
      Unrealized
                  
                  
                  Gross
      Unrealized
                  
                  
                  FairCost
                  
                  
                  Gains
                  
                  
                  Losses
                  
                  
                  ValueAvailable
      for Sale:U.S.
      Government agency debt obligations
                  
                  $
                  7,728,072
                  
                  
                  $
                  166,129
                  
                  
                  $
                  -
                  
                  
                  $
                  7,894,201Obligations
      of states and political subdivisions
                  
                  
                  25,460,985
                  
                  
                  
                  844,546
                  
                  
                  
                  (98,103
                  )
                  
                  
                  26,207,428Mortgage-backed
      securities
                  
                  
                  45,628,099
                  
                  
                  
                  1,715,676
                  
                  
                  
                  (246,465
                  )
                  
                  
                  47,097,310Trust
      Preferred securities
                  
                  
                  436,341
                  
                  
                  
                  -
                  
                  
                  
                  (357,863
                  )
                  
                  
                  78,478Total
                  
                  $
                  79,253,497
                  
                  
                  $
                  2,726,351
                  
                  
                  $
                  (702,431
                  )
                  
                  $
                  81,277,417
  Amortized
                  
                  
                  Gross
      Unrecognized
                  
                  
                  Gross
      Unrecognized
                  
                  
                  FairHeld
      to Maturity:
                  
                  Cost
                  
                  
                  Gains
                  
                  
                  Losses
                  
                  
                  ValueMortgage-backed
      securities
                  
                  $
                  4,628,873
                  
                  
                  $
                  -
                  
                  
                  $
                  (122,476
                  )
                  
                  $
                  4,506,397Total
                  
                  $
                  4,628,873
                  
                  
                  $
                  -
                  
                  
                  $
                  (122,476
                  )
                  
                  $
                  4,506,397
  December
      31, 2008Amortized
                  
                  
                  Gross
      Unrealized
                  
                  
                  Gross
      Unrealized
                  
                  
                  FairCost
                  
                  
                  Gains
                  
                  
                  Losses
                  
                  
                  ValueAvailable
      for Sale:U.S.
      Government agency debt obligations
                  
                  $
                  8,038,385
                  
                  
                  $
                  230,747
                  
                  
                  $
                  -
                  
                  
                  $
                  8,269,132Obligations
      of states and political subdivisions
                  
                  
                  21,908,378
                  
                  
                  
                  87,023
                  
                  
                  
                  (737,771
                  )
                  
                  
                  21,257,630Mortgage-backed
      securities
                  
                  
                  47,449,188
                  
                  
                  
                  943,358
                  
                  
                  
                  (357,953
                  )
                  
                  
                  48,034,593Trust
      Preferred securities
                  
                  
                  948,290
                  
                  
                  
                  -
                  
                  
                  
                  (717,390
                  )
                  
                  
                  230,900Total
                  
                  $
                  78,344,241
                  
                  
                  $
                  1,261,128
                  
                  
                  $
                  (1,813,114
                  )
                  
                  $
                  77,792,255
  10
 Index
  The fair
values of debt securities available for sale and held to maturity at September
30, 2009 and December 31, 2008, by contractual maturity, are shown below.
Securities not due at a single date, primarily mortgage-backed securities, are
shown separately. Expected maturities may differ from contractual maturities
because borrowers may have the right to call or prepay obligations with or
without penalties.
 
 9/30/2009
                  Weighted
                  Average
                  Yield
                
                
                9/30/2009
                  
                  Fair
                  Value
                
                
                12/31/2008
                  Weighted
                  Average
                  Yield
                
                
                12/31/2008
                  
                  Fair
                  ValueAvailable
      for sale:Agencies:Due
      in one year or less
                
                
                0.00
                %
                
                $
                -
                
                
                
                0.00
                %
                
                $
                -Due
      after one to five years
                
                
                3.89
                %
                
                
                4,598,045
                
                
                
                4.45
                %
                
                
                5,739,408Due
      after five years
                
                
                4.07
                %
                
                
                1,782,721
                
                
                
                4.10
                %
                
                
                2,529,724Due
      after ten years
                
                
                3.53
                %
                
                
                1,513,435
                
                
                
                0.00
                %
                
                
                -Total
      Agencies
                
                
                3.86
                %
                
                $
                7,894,201
                
                
                
                4.35
                %
                
                $
                8,269,132Mortgage-backed
      securities:Mortgage-backed
      securities
                
                
                4.72
                %
                
                $
                47,097,310
                
                
                
                4.66
                %
                
                $
                48,034,593Obligations
      of state and political subdivisions:Due
      in one year or less
                
                
                5.03
                %
                
                $
                192,402
                
                
                
                4.30
                %
                
                $
                110,790Due
      after one to five years
                
                
                4.63
                %
                
                
                1,998,808
                
                
                
                5.07
                %
                
                
                806,104Due
      after five to ten years
                
                
                5.98
                %
                
                
                6,505,282
                
                
                
                5.87
                %
                
                
                5,180,237Due
      after ten years
                
                
                6.21
                %
                
                
                17,510,936
                
                
                
                6.15
                %
                
                
                15,160,499Total
      Obligations of state and political subdivisions
                
                
                6.03
                %
                
                $
                26,207,428
                
                
                
                6.03
                %
                
                $
                21,257,630Trust
      Preferred SecuritiesDue
      after ten years
                
                
                1.15
                %
                
                $
                78,478
                
                
                
                3.11
                %
                
                $
                230,900Held
      to maturity:Mortgage-backed
      securities:Mortgage-backed
      securities
                
                
                12.69
                %
                
                $
                4,506,397
                
                
                
                0.00
                %
                
                $
                -
 
 Proceeds
from securities sold classified as available for sale totaled $6.7 million and
$5.2 million as of September 30, 2009 and September 30, 2008,
respectively.  Gross gains realized were $209,892 and $65,841, with an
approximate tax expense of $71,363 and $22,386, as of September 30, 2009 and
September 30, 2008, respectively.  There were no gross losses realized
on the sale of available for sale securities during the nine month periods
ending September 30, 2009 and September 30, 2008.  Also impacting
earnings during the third quarter of 2009 is an other-than-temporary impairment
charge related to a credit loss on one trust preferred security in the amount of
$477,344, described below.  The impairment recognized in the third
quarter brought the security down to 43.2% of its par value; therefore, only
$436,341 of book value remains on the security.
 
 Securities
with a carrying value of $2.8 million and $3.8 million were pledged to secure
borrowings from the FHLB at September 30, 2009 and December 31, 2008,
respectively.  Securities with a carrying value of $22.2 million and
$5.1 million were pledged to the Federal Reserve to secure potential borrowings
at the Discount Window at September 30, 2009 and December 31, 2008,
respectively.  Securities with a carrying value of $5.8 million and
$6.1 million were pledged at Wells Fargo and securities with
a  carrying value of $3.9 million and $0 were pledged at the First
Tennessee Bank to secure federal funds lines of credit at September 30, 2009 and
December 31, 2008, respectively.  At September 30, 2009, there were no
holdings of any one issuer, other than the U.S. Government and its agencies and
corporations, in an amount greater than 10% of stockholders'
equity.
  11
 Index
  Securities
with unrealized losses at September 30, 2009 not recognized in income are as
follows:
 
 Continuing
      Unrealized Losses for Less than 12 months
                
                
                Continuing
      Unrealized Losses for More than 12 months
                
                
                TotalFair
      Value
                
                
                Gross
      Unrealized Losses
                
                
                Fair
      Value
                
                
                Gross
      Unrealized Losses
                
                
                Fair
      Value
                
                
                Gross
      Unrealized LossesAvailable
      for sale:U.S.
      Government agency debt obligations
                
                $
                -
                
                
                $
                -
                
                
                $
                -
                
                
                $
                -
                
                
                $
                -
                
                
                $
                -Obligations
      of states and political subdivisions
                
                
                298,690
                
                
                
                (6,557
                )
                
                
                2,935,198
                
                
                
                (91,546
                )
                
                
                3,233,888
                
                
                
                (98,103
                )Mortgage-backed
      securities
                
                
                1,514,719
                
                
                
                (5,323
                )
                
                
                498,218
                
                
                
                (241,142
                )
                
                
                2,012,937
                
                
                
                (246,465
                )Trust
      preferred securities
                
                
                -
                
                
                
                -
                
                
                
                78,478
                
                
                
                (357,863
                )
                
                
                78,478
                
                
                
                (357,863
                )Total
      temporarily impaired
                
                $
                1,813,409
                
                
                $
                (11,880
                )
                
                $
                3,511,894
                
                
                $
                (690,551
                )
                
                $
                5,325,303
                
                
                $
                (702,431
                )Fair
      Value
                
                
                Gross
      Unrecognized Losses
                
                
                Fair
      Value
                
                
                Gross
      Unrecognized Losses
                
                
                Fair
      Value
                
                
                Gross
      Unrecognized LossesHeld
      to maturity:Mortgage-backed
      securities
                
                
                4,506,397
                
                
                
                (122,476
                )
                
                
                -
                
                
                
                -
                
                
                
                4,506,397
                
                
                
                (122,476
                )Total
      temporarily impaired
                
                $
                4,506,397
                
                
                $
                (122,476
                )
                
                $
                -
                
                
                $
                -
                
                
                $
                4,506,397
                
                
                $
                (122,476
                )
  Securities
with unrealized losses at December 31, 2008 not recognized in income are as
follows:
 
 Continuing
      Unrealized Losses for Less than 12 months
                
                
                Continuing
      Unrealized Losses for More than 12 months
                
                
                TotalFair
      Value
                
                
                Gross
      Unrealized Losses
                
                
                Fair
      Value
                
                
                Gross
      Unrealized Losses
                
                
                Fair
      Value
                
                
                Gross
      Unrealized LossesU.S.
      Government agency debt obligations
                
                $
                -
                
                
                $
                -
                
                
                $
                -
                
                
                $
                -
                
                
                $
                -
                
                
                $
                -Obligations
      of states and political subdivisions
                
                
                17,180,355
                
                
                
                (649,015
                )
                
                
                816,971
                
                
                
                (88,756
                )
                
                
                17,997,326
                
                
                
                (737,771
                )Mortgage-backed
      securities
                
                
                5,490,894
                
                
                
                (357,953
                )
                
                
                -
                
                
                
                -
                
                
                
                5,490,894
                
                
                
                (357,953
                )Trust
      preferred securities
                
                
                -
                
                
                
                -
                
                
                
                230,900
                
                
                
                (717,390
                )
                
                
                230,900
                
                
                
                (717,390
                )Total
      temporarily impaired
                
                $
                22,671,249
                
                
                $
                (1,006,968
                )
                
                $
                1,047,871
                
                
                $
                (806,146
                )
                
                $
                23,719,120
                
                
                $
                (1,813,114
                )
  Unrealized
losses on mortgage-backed securities and state and municipality bonds have not
been recognized into income because most of the issuers’ bonds are of high
credit quality and management has the intent and ability to hold for the
foreseeable future; however, see discussion on mortgage-backed securities that
are not of investment grade in the mortgage-backed security
section.  Of the bonds that are deemed to not be
other-than-temporarily-impaired, the fair value is expected to recover as the
bonds approach their maturity and/or as market rates continue to
decline.
 
 We
evaluate securities for other-than-temporary impairment (OTTI) at least on a
quarterly basis, and more frequently when economic or market concerns warrant
such evaluation.  The investment securities portfolio is evaluated for
OTTI by segregating the portfolio into two general segments and applying the
appropriate OTTI forecast assumptions. Investment securities classified as
available for sale are generally evaluated for OTTI in accordance with
accounting standards on how to account for certain investments in debt and
equity securities. However, certain purchased beneficial interests, including
asset-backed securities and collateralized debt obligations, that had credit
ratings at the time of purchase of below AA are evaluated using the model
outlined in FASB ASC 325-40-55, Recognition of Interest Income and Impairment on
Purchased Beneficial Interests and Beneficial Interests that Continue to be Held
by a Transfer in Securitized Financial Assets.
  12
 Index
  In
determining OTTI under a recent staff position outlining how to recognize and
present other than temporary impairments, management considers many factors,
including: (1) the length of time and the extent to which the fair value
has been less than cost, (2) the financial condition and near-term
prospects of the issuer, (3) whether the market decline was affected by
macroeconomic conditions, and (4) whether the entity has the intent to sell
the debt security or more likely than not will be required to sell the debt
security before its anticipated recovery. 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.
 
 The
second segment of the portfolio uses the OTTI guidance that is specific to
purchased beneficial interests that, on the purchase date, were rated below AA.
The Company compares the present value of the remaining cash flows as estimated
at the preceding evaluation date to the current expected remaining cash flows.
An OTTI is deemed to have occurred if there has been an adverse change in the
remaining expected future cash flows.
 
 When
other-than-temporary-impairment occurs under either model, the amount of the
other-than-temporary-impairment recognized in earnings depends on whether an
entity intends to sell the security or more likely than not will be required to
sell the security before recovery of its amortized cost basis less any
current-period credit loss. If an entity intends to sell or more likely than not
will be required to sell the security before recovery of its amortized cost
basis less any current-period credit loss, the other-than-temporary-impairment
shall 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.
If an entity does not intend to sell the security and it is not more likely than
not that the entity will be required to sell the security before recovery of its
amortized cost basis less any current-period loss, the
other-than-temporary-impairment shall be separated into the amount representing
the credit loss and the amount related to all other factors. The amount of the
total other-than-temporary-impairment 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 total other-than-temporary-impairment
related to other factors shall be recognized in other comprehensive income, net
of applicable taxes. The previous amortized cost basis less the
other-than-temporary-impairment recognized in earnings shall become the new
amortized cost basis of the investment.
 
 As of
September 30, 2009, Tower Financial Corporation’s security portfolio consisted
of 172 securities, 12 of which were in an unrealized loss position. The majority
of unrealized losses are related to the Company’s mortgage-backed and trust
preferred securities, as discussed below:
 
 Mortgage-backed
Securities
 At
September 30, 2009, approximately 89% of the mortgage-backed securities we held
were issued by U.S. government-sponsored entities and agencies, primarily Fannie
Mae and Freddie Mac, institutions which the government has affirmed its
commitment to support. Because the decline in market value is attributable to
changes in interest rates and illiquidity, and not credit quality, and because
the Company does not have the intent to sell these mortgage-backed securities
and it is likely that it will not be required to sell the securities before
their anticipated recovery, the Company does not consider these securities to be
other-than-temporarily impaired at September 30, 2009.
 
 The
Company’s mortgage-backed securities portfolio did contain one non-agency
collateralized mortgage obligation with a market value of $498,218 which had
unrealized losses of $241,143 at September 30, 2009. This non-agency
mortgage-backed security was rated AAA at the time of purchase and is currently
rated CCC by S&P. The Company monitors to insure it has adequate credit
support and as of September 30, 2009, the Company believes there is no
other-than-temporary-impairment and does not have the intent to sell the
security and it is likely that it will not be required to sell the security
before its anticipated recovery.
 
 In the
second quarter of 2009, we purchased $4.7 million of non-agency backed CMO
investments. These investments were purchased as loan alternatives. The bonds
are classified as held to maturity as we have no intention of using the
securities for liquidity purposes. The four securities purchased all had AAA
rating from Standard & Poors. These bonds make up less than 10% of
capital.  The Company continues to monitor these securities and obtain
current market prices at least on a quarterly basis.  Based on this
review, the Company does not consider these securities to be
other-than-temporarily impaired at September 30, 2009.
  Trust
Preferred Securities
 
 The
Company, through the bank’s investment subsidiary, owns a $1 million original
investment in PreTSL XXV, a pooled $877.4 million book value at the time of
purchase.  This is the company’s only pooled trust preferred security.
At September 30, 2009, the market value of the investment was $78,478 and the
book value was $436,341.  The investment was rated Ca by Moody’s and C
by Fitch.
 
 The
investment is divided into seven tranches.  Tower’s investment is in
the fifth tranche (C-1), meaning the cashflows on the investment are
subordinated to the higher placed tranches. There are sixty-eight (68) issuing
participants in PreTSL XXV.  Fifty-eight (58) of the issuers are banks
or bank holding companies, with the remaining issuers being insurance
companies.  As of September 30, 2009, the amount of deferrals and
defaults was $264.1 million, or 30.1% of the total pool.  Of the total
$877.4 million of original collateral, $613.3 million is currently paying
interest.  The defaults and deferrals occurred as
follows:
  13
 Index
 
 Deferral
                
                
                DefaultMarch
      31, 2008
                
                $
                -
                
                
                $
                25,000,000September
      30, 2008
                
                
                20,000,000
                
                
                
                -December
      31, 2008
                
                
                15,000,000
                
                
                
                35,000,000March
      31, 2009
                
                
                22,500,000
                
                
                
                -June
      30, 2009
                
                
                35,600,000
                
                
                
                25,000,000September
      30, 2009
                
                
                86,000,000
                
                
                
                -
 
 We have
concluded that as of September 30, 2009, the investment had OTTI of
approximately 52.5%, or $525,000.  This created an OTTI charge in the
third quarter of $477,344, as we had previously recorded an OTTI charge of
$47,656 in the second quarter.
 
 The
Company uses the OTTI evaluation model to compare the present value of expected
cash flows to the previous estimate to determine whether an adverse change in
cash flows has occurred during the quarter. The OTTI model considers the
structure and term of the collateralized debt obligation (“CDO”) and the
financial condition of the underlying issuers. Specifically, the model details
interest rates, principal balances of note classes and underlying issuers, the
timing and amount of interest and principal payments of the underlying issuers,
and the allocation of the payments to the note classes. The current estimate of
expected cash flows is based on the most recent trustee reports and any other
relevant market information including announcements of interest payment
deferrals or defaults of underlying trust preferred securities. Assumptions used
in the model include expected future default rates and prepayments. We assume
that all interest payment deferrals will become defaults prior to their next
payment dates and that there will be no recoveries on defaults. In addition we
use the model to “stress” each CDO, or make assumptions more severe than
expected activity, to determine the degree to which assumptions could
deteriorate before the CDO could no longer fully support repayment of Tower’s
note class. We evaluate the credit quality of each underlying issuer in the pool
and apply a risk rating for each issuer and then put this risk rating into a
relevant risk model to identify immediate default risk.  Upon
completion of the September 30, 2009 analysis, our model indicated
other-than-temporary impairment on this security due to additional deferrals and
risk of immediate default during the fourth quarter.
 
 Note
5 – Comprehensive Income (Loss)
 
 Comprehensive
income (loss) consists of net income (loss) and other comprehensive income
(loss) (“OCI”). Other comprehensive income (loss) includes unrealized gains and
losses on securities available-for-sale.  All items reported in other
comprehensive income (loss) are reported net of tax.  Following is a
summary of other comprehensive income (loss) for the three and nine months ended
September 30, 2009 and 2008:
 
 Three
      months ended September 302009
                
                
                2008Net
      Income (Loss)
                
                $
                (720,575
                )
                
                $
                329,601Change
      in securities available-for-sale:Other-than-temporary
      impairment on available-for-sale securities
                
                
                4,425
                
                
                
                -Other-than-temporary
      impairment on available-for-sale securities associated with credit losses
      realized in income
                
                
                477,344
                
                
                
                -Other-than-temporary
      impairment on available-for-sale securities, recorded in
    OCI
                
                
                481,769
                
                
                
                -Unrealized
      gains (losses) on interest rate floor
                
                
                41,260
                
                
                
                137,517Unrealized
      holding gains (losses) on available-for-sale securities arising during the
      period
                
                
                1,810,720
                
                
                
                (350,525
                )Reclassification
      adjustment for gains (losses) realized in income on interest rate
      floor
                
                
                (41,260
                )
                
                
                (137,517
                )Reclassification
      adjustment for gains (losses) realized in income on available-for-sale
      securities
                
                
                (14,880
                )
                
                
                (6,004
                )Net
      unrealized gains (losses)
                
                
                1,795,840
                
                
                
                (356,529
                )Income
      tax expense (benefit)
                
                
                774,387
                
                
                
                378,815Total
      other comprehensive income (loss)
                
                
                1,503,222
                
                
                
                (735,344
                )Comprehensive
      Income (Loss)
                
                $
                782,647
                
                
                $
                (405,743
                )
  14
 Index
 
 Nine
      months ended September 302009
                
                
                2008Net
      Income (Loss)
                
                $
                (4,405,830
                )
                
                $
                1,383,480Change
      in securities available-for-sale:Other-than-temporary
      impairment on available-for-sale securities
                
                
                (165,474
                )
                
                
                -Other-than-temporary
      impairment on available-for-sale securities associated with credit losses
      realized in income
                
                
                525,000
                
                
                
                -Other-than-temporary
      impairment on available-for-sale securities, recorded in
    OCI
                
                
                359,526
                
                
                
                -Unrealized
      gains (losses) on interest rate floor
                
                
                309,637
                
                
                
                298,076Unrealized
      holding gains (losses) on available-for-sale securities arising during the
      period
                
                
                2,116,633
                
                
                
                (1,641,941
                )Reclassification
      adjustment for gains (losses) realized in income on interest rate
      floor
                
                
                (309,637
                )
                
                
                (277,349
                )Reclassification
      adjustment for gains (losses) realized in income on available-for-sale
      securities
                
                
                (209,892
                )
                
                
                (65,841
                )Net
      unrealized gains (losses)
                
                
                1,906,741
                
                
                
                (1,687,055
                )Income
      tax expense (benefit)
                
                
                770,531
                
                
                
                (573,599
                )Total
      other comprehensive income (loss)
                
                
                1,495,736
                
                
                
                (1,113,456
                )Comprehensive
      Income (Loss)
                
                $
                (2,910,094
                )
                
                $
                270,024
 
 Note
6 - Earnings Per Share
 
 The
following table reflects the calculation of basic and diluted earnings per
common share for the three and nine-month periods ended September 30, 2009 and
September 30, 2008.  Options not considered in the calculation of
diluted earnings per common share because they were antidilutive, totaled
102,934 and 187,925 for the three-month period and 102,934 and 99,804 for the
nine-month period ended September 30, 2009 and 2008, respectively.  In
addition, preferred stock convertible to common stock was not considered in the
calculation of diluted earnings per common share because they were anitdilutive
totaling 303,987 shares for the three and nine month periods ended September 30,
2009.
 
 Three
      Months Ended
                
                
                Nine
      Months EndedSeptember
      30
                
                
                September
      302009
                
                
                2008
                
                
                2009
                
                
                2008BasicNet
      income (loss)
                
                $
                (720,575
                )
                
                $
                329,601
                
                
                $
                (4,405,830
                )
                
                $
                1,383,480Less:
      Preferred stock dividends
                
                
                1,579
                
                
                
                -
                
                
                
                1,579
                
                
                
                -Net
      income (loss) available to common stockholders
                
                $
                (722,154
                )
                
                $
                329,601
                
                
                $
                (4,407,409
                )
                
                $
                1,383,480Weighted
      average common shares outstanding
                
                
                4,090,432
                
                
                
                4,084,432
                
                
                
                4,090,410
                
                
                
                4,072,762Basic
      earnings (loss) per common share
                
                $
                (0.18
                )
                
                $
                0.08
                
                
                $
                (1.08
                )
                
                $
                0.34DilutedNet
      income (loss)
                
                $
                (720,575
                )
                
                $
                329,601
                
                
                $
                (4,405,830
                )
                
                $
                1,383,480Less:
      Preferred stock dividends
                
                
                1,579
                
                
                
                -
                
                
                
                1,579
                
                
                
                -Net
      income (loss) available to common stockholders
                
                $
                (722,154
                )
                
                $
                329,601
                
                
                $
                (4,407,409
                )
                
                $
                1,383,480Weighted
      average common shares outstanding
                
                
                4,090,432
                
                
                
                4,084,432
                
                
                
                4,090,410
                
                
                
                4,072,762Add: dilutive
      effect of assumed stock option exercises
                
                
                -
                
                
                
                2,325
                
                
                
                -
                
                
                
                8,679Weighted
      average common shares and dilutive potential common shares
      outstanding
                
                
                4,090,432
                
                
                
                4,086,757
                
                
                
                4,090,410
                
                
                
                4,081,441Diluted
      earnings (loss) per common share
                
                $
                (0.18
                )
                
                $
                0.08
                
                
                $
                (1.08
                )
                
                $
                0.34
 
 Note
7 – Equity Incentive Plans
 
 Options
to buy stock were previously granted to directors, officers and employees under
the 1998 and 2001 Stock Option and Incentive Plans (the “Plans”), which together
provided for issuance of up to 435,000 shares of common stock of the
Company.  Options for all 435,000 shares were issued under the Plans,
of which 102,934 remain outstanding as of September 30, 2009.  Option
awards were granted with an exercise price equal to the market price of the
Company’s stock at the date of each grant, vesting over a four-year period, and
issued with a ten-year contractual term.  The compensation cost that
has been charged against income for options granted under the Plans was $6,451
and $14,760 for the three months ended September 30, 2009 and September 30,
2008, respectively, and $19,845 and $43,955 for the nine months ended September
30, 2009 and September 30, 2008, respectively.  No income tax benefit
was recognized in the income statement for the share-based compensation
arrangements.
  15
 Index
  A summary
of the option activity under the Plans as of September 30, 2009 and changes
during the nine-month period then ended are presented below:
  Options
                
                Shares
                
                
                Weighted-
      Average Aggregate Exercise Price
                
                
                Weighted-
      Average Remaining Contractual Term
                
                
                Instrinsic
      ValueOutstanding
      at January 1, 2009
                
                
                166,675
                
                
                $
                11.88
                
                
                
                -
                
                
                $
                -Granted
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -Exercised
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -Forfeited
      or expired
                
                
                (63,741
                )
                
                
                10.05
                
                
                
                -
                
                
                
                -Outstanding
      at September 30, 2009
                
                
                102,934
                
                
                
                13.02
                
                
                
                3.54
                
                
                
                -Vested
      or expected to vest at September 30, 2009
                
                
                102,238
                
                
                
                13.00
                
                
                
                3.52
                
                
                
                -Exercisable
      at September 30, 2009
                
                
                98,707
                
                
                
                12.89
                
                
                
                3.43
                
                
                
                -
 
 No
further options will be granted under either of these Plans, but the plans will
remain in effect for purposes of administering already existing options
previously granted and still outstanding under the Plans.  As of
September 30, 2009, the unrecognized compensation expense for the 1998 and 2001
Stock Options plan was $2,150, which will be recorded in 2009.
 
 On April
19, 2006, at our annual meeting of stockholders, stockholders approved Tower
Financial Corporation’s 2006 Equity Incentive Plan, under which 150,000 shares
have been reserved for issuance as incentive stock options, nonstatutory stock
options, restricted stock awards, unrestricted stock awards, performance awards,
or stock appreciation rights.  As of September 30, 2009, 19,500
restricted shares are outstanding under the 2006 Equity Incentive
Plan.  During 2008, 13,500 restricted shares were granted under the
2006 Equity Incentive Plan.  The fair value of the restricted shares
issued was $135,000.  All 13,500 restricted shares were awarded May
10, 2008, in exchange for a non-solicitation agreement signed by those 10
recipients that were not already under contract.  The restricted
shares will vest annually on a pro-rata basis over a four-year period as
specified by the compensation committee.  On January 2, 2009, 6,000
restricted shares were granted as incentives to four employees who have been
recognized for their important contributions to the success of the
Company.  These restricted shares will vest semi-annually on a
pro-rata basis over a three year period as specified by the compensation
committee.  The compensation cost that has been charged against income
for restricted shares awarded under the Plan was $11,727 and $8,438 for the
three months ended September 30, 2009 and September 30, 2008, respectively, and
$35,183 and $11,250 for the nine months ended September 30, 2009 and September
30, 2008, respectively.  Future expense related to this award will be
$11,727 in 2009, $46,910 in 2010 and 2011, and $14,062 in 2012.
 
 Note
8 – Interest Rate Floor
 
 We
utilized an interest rate floor as part of our asset liability management
strategy to help manage our interest rate risk position from 2006 to March of
2008.  The notional amount of the interest rate floor did not
represent amounts exchanged by the parties.  The amount exchanged was
determined by reference to the notional amount and the other terms of the
agreement.
 
 We
purchased the interest rate floor for $147,000 in 2006.  The notional
amount of the floor was $30 million, with a term of three years and a strike
price of 7.5%.  The purchase price was amortized to earnings in the
same period the hedged item affected earnings.
 
 This
interest rate floor was measured at fair value and reported as an asset on the
consolidated balance sheet at December 31, 2008.  The portion of the
change in fair value of the interest rate floor that was deemed effective in
hedging the cash flows of the designated assets was recorded in accumulated
other comprehensive income (loss), net of tax effects, and reclassified into
interest income when such cash flows occur in the future.  Any
ineffectiveness resulting from the interest rate floor was recorded as a gain or
loss in the consolidated statements of operations as a part of non-interest
income.
 
 This
instrument was designated as a cash flow hedge.  The objective of the
floor was to protect the overall change in cash flows of the designated
Prime-rate based loans with a spread of zero percent from extreme market
interest rate changes.  Changes in the cash flows of the floor were
expected to be highly effective in offsetting the variability in the expected
future cash flows of the hedged loans attributed to fluctuations in Prime rates
below 7.5% (strike price of floor as stated above).
  16
 Index
  In March
of 2008, we settled the interest rate floor agreement with our counterparty and
received a payment of $833,750.  There was an unrealized gain of
$722,769 at the time of settlement and was reclassified out of accumulated other
comprehensive income on a monthly basis until the expiration of the original
floor agreement on August 1, 2009 as our hedged risk, exposure to changes in
cash flows from the designated prime-rate based loans with a spread of zero
payment, remained.  The unrealized gain has been reclassified out of
accumulated other comprehensive income into earnings using the straightline
method over the term of the original floor agreement.
 
 Note
9 – Business Segments
 
 Management
separates Tower Financial Corporation into three distinct businesses for
reporting purposes.  The three segments are Banking, Wealth
Management, and Corporate and Intercompany.  The segments are
evaluated separately on their individual performance, as well as their
contribution as a whole.
 
 The
majority of assets and income result from the Banking segment.  The
Bank is a full-service commercial bank with six Allen County locations and one
Warsaw location.  The Wealth Management segment is made up of Tower
Trust Company.  The Trust Company provides estate planning, investment
management, and retirement planning, as well as investment brokerage
services.  The Corporate and Intercompany segment includes the holding
company and subordinated debentures.  We incur general corporate
expenses, as well as interest expense on the subordinated
debentures.
 
 Information
reported internally for performance assessment follows:
 
 As
      of and for the three months ending September 30, 2009Wealth
                
                
                Corporate
      &Bank
                
                
                Management
                
                
                Intercompany
                
                
                Eliminations
                
                
                TotalIncome
      Statement InformationNet
      interest income
                
                $
                5,339,196
                
                
                $
                20,327
                
                
                $
                (282,671
                )
                
                $
                -
                
                
                $
                5,076,852Non-interest
      income
                
                
                383,845
                
                
                
                822,210
                
                
                
                (372,816
                )
                
                
                376,606
                
                
                
                1,209,845Non-interest
      expense
                
                
                4,663,443
                
                
                
                545,423
                
                
                
                259,021
                
                
                
                -
                
                
                
                5,467,887Noncash
      itemsProvision
      for loan losses
                
                
                1,995,000
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                1,995,000Depreciation/Amortization
                
                
                314,880
                
                
                
                9,927
                
                
                
                -
                
                
                
                -
                
                
                
                324,807Income
      tax expense(benefit)
                
                
                (367,687
                )
                
                
                106,006
                
                
                
                (193,934
                )
                
                
                -
                
                
                
                (455,615
                )Segment
      Profit (Loss)
                
                
                (567,715
                )
                
                
                191,108
                
                
                
                (720,574
                )
                
                
                376,606
                
                
                
                (720,575
                )Balance
      Sheet InformationSegment
      Assets
                
                
                673,570,332
                
                
                
                6,163,095
                
                
                
                70,585,692
                
                
                
                (70,925,217
                )
                
                
                679,393,902
  17
 Index
 
 As
      of and for the nine months ending September 30, 2009Wealth
                
                
                Corporate
      &Bank
                
                
                Management
                
                
                Intercompany
                
                
                Eliminations
                
                
                TotalIncome
      Statement InformationNet
      interest income
                
                $
                15,218,010
                
                
                $
                68,254
                
                
                $
                (845,968
                )
                
                $
                -
                
                
                $
                14,440,296Non-interest
      income
                
                
                2,121,771
                
                
                
                2,508,007
                
                
                
                (3,335,220
                )
                
                
                3,303,538
                
                
                
                4,598,096Non-interest
      expense
                
                
                14,348,587
                
                
                
                1,737,687
                
                
                
                832,765
                
                
                
                -
                
                
                
                16,919,039Noncash
      itemsProvision
      for loan losses
                
                
                9,505,000
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                9,505,000Depreciation/Amortization
                
                
                982,354
                
                
                
                29,800
                
                
                
                -
                
                
                
                -
                
                
                
                1,012,154Income
      tax expense(benefit)
                
                
                (2,669,222
                )
                
                
                297,529
                
                
                
                (608,124
                )
                
                
                -
                
                
                
                (2,979,817
                )Segment
      Profit (Loss)
                
                
                (3,844,584
                )
                
                
                541,045
                
                
                
                (4,405,829
                )
                
                
                3,303,538
                
                
                
                (4,405,830
                )Balance
      Sheet InformationSegment
      Assets
                
                
                673,570,332
                
                
                
                6,163,095
                
                
                
                70,585,692
                
                
                
                (70,925,217
                )
                
                
                679,393,902
 
 
 As
      of and for the three months ending September 30, 2008Wealth
                
                
                Corporate
      &Bank
                
                
                Management
                
                
                Intercompany
                
                
                Eliminations
                
                
                TotalIncome
      Statement InformationNet
      interest income
                
                $
                5,683,803
                
                
                $
                24,815
                
                
                $
                (283,071
                )
                
                $
                -
                
                
                $
                5,425,547Non-interest
      income
                
                
                721,888
                
                
                
                936,956
                
                
                
                671,747
                
                
                
                (518,370
                )
                
                
                1,812,221Non-interest
      expense
                
                
                4,230,260
                
                
                
                682,207
                
                
                
                130,332
                
                
                
                -
                
                
                
                5,042,799Noncash
      itemsProvision
      for loan losses
                
                
                1,999,000
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                1,999,000Depreciation/Amortization
                
                
                198,311
                
                
                
                10,505
                
                
                
                -
                
                
                
                -
                
                
                
                208,816Income
      tax expense(benefit)
                
                
                (139,639
                )
                
                
                77,264
                
                
                
                (71,257
                )
                
                
                -
                
                
                
                (133,632
                )Segment
      Profit
                
                
                316,070
                
                
                
                202,300
                
                
                
                329,601
                
                
                
                (518,370
                )
                
                
                329,601Balance
      Sheet InformationSegment
      Assets
                
                
                691,632,202
                
                
                
                5,896,555
                
                
                
                69,008,900
                
                
                
                (70,476,572
                )
                
                
                696,061,085
  18
 Index
 
 As
      of and for the nine months ending September 30, 2008Wealth
                
                
                Corporate
      &Bank
                
                
                Management
                
                
                Intercompany
                
                
                Eliminations
                
                
                TotalIncome
      Statement InformationNet
      interest income
                
                $
                16,564,992
                
                
                $
                83,351
                
                
                $
                (847,791
                )
                
                $
                -
                
                
                $
                15,800,552Non-interest
      income
                
                
                2,190,086
                
                
                
                2,770,350
                
                
                
                2,218,310
                
                
                
                (2,257,282
                )
                
                
                4,921,464Non-interest
      expense
                
                
                13,559,557
                
                
                
                2,084,834
                
                
                
                497,617
                
                
                
                -
                
                
                
                16,142,008Noncash
      itemsProvision
      for loan losses
                
                
                3,174,000
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                3,174,000Depreciation/Amortization
                
                
                879,678
                
                
                
                30,963
                
                
                
                -
                
                
                
                -
                
                
                
                910,641Income
      tax expense(benefit)
                
                
                219,281
                
                
                
                313,825
                
                
                
                (510,578
                )
                
                
                -
                
                
                
                22,528Segment
      Profit
                
                
                1,802,240
                
                
                
                455,042
                
                
                
                1,383,480
                
                
                
                (2,257,282
                )
                
                
                1,383,480Balance
      Sheet InformationSegment
      Assets
                
                
                691,632,202
                
                
                
                5,896,555
                
                
                
                69,008,900
                
                
                
                (70,476,572
                )
                
                
                696,061,085
  Note
10 – Loans and Allowance for Loan Losses
 
 Loans at
September 30, 2009 and December 31, 2008 were as follows:
 
 September
      30, 2009
                
                
                December
      31, 2008Balance
                
                
                %
                
                
                Balance
                
                
                %Commercial
                
                $
                250,950,687
                
                
                
                46.8
                %
                
                $
                255,027,227
                
                
                
                45.5
                %Commercial
      real estate
                
                
                138,912,021
                
                
                
                25.9
                %
                
                
                152,417,413
                
                
                
                27.2
                %Residential
      real estate
                
                
                88,314,328
                
                
                
                16.5
                %
                
                
                98,431,638
                
                
                
                17.5
                %Home
      equity
                
                
                40,940,315
                
                
                
                7.6
                %
                
                
                34,957,139
                
                
                
                6.2
                %Consumer
                
                
                17,167,917
                
                
                
                3.2
                %
                
                
                20,329,830
                
                
                
                3.6
                %Total
      loans
                
                
                536,285,268
                
                
                
                100.0
                %
                
                
                561,163,247
                
                
                
                100.0
                %Net
      deferred loan costs/(fees)
                
                
                (211,400
                )
                
                
                
                
                
                
                (151,572
                )Allowance
      for loan losses
                
                
                (14,905,393
                )
                
                
                
                
                
                
                (10,654,879
                )Net
      loans
                
                $
                521,168,475
                
                
                
                
                
                
                $
                550,356,796
 
 The
following table summarizes changes in the Company’s allowance for loan losses
for the periods indicated:
  2009
                  
                  
                  2008Beginning
      balance, January 1
                  
                  $
                  10,654,879
                  
                  
                  $
                  8,208,162Provision
      expense
                  
                  
                  9,505,000
                  
                  
                  
                  3,174,000Charge-offs
                  
                  
                  (5,694,033
                  )
                  
                  
                  (3,460,880
                  )Recoveries
                  
                  
                  439,547
                  
                  
                  
                  1,356,557Ending
      balance, September 30
                  
                  $
                  14,905,393
                  
                  
                  $
                  9,277,839Net
      charge-offs to average loans (annualized)
                  
                  
                  1.29
                  %
                  
                  
                  0.50
                  %
  19
 Index
  The table
below summarizes the allowance allocations by type as of the indicated
dates:
 
 September
      30, 2009
                
                
                December
      31, 2008Specific
      allocations
                
                $
                7,111,000
                
                
                $
                3,101,000Loan
      pool percentage allocations
                
                
                7,779,000
                
                
                
                7,497,000Unallocated
                
                
                15,393
                
                
                
                56,879Total
      allowance for loan losses
                
                $
                14,905,393
                
                
                $
                10,654,879
  The
following table summarizes the Company’s nonperforming assets at the dates
indicated:
 September
      30, 2009
                
                
                December
      31, 2008Loans
      past due over 90 days and still accruing
                
                $
                1,476,963
                
                
                $
                1,019,857Restructured
      loans
                
                
                162,506
                
                
                
                327,967Nonaccrual
      loans
                
                
                20,218,736
                
                
                
                15,675,334Total
      nonperforming loans
                
                $
                21,858,205
                
                
                $
                17,023,158Other
      real estate owned
                
                
                3,990,126
                
                
                
                2,660,310Total
      nonperforming assets
                
                $
                25,848,331
                
                
                $
                19,683,468Nonperforming
      assets to total assets
                
                
                3.80
                %
                
                
                2.83
                %Nonperforming
      loans to total loans
                
                
                4.08
                %
                
                
                3.03
                %
  Impaired
loans were as follows:
 September
      30, 2009
                
                
                December
      31, 2008Loans
      with no allocated allowance for loan losses
                
                $
                10,087,053
                
                
                $
                6,462,113Loans
      with allocated allowance for loan losses
                
                
                18,709,292
                
                
                
                16,898,392Total
      Impaired
                
                $
                28,796,345
                
                
                $
                23,360,505Amount
      of allowance for loan losses allocated
                
                $
                7,111,000
                
                
                $
                3,101,000Average
      impaired loans during the period
                
                $
                28,517,204
                
                
                $
                22,414,645Interest
      recognized on impaired loans
                
                $
                585,490
                
                
                $
                244,703Cash-basis
      interest income recognized
                
                $
                661,848
                
                
                $
                244,703
  20
 Index
  Note
11 – Federal Home Loan Bank Advances
 
 Advances
from the Federal Home Loan Bank (“FHLB”) were:
  September
      30, 2009
                
                
                December
      31, 20080.65%
      variable rate advance, principal due at maturity April 13,
      2009
                
                
                -
                
                
                
                2,000,0000.65%
      variable rate advance, principal due at maturity May 20,
    2009
                
                
                -
                
                
                
                3,000,0000.65%
      variable rate advance, principal due at maturity June 29,
    2009
                
                
                -
                
                
                
                9,000,0005.00%
      bullet advance, principal due at maturity April 27, 2009
                
                
                -
                
                
                
                4,000,0005.16%
      bullet advance, principal due at maturity August 18, 2009
                
                
                -
                
                
                
                4,000,0003.08%
      bullet advance, principal due at maturity August 27, 2009
                
                
                -
                
                
                
                1,000,0002.29%
      bullet advance, principal due at maturity March 22, 2010
                
                
                2,000,000
                
                
                
                2,000,0002.26%
      bullet advance, principal due at maturity April 28, 2010
                
                
                1,500,000
                
                
                
                1,500,0003.63%
      bullet advance, principal due at maturity June 28, 2010
                
                
                4,000,000
                
                
                
                4,000,0004.32%
      bullet advance, principal due at maturity June 29, 2010
                
                
                1,200,000
                
                
                
                1,200,0003.19%
      bullet advance, principal due at maturity March 28, 2011
                
                
                2,000,000
                
                
                
                2,000,0003.60%
      bullet advance, principal due at maturity April 28, 2011
                
                
                1,500,000
                
                
                
                1,500,0003.55%
      bullet advance, principal due at maturity March 26, 2012
                
                
                2,000,000
                
                
                
                2,000,0003.81%
      bullet advance, principal due at maturity March 26, 2013
                
                
                2,000,000
                
                
                
                2,000,000$
                16,200,000
                
                
                $
                39,200,000
  Of the
total FHLB borrowings at September 30, 2009 and December 31, 2008 no advances
had callable options.
 
 At
September 30, 2009 scheduled principal reductions on these FHLB advances were as
follows:
  Year
                
                Advances2009
                
                
                -2010
                
                
                8,700,0002011
                
                
                3,500,0002012
                
                
                2,000,0002013
                
                
                2,000,000$
                16,200,000
 
 Note
12 – Fair Value Measurement
 
 The fair
value hierarchy requires an entity to maximize the use of observable inputs and
minimize the use of unobservable inputs when measuring fair value. The standard
describes three levels of inputs that may be used to measure fair
value:
 
 Level 1:
Quoted prices (unadjusted) for identical assets or liabilities in active markets
that the entity has the ability to access as of the measurement
date.
 
 Level 2:
Significant other observable inputs other than Level 1 prices such as quoted
prices for similar assets or liabilities; quoted prices in markets that are not
active; or other inputs that are observable or can be corroborated by observable
market data.
 
 Level 3:
Significant unobservable inputs that reflect a reporting entity’s own
assumptions about the assumptions that market participants would use in pricing
an asset or liability.
 
 For
additional information of how the Corporation measures fair value, see Note 2 – Summary of Critical
Accounting Policies.
 
 Items
measured at Fair Value on a Recurring Basis
 
 We
measure certain assets at fair value on a recurring basis.  These
assets include available-for-sale securities.  Available-for-sale
securities largely include debt securities, whose fair value is determined from
evaluations based on either quoted market prices or matrix
pricing.  Securities valued based on quoted market prices are
classified as Level 1 and usually include agency-backed obligations and
mortgage-backed securities.  Matrix pricing is a mathematical
technique widely used in the industry to value debt securities without relying
exclusively on quoted prices for the specific securities but rather by relying
on the securities’ relationship to other benchmark quoted
securities.  Such items are mostly classified in Level 2 of the fair
value hierarchy, which include municipal bonds.  In certain cases
where market data is not readily available because of lack of market activity or
little public disclosure, values may be based on unobservable inputs and
classified in Level 3 of the fair value hierarchy.  Trust Preferred
Securities which are issued by financial institutions and insurance companies
were historically priced using Level 2 inputs, the decline in the level of
observable inputs and market activity in this class of investments has been
significant and resulted in unreliable external pricing.  Broker
pricing and bid/ask spreads, when available, vary widely.  The once
active market has become comparatively inactive.  As such, this
investment is priced at September 30, 2009 and December 31, 2008 using Level 3
inputs.
  21
 Index
  The
Company uses information such as historical and current performance of the
underlying collateral, deferral/default rates, collateral coverage ratios, break
in yield calculations, cash flow projections, liquidity and credit premiums
required by a market participant, and financial trend analysis with respect to
the individual issuing financial institutions and insurance companies, to
determine a discount rate which is applied to projected cash flows to estimate
fair value.  Due to current market conditions as well as the limited
trading activity of these securities, the fair value of this security is highly
sensitive to assumption changes and market volatility.
 
 The
following tables present for each of the fair-value hierarchy levels our assets
that are measured at fair value on a recurring basis.
  September
      30, 2009Level
      1
                
                
                Level
      2
                
                
                Level
      3
                
                
                TotalAvailable
      for Sale:U.S.
      Government agency debt obligations
                
                $
                7,894,201
                
                
                $
                -
                
                
                $
                -
                
                
                $
                7,894,201Obligations
      of states and political subdivisions
                
                
                -
                
                
                
                26,207,428
                
                
                
                -
                
                
                
                26,207,428Mortgage-backed
      securities
                
                
                44,987,310
                
                
                
                2,110,000
                
                
                
                -
                
                
                
                47,097,310Trust
      Preferred securities
                
                
                -
                
                
                
                -
                
                
                
                78,478
                
                
                
                78,478Total
                
                $
                52,881,511
                
                
                $
                28,317,428
                
                
                $
                78,478
                
                
                $
                81,277,417
 
 
 December
      31, 2008Level
      1
                
                
                Level
      2
                
                
                Level
      3
                
                
                TotalAvailable
      for Sale:U.S.
      Government agency debt obligations
                
                $
                8,269,132
                
                
                $
                -
                
                
                $
                -
                
                
                $
                8,269,132Obligations
      of states and political subdivisions
                
                
                -
                
                
                
                21,257,630
                
                
                
                -
                
                
                
                21,257,630Mortgage-backed
      securities
                
                
                46,028,393
                
                
                
                2,006,200
                
                
                
                -
                
                
                
                48,034,593Trust
      Preferred securities
                
                
                -
                
                
                
                -
                
                
                
                230,900
                
                
                
                230,900Total
                
                $
                54,297,525
                
                
                $
                23,263,830
                
                
                $
                230,900
                
                
                $
                77,792,255
  The
following table represents the changes in the Level 3 fair-value category for
the period ended September 30, 2009.  We classify financial
instruments in Level 3 of the fair-value hierarchy when there is reliance on at
least one significant unobservable input in the valuation model.  In
addition to these unobservable inputs, the valuation models for Level 3
financial instruments typically also rely on a number of inputs that are readily
observable either directly or indirectly.  Thus, the gains and losses
presented below include changes in the fair value related to both observable and
unobservable inputs for the three and nine month periods ended September 30,
2009.
 
 Available-for-sale
                  securitiesFor
      the three months ended
                
                September
      30, 2009Beginning
      Balance, July 1
                
                $
                74,053Net
      realized/unrealized gains (losses)Included
      in earnings:Interest
      income on securities
                
                
                -Credit
      loss recognized in earnings
                
                
                (477,344
                )Included
      in other comprehensive income
                
                
                481,769Ending
      Balance, September 30
                
                $
                78,478
  22
 Index
 
 Available-for-sale
                  securitiesFor
      the nine months ended
                
                September
      30, 2009Beginning
      Balance, January 1
                
                $
                230,900Net
      realized/unrealized gains (losses)Included
      in earnings:Interest
      income on securities
                
                
                13,052Credit
      loss recognized in earnings
                
                
                (525,000
                )Included
      in other comprehensive income
                
                
                359,526Ending
      Balance, September 30
                
                $
                78,478
  Assets
Measured at Fair Value on a Non-recurring Basis
 
 Other
certain assets and liabilities are measured at fair value on a non-recurring
basis and are therefore not included in the tables above.  These
include impaired loans, which are measured at fair value based on the fair value
of the underlying collateral, and other real estate owned.  Fair value
is determined, where possible, using market prices derived from an appraisal or
evaluation.  However, certain assumptions and unobservable inputs are
used many times by the appraiser, therefore, qualifying the assets as Level 3 in
the fair-value hierarchy.
 
 The
following tables present for each of the fair-value hierarchy levels our assets
that are measured at fair value on a non-recurring basis.
  September
      30, 2009Level
      1
                
                
                Level
      2
                
                
                Level
      3
                
                
                TotalImpaired
      loans
                
                
                -
                
                
                
                -
                
                
                
                11,598,292
                
                
                
                11,598,292Other
      real estate owned
                
                
                -
                
                
                
                -
                
                
                
                3,990,126
                
                
                
                3,990,126
 
 December
      31, 2008Level
      1
                
                
                Level
      2
                
                
                Level
      3
                
                
                TotalImpaired
      loans
                
                
                -
                
                
                
                -
                
                
                
                15,515,583
                
                
                
                15,515,583
  Impaired
loans, with specific loss allocations which are measured for impairment using
the fair value of the collateral for collateral dependent loans, had a principal
value of $18.7 million, with a valuation allowance of $7.1 million at September
30, 2009.  This compares to a carrying value of $18.6 million and a
valuation allowance of $3.1 million at December 31, 2008.  This
resulted in additional provision-for-loan-losses of $5.7 million relating to
these loans for the third quarter of 2009.  The increase in the
valuation allowance during the first nine months of 2009 was primarily due to
the depreciation in value of the collateral on three impaired commercial real
estate loan relationships, two commercial loan relationships, and one
relationship with both commercial and commercial real estate loans causing an
increase in specific reserves by $5.2 million.  The decrease in
carrying value is due to charging down four commercial and one commercial real
estate loan relationships by $4.9 million.  The increase in other real
estate owned from December 31, 2008 to September 30, 2009 was primarily due to
the foreclosure of a $2.7 million commercial real estate loan, which was offset
by a charge-down of $950,000 on a commercial property from a decline in value
based on a recent appraisal.
  23
 Index
  In
accordance with financial accounting standards, the carrying values and
estimated fair values of our financial instruments, not previously presented, at
September 30, 2009 and December 31, 2008 are as follows:
  September
      30, 2009
                
                
                December
      31, 2008Carrying
                
                
                Fair
                
                
                Carrying
                
                
                FairValue
                
                
                Value
                
                
                Value
                
                
                ValueFinancial
      assets:Cash
      and cash equivalents
                
                $
                29,939,817
                
                
                $
                29,939,817
                
                
                $
                31,576,373
                
                
                $
                31,576,373Securities
      available for sale
                
                
                81,277,417
                
                
                
                81,277,417
                
                
                
                77,792,255
                
                
                
                77,792,255Securities
      held to maturity
                
                
                4,628,873
                
                
                
                4,506,397
                
                
                
                -
                
                
                
                -FHLBI
      and FRB stock
                
                
                4,032,446
                
                
                
                N/A
                
                
                
                4,032,446
                
                
                
                N/ALoans
      held for sale
                
                
                1,387,958
                
                
                
                1,387,958
                
                
                
                151,614
                
                
                
                151,614Loans,
      net
                
                
                521,168,475
                
                
                
                523,570,523
                
                
                
                550,356,796
                
                
                
                555,695,490Accrued
      interest receivable
                
                
                2,511,735
                
                
                
                2,511,735
                
                
                
                2,615,260
                
                
                
                2,615,260Financial
      liabilities:Deposits
                
                
                (592,730,622
                )
                
                
                (594,867,696
                )
                
                
                (586,237,114
                )
                
                
                (589,369,429
                )FHLB
      advances
                
                
                (16,200,000
                )
                
                
                (21,543,065
                )
                
                
                (39,200,000
                )
                
                
                (39,870,750
                )Junior
      subordinated debt
                
                
                (17,527,000
                )
                
                
                (17,085,699
                )
                
                
                (17,527,000
                )
                
                
                (14,532,211
                )Accrued
      interest payable
                
                
                (501,328
                )
                
                
                (501,328
                )
                
                
                (658,956
                )
                
                
                (658,956
                )
  Estimated
fair value for securities available for sale is consistent with the hierarchy
described in Note 12 regarding fair value measurements.  Estimated
fair value for securities held to maturity are based on quoted market prices, if
available.  For securities where quoted prices are not available, fair
values are estimated based on market prices of similar
securities.  Estimated fair value of FHLBI and FRB stock cannot be
determined due to restrictions placed on its
transferability.  Estimated fair value for loans is based on the rates
charged at year-end for new loans with similar maturities, applied until the
loan is assumed to reprice or be paid and the allowance for loan losses is
considered to be a reasonable estimate of discount for credit quality concerns.
Estimated fair value for IRAs, CDs, short-term borrowings, fixed rate advances
from the FHLB and the junior subordinated debt is based on the rates at year-end
for new deposits or borrowings, applied until maturity. Estimated fair value for
other financial instruments and off-balance-sheet loan commitments is considered
to approximate carrying value.
 
 Note
13 – Reclassifications
 
 Certain
items in the financial statements and notes thereto were reclassified to conform
to the current presentation.  The reclassifications had no effect on
net income or stockholders’ equity as previously reported.
 
 Note
14 – Subsequent Events
 
 Management
has performed an evaluation of subsequent events through November 13, 2009, the
date the financial statements were issued, and no significant subsequent events
were identified.
 
 Item
2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
 The
following presents management’s discussion and analysis of the consolidated
financial condition of the Company as of September 30, 2009 and December 31,
2008 and results of operations for the nine-month periods ended September 30,
2009 and September 30, 2008.  This discussion should be read in
conjunction with the Company’s consolidated condensed financial statements and
the related notes appearing elsewhere in this report and the Company’s Annual
Report on Form 10-K for the year ended December 31, 2008.
 
 Executive
Overview
 
 Net loss
was $720,575 and $4.4 million for the third quarter 2009 and year-to-date, a
decrease of $1.1 million and $5.8 million from the same periods in
2008.  The year-to-date net loss for the third quarter 2009 compared
to year-to-date net income for the third quarter 2008 was due primarily to the
following:
 
 ·
                Increased
      loan loss provisions of $6.3
million
 ·
                Letter
      of credit claim totaling $325,000 that was recorded as a contingent
      liability
 ·
                Write
      down in value of a foreclosed property totaling
  $950,000
 ·
                Increased
      FDIC assessments totaling $453,145
 ·
                One-time,
      industry imposed, special FDIC assessment of
  $315,000
 ·
                Impairment
      charge on a security totaling
$525,000
 ·
                Margin
      compression lowered net interest income by $1.4
  million
  24
 Index
  Taking
the extraordinary expense items noted above into account, our typical operating
expenses decreased by approximately $1.3 million.  Expense savings
were made up primarily of $932,521 in employment expenses, $138,831 in marketing
expenses, $114,545 in business development expenses, and $111,121 in
communication expenses.   Net interest income declined as lower
interest rates caused our net interest margin to drop from 3.31% year to date at
September 30, 2008 to 3.03% year to date as of September 30, 2009.
 
 Total
assets decreased by $17.2 million from December 31, 2008 to September 30,
2009.  The decrease in total assets was mostly due to a decrease of
$29.2 million in net loans, primarily in commercial real estate and residential
real estate with decreases of $13.5 million and $10.1 million,
respectively.  The decrease in net loans resulted from management’s
strategic decision to focus on asset quality and profitability by removing
problem customer relationships from the institution through refinancing through
another institution or charging the loans down as it become necessary and
choosing to broker residential real estate loans versus retaining them within
the institution.  This strategy has helped to begin restructuring the
balance sheet through a reduction of net loans from 79.0% of total assets at
December 31, 2008 to 76.7% at September 30, 2009 and by increasing long-term
investments by $8.1 million from 11.2% of total assets at December 31, 2008 to
12.6% at September 30, 2009.  Management believes this strategy will
allow the institution to diversify the risk on the balance sheet and to prepare
for the inevitable increase in interest rates.
 
 Total
deposits increased $6.5 million, or 1.1%, from December 31, 2008 to September
30, 2009. The increase was primarily driven by increases in non-interest bearing
checking accounts, interest bearing checking accounts, and money market accounts
of $16.8 million, $7.9 million and $34.2 million, respectively.  This
increase was offset by decreases in non-core deposits of $41.2 million, which
includes decreases in certificate of deposits greater than $100,000 and brokered
certificate of deposits in the amounts of $27.7 and $13.5 million,
respectively.  Along with the reduction in brokered deposits, the
Company utilized some of its excess liquidity from deposit growth and loan
shrinkage to reduce its borrowings with the Federal Home Loan Bank of
Indianapolis (FHLBI) by $23.0 million during the first nine months of
2009.
 
 Total
equity decreased $1.1 million from $49.6 million on December 31, 2008 to $48.5
million on September 30, 2009.  The decrease was primarily due to the
net loss recorded of $4.4 million during the first nine months of
2009.  The net loss was offset by a capital raise of Series A
Convertible Preferred Stock in the net amount of $1.8 million along with an
increase of $1.5 million in unrealized gains, net of tax, on securities
available for sale.
 
 Financial
Condition
 
 Total
assets were $679.4 million at September 30, 2009 compared to total assets at
December 31, 2008 of $696.6 million.  The 2.5% decrease in assets was
mostly due to a decrease in net loans of $29.2 million, primarily in commercial
real estate and residential real estate loans with decreases of $13.5 million
and $10.1 million, respectively.  We experienced growth in our total
deposits of $6.5 million during the first nine months of 2009, of which $16.8
million, $7.9 million, and $34.2 million in increases were in non-interest
bearing checking accounts, interest bearing checking accounts, and money
markets, respectively.  The increase in deposits, along with the
decrease in loan outstandings allowed us to increase our investment portfolio by
$8.1 million, and decrease our brokered deposits and FHLBI borrowings by $13.5
million and $23.0 million, respectively.
 Cash and
Investments.   Cash and cash equivalents, which include
federal funds sold, were $29.9 million at September 30, 2009, a decrease of $1.6
million, or 5.2%.  Securities available for sale and held to maturity
were $81.3 million and $4.6 million at the end of the third quarter of 2009, an
increase of $8.1 million in total securities from December 31,
2008.  The increase in the investment portfolio was the result of our
strategy to focus on liquidity by using loan principal paydowns and new deposit
money to purchase investments and slowly reduce the loan
outstandings.
 
 Loans.  Total loans
were $536.1 million at September 30, 2009 reflecting a 4.5% decrease from total
loans of $561.0 million at December 31, 2008.   The decline in
loans during the first nine months of 2009 occurred mainly in the commercial
real estate and residential portfolios.  While the residential real
estate portfolio has decreased, we have seen a significant increase in the
number of brokered loans we have originated.  During the first nine
months 2009, we originated 148 loans compared to 52 loans during the same time
period in 2008.  The overall mix of the loan portfolio has remained
the same since year-end.  The total of commercial and commercial real
estate loans in the portfolio was 72.7% at September 30, 2009 and December 31,
2008.
  25
 Index
  Nonperforming
Assets.  Nonperforming assets include nonperforming loans and
other real estate owned (OREO).  Nonperforming loans include loans
past due over 90 days and still accruing interest, restructured loans, and all
nonaccrual loans.  Nonperforming assets have increased from $19.7
million, or 2.8% of total assets at December 31, 2008 to $25.8 million, or 3.8%
of total assets, at September 30, 2009.  The increase is primarily
attributed to the continued economic downturn and the declining property
values.  While a few commercial loan customers had to close their
business due to a lack of sales, the commercial real estate loan customers are
struggling to sell their properties and are additionally battling the decrease
in property values.  Nonaccrual loans increased by $4.5 million
primarily due to four commercial loan relationships and one commercial real
estate loan relationship being downgraded to non-accrual and charged-down by
$4.9 million to a total value of $4.5 million. Total impaired loans at September
30, 2009 were $28.8 million, compared to $23.4 million at December 31,
2008.  At September 30, 2009, management believes it has allocated
adequate specific reserves for these risks.  Other real estate owned
increased by $1.3 million, primarily due to transferring in a commercial
property in the amount of $2.7 million during the first quarter, which was
charged down by $950,000 to its recently appraised value in the second quarter
of 2009.
 
 Allowance for Loan
Losses.In each quarter the allowance for loan loss is
adjusted by management to the amount management believes is necessary to
maintain the allowance at adequate levels. Management allocates specific
portions of the allowance for loan losses to specific problem
loans.  Problem loans are identified through a loan risk rating system
and monitored through watchlist reporting.  Specific reserves are
determined for each identified problem loan based on delinquency rates,
collateral and other risk factors specific to that problem
loan.  Management’s allocation of the allowance to other loan pools
considers various factors including historical loss experience, the present and
prospective financial condition of borrowers, industry concentrations within the
loan portfolio, general economic conditions, and peer industry data of
comparable banks.
 
 The
allowance for loan losses at September 30, 2009 was $14.9 million, or 2.78% of
total loans outstanding, an increase of $4.2 million from $10.7 million, or
1.90% of total loans outstanding, at December 31, 2008.  The provision
for loan losses during the first nine months of 2009 was $9.5 million compared
to $3.2 million in the first nine months of 2008.  The increase in
loan loss provision was due to an increase of $5.2 million in specific
allocations reserved primarily on five lending relationships, and net
charge-offs of $5.3 million of which only $1.7 million was previously
reserved.
 
 For the
first nine-months of 2009 we were in a net charge-off position of $5.3 million
compared to a net charge-off position of $2.1 million for the first nine-months
of 2008.  As the economy continues to decline, an added strain has
been placed on our customers who depend on sales of inventory and/or services to
be able repay their notes based on the current terms, which contributed to the
increase in nonperforming loans of $4.8 million during the first nine-months of
2009.  To prepare for an extended economic downturn, our Company
continues to build its reserves to ensure adequate coverage in the case of
unforeseen losses.  We also have seen a significant decline in the
sale of residential development lots causing our customers’ cash flow to slowly
diminish requiring us to downgrade the relationships and add specific reserves
for the declining property values.  The specific allowance allocations
increased by $1.0 million to $7.1 million in the third quarter of 2009 primarily
due to becoming more granular in our allowance for loan and lease loss
calculation.  During the third quarter of 2009, we have reviewed all
loan relationships greater than $1.5 million in the “special mention” category
and $1.0 million in the “substandard” category in detail and set a specific
reserve for each one of those loans.
 
 Other
Assets.   The $2.7 million increase in other assets was
primarily attributable to the increase in the deferred tax asset of $3.9
million, which was recorded based on the increase in the allowance for loan and
lease losses.  At this time, we believe we will be able to use the
deferred tax asset within a reasonable time frame as the majority of the balance
is comprised of the allowance for loan and lease losses.  As we begin
to use and/or reduce the balance of the allowance for loan and lease losses, the
deferred tax asset will be directly impacted and will begin to
decrease.  We will also be able to carryback the tax net operating
loss created in 2009 to the tax year ending December 31, 2008 with none to
carryforward.  The increase in other assets was offset by a decrease
in the equity investment in a limited partnership held at the Holding
Company.  Due to the volatility of the investment, the board of
directors approved the gradual liquidation of this $1.0 million
investment.  A request was made on October 14, 2008 to withdraw
$500,000 from the investment based on the balance at December 31, 2008, which
was received January 15, 2009.  The second installment was received on
April 15, 2009 in the amount of $240,437.  The remaining balance
$90,325 will be distributed in accordance with the limited partnership
agreement, most likely in early- to mid-2010.
 
 Deposits.   Total
deposits were $592.7 million at September 30, 2009 compared to total deposits at
December 31, 2008 of $586.2 million. The increase of $6.5 million, or 1.1%,
during the first nine months of 2009 was reflective of the $47.7 million
increase in core deposits, including increases of $16.8 million in non-interest
bearing checking accounts, $7.9 million in interest bearing checking accounts,
and $34.2 million in money market accounts.  The increase was offset
by a $41.2 million decrease in non-core deposits, which includes a decrease of
$27.7 million and $13.5 million in certificate of deposits greater than $100,000
and brokered certificate of deposits, respectively.  The significant
growth in our in-market deposits during the first nine months of 2009 allowed us
to let out-of-market funding mature without being replaced.  Brokered
certificate of deposits were $71.0 million and $84.6 million at September 30,
2009 and December 31, 2008, respectively.
  26
 Index
  The
following table summarizes the Company’s deposit balances at the dates
indicated:
 
 September
      30, 2009
                
                
                December
      31, 2008Balance
                
                
                %
                
                
                Balance
                
                
                %Core
      deposits:Noninterest-bearing
      demand
                
                $
                98,858,989
                
                
                
                16.7
                %
                
                $
                82,107,483
                
                
                
                14.0
                %Interest-bearing
      checking
                
                
                81,380,180
                
                
                
                13.7
                %
                
                
                73,452,486
                
                
                
                12.5
                %Money
      market
                
                
                174,627,509
                
                
                
                29.5
                %
                
                
                140,384,566
                
                
                
                24.0
                %Savings
                
                
                17,296,592
                
                
                
                2.9
                %
                
                
                17,049,660
                
                
                
                2.9
                %Time,
      under $100,000
                
                
                82,285,610
                
                
                
                13.9
                %
                
                
                93,764,792
                
                
                
                16.0
                %Total
      core deposits
                
                
                454,448,880
                
                
                
                76.7
                %
                
                
                406,758,987
                
                
                
                69.4
                %Non-core
      deposits:In-market
      core deposits:Time,
      $100,000 and over
                
                
                67,237,670
                
                
                
                11.3
                %
                
                
                94,926,801
                
                
                
                16.2
                %Out-of-market
      non-core deposits:Brokered
      certificate of deposits
                
                
                71,044,072
                
                
                
                12.0
                %
                
                
                84,551,326
                
                
                
                14.4
                %Total
      non-core deposits
                
                
                138,281,742
                
                
                
                23.3
                %
                
                
                179,478,127
                
                
                
                30.6
                %Total
      deposits
                
                $
                592,730,622
                
                
                
                100.0
                %
                
                $
                586,237,114
                
                
                
                100.0
                %
 
 Borrowings.   The
Company had borrowings in the amount of $16.2 million in Federal Home Loan Bank
(“FHLB”) advances at September 30, 2009 and $39.2 million at December 31,
2008.  All FHLB advances are bullet advances and mature in a range
from March 2010 through March 2013.
 
 Other
Liabilities.Other liabilities increased slightly by $550,544
to $3.9 million from December 31, 2008 to September 30, 2009.  The
increase was primarily due to an accrual for an expected loss of $325,000 on a
commercial letter of credit.
 
 Results
of Operations
 
 For The Three-Month Periods
Ended September 30
 
 Results
of operations for the three-month period ended September 30, 2009 reflected net
loss of $720,575 or ($0.18) per diluted share.   This was a $1.1
million decrease from 2008’s third quarter net income of $329,601, or $0.08 per
diluted share.  The decrease in net income was caused primarily from
the following:
 
 ·
                Net
      interest income was lower by $348,695 due to a compressed net interest
      margin and reduced earning assets
 ·
                Impairment
      charge of $477,344 on an investment
security.
 ·
                An
      increase of $177,102 in FDIC insurance
premiums.
 ·
                A
      letter of credit claim of $325,000 that was recorded as a contingent
      liability
 
 Total
revenue, defined as net interest income plus total noninterest income, declined
by $951,071 from the third quarter 2008 to the third quarter 2009 primarily due
to the drop in net interest margin over the same period of time and the
recognition of an other-than-temporary impairment on a trust preferred security
of $477,344.  Short-term interest rates are down 1.75% from the third
quarter of 2008, which has caused a reduction in our net interest
margin.  For the three-month period ended September 30, 2009, net
interest income decreased 6.4%, while total noninterest income decreased
33.2%.
   Performance
      Ratios
                  
                  September
      302009
                  
                  
                  2008Return
      on average assets *
                  
                  
                  -0.42
                  %
                  
                  
                  0.19
                  %Return
      on average equity *
                  
                  
                  -6.12
                  %
                  
                  
                  2.66
                  %Net
      interest margin (TEY) *
                  
                  
                  3.23
                  %
                  
                  
                  3.42
                  %Efficiency
      ratio
                  
                  
                  86.98
                  %
                  
                  
                  69.67
                  %
 
 
 Net Interest
Income.   Interest income for the three-month periods
ended September 30, 2009 and 2008 was $8.0 million and $9.3 million,
respectively, while interest expense for the third quarter was $2.9 million in
2009 and $3.9 million in 2008, resulting in net interest income of $5.1 million
for the third quarter of 2009 and $5.4 million for the second quarter of
2008.  Due to a slight decrease in average earning assets and a 175
basis point decrease in short-term interest rates from the third quarter of
2008, the net interest margin has been negatively impacted and has caused a
decrease in our net interest income.  In a declining interest-rate
environment, our variable rate assets re-price immediately, but our variable
rate liabilities typically re-price over a time period of thirty to forty-five
days.  The tax equivalent net interest margin for the third quarter of
2009 was 3.23%, while the tax equivalent net interest margin for the third
quarter of 2008 was 3.42%.  Interest income was also negatively
impacted during the third quarter 2009 as the gain on the sale of the interest
rate floor completely amortized in July, which was providing approximately
$40,000 a month in interest income.
  27
 Index
  The
following table reflects the average balance, interest earned or paid, and
yields or costs of the Company’s assets, liabilities and stockholders’ equity at
and for the dates indicated:
 
 As
      of and For The Three Month Period EndedSeptember
      30, 2009
                  
                  
                  September
      30, 2008($
      in thousands)
                  
                  Average
      Balance
                  
                  
                  Interest
      Earned or Paid
                  
                  
                  Annualized
      Yield or Cost
                  
                  
                  Average
      Balance
                  
                  
                  Interest
      Earned or Paid
                  
                  
                  Annualized
      Yield or CostAssetsShort-term
      investments andinterest-earning
      deposits
                  
                  $
                  1,772
                  
                  
                  $
                  -
                  
                  
                  
                  0.00
                  %
                  
                  $
                  5,641
                  
                  
                  $
                  27
                  
                  
                  
                  1.90
                  %Federal
      funds sold
                  
                  
                  3,846
                  
                  
                  
                  2
                  
                  
                  
                  0.21
                  %
                  
                  
                  6,636
                  
                  
                  
                  33
                  
                  
                  
                  1.98
                  %Securities
      - taxable
                  
                  
                  63,430
                  
                  
                  
                  824
                  
                  
                  
                  5.15
                  %
                  
                  
                  59,096
                  
                  
                  
                  735
                  
                  
                  
                  4.95
                  %Securities
      - tax exempt (1)
                  
                  
                  23,534
                  
                  
                  
                  368
                  
                  
                  
                  6.20
                  %
                  
                  
                  21,065
                  
                  
                  
                  334
                  
                  
                  
                  6.31
                  %Loans
      held for sale
                  
                  
                  3,598
                  
                  
                  
                  -
                  
                  
                  
                  0.00
                  %
                  
                  
                  710
                  
                  
                  
                  -
                  
                  
                  
                  0.00
                  %Loans
                  
                  
                  542,921
                  
                  
                  
                  6,960
                  
                  
                  
                  5.09
                  %
                  
                  
                  551,407
                  
                  
                  
                  8,304
                  
                  
                  
                  5.99
                  %Total
      interest-earning assets
                  
                  
                  639,101
                  
                  
                  
                  8,154
                  
                  
                  
                  5.06
                  %
                  
                  
                  644,555
                  
                  
                  
                  9,433
                  
                  
                  
                  5.82
                  %Allowance
      for loan losses
                  
                  
                  (14,403
                  )
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (8,995
                  )Cash
      and due from banks
                  
                  
                  25,759
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  15,217Other
      assets
                  
                  
                  36,295
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  32,178Total
      assets
                  
                  $
                  686,752
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  $
                  682,955Liabilities
      and Stockholders' EquityInterest-bearing
      checking
                  
                  $
                  81,165
                  
                  
                  $
                  124
                  
                  
                  
                  0.61
                  %
                  
                  $
                  68,851
                  
                  
                  $
                  200
                  
                  
                  
                  1.16
                  %Savings
                  
                  
                  17,200
                  
                  
                  
                  17
                  
                  
                  
                  0.39
                  %
                  
                  
                  17,235
                  
                  
                  
                  43
                  
                  
                  
                  0.99
                  %Money
      market
                  
                  
                  167,038
                  
                  
                  
                  393
                  
                  
                  
                  0.93
                  %
                  
                  
                  145,448
                  
                  
                  
                  791
                  
                  
                  
                  2.16
                  %Certificates
      of deposit
                  
                  
                  235,843
                  
                  
                  
                  1,957
                  
                  
                  
                  3.29
                  %
                  
                  
                  276,206
                  
                  
                  
                  2,288
                  
                  
                  
                  3.30
                  %Short-term
      borrowings
                  
                  
                  426
                  
                  
                  
                  1
                  
                  
                  
                  0.93
                  %
                  
                  
                  452
                  
                  
                  
                  3
                  
                  
                  
                  2.64
                  %FHLB
      Advances
                  
                  
                  19,877
                  
                  
                  
                  177
                  
                  
                  
                  3.53
                  %
                  
                  
                  31,368
                  
                  
                  
                  285
                  
                  
                  
                  3.61
                  %Junior
      subordinated debt
                  
                  
                  17,527
                  
                  
                  
                  283
                  
                  
                  
                  6.42
                  %
                  
                  
                  17,527
                  
                  
                  
                  283
                  
                  
                  
                  6.42
                  %Total
      interest-bearing liabilities
                  
                  
                  539,076
                  
                  
                  
                  2,952
                  
                  
                  
                  2.17
                  %
                  
                  
                  557,087
                  
                  
                  
                  3,893
                  
                  
                  
                  2.78
                  %Noninterest-bearing
      checking
                  
                  
                  96,546
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  72,845Other
      liabilities
                  
                  
                  4,452
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  3,529Stockholders'
      equity
                  
                  
                  46,678
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  49,494Total
      liabilities and stockholders' equity
                  
                  $
                  686,752
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  $
                  682,955Net
      interest income
                  
                  
                  
                  
                  
                  $
                  5,202
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  $
                  5,540Rate
      spread
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  2.89
                  %
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  3.04
                  %Net
      interest income as a percent of average earning assets
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  3.23
                  %
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  3.42
                  %
  (1)
Computed on a tax equivalent basis for tax exempt securities using a 34%
statutory tax rate.
 Provision for Loan
Losses.   A provision for loan losses was recorded in the
amount of $2.0 million, or 146 basis points (annualized) on average loans during
third quarter of 2009 as compared to $2.0 million, or 146 basis points
(annualized) on average loans for the third quarter of 2008.  The
large provision recorded for the third quarter of 2009 came primarily from four
borrowing relationships.  Two commercial loan relationships were
charged down in the amount of $855,000, of which $200,000 was previously
reserved.  Additionally, we increased specific reserves by $925,000 on
two lending relationships. The allowance for loan losses at September 30, 2009
totaled $14.9 million and was 2.78% of total loans outstanding on that
date.  For the three-month period ended September 30, 2009, we were in
a net charge-off position of $1.2 million, or 88 basis points (annualized) on
average loans compared to net charge-offs of $1.6 million, or 115 basis points
(annualized) on average loans during the same period a year
ago.
  28
 Index
  Noninterest
Income.   Noninterest income was $1.2 million during the
third quarter of 2009.  This was a $602,376, or 33.2%, decrease
compared to the third quarter of 2008.  The majority of the decrease
relates to an other-than-temporary-impairment on a trust preferred security of
$477,344 and a decrease in trust and brokerage fees of $117,851.  The
impairment recognized in the third quarter brought the security down to 43.2% of
its par value; therefore, only $436,341 of book value remains on the
security.  An offset to the decrease in noninterest income was an
increase in loan broker fees of $153,795.  We experienced a
significant increase in mortgage originations in the third quarter 2009 at 53
compared to the third quarter 2008 of approximately 18 loans.  Trust
and brokerage fees have decreased compared to September 30, 2008 as the stock
market has only started to recover from its rapid decline of approximately 40%
in 2008.  The market decline directly impacts trust and brokerage fees
as they are typically determined by the amount of assets under
management.
 
 Noninterest
Expense.   Noninterest expense was $5.5 million for the
third quarter of 2009 while noninterest expense for the quarter ended September
30, 2008 was $5.0 million.  The main components of noninterest expense
for the third quarter of 2009 were salaries and benefits of $2.7 million,
occupancy and equipment costs of $779,044, FDIC insurance premiums of $357,138,
and loan and professional expenses in the amount of $445,546.  While
our total non-interest expenses increased by $425,088, the majority of the
increase is due to an expected loss on a claim made on a commercial letter of
credit in the amount of $325,000 and an increase in FDIC insurance premiums of
$177,102.  There was a significant increase in FDIC insurance premiums
as the FDIC has continued to increase the premiums for all banks in order to
replenish the depleting insurance reserve due to an increasing number of bank
failures across the nation and increased FDIC insurance limits to $250,000 for
interest-bearing accounts and unlimited insurance for non-interest bearing
accounts from the previous $100,000 insurance limit on all deposit
accounts.  The increase in loan and professional costs was due to
increased professional expenses to comply with Sarbanes Oxley 404 standards,
increased legal costs related to asset quality and collections, and a fee from a
consulting firm engaged to increase efficiency within the
Bank.  Without the FDIC insurance increases and the claim on the
letter of credit, we would have experienced a slight decrease as some operating
expenses showed declines in the third quarter 2009 compared to the third quarter
2008, including employment expenses of $161,686, marketing of $43,487, and
communication of $47,637.  Employment expenses decreased due to a
reduction in the number of full-time employees from September 30, 2008 and a
decrease in bonus expense.  Marketing and communication expenses
decreased to an amount similar to years prior to 2008, as 2008 incurred
marketing costs for the production of two television commercials and
communication expenses to upgrade our on-line banking system.
 
 Income
Taxes. During the quarters ended September 30, 2009 and
2008, the Company recorded ($455,615) and ($133,632), in income taxes benefit.
The effective tax rate recorded was (38.7%) for the third quarter 2009 as
compared to (68.2%) for the third quarter 2008.  The tax benefit in
2009 is the result of a net loss coupled with excess tax-exempt income over net
income from bank owned life insurance income and municipal bond
income.
 
 For The Nine-Month Periods
Ended September 30
 
 Results
of operations for the nine-month period ended September 30, 2009 reflected net
loss of $4.4 million, or ($1.08) per diluted share.   This was a
$5.8 million decrease from 2008’s third quarter net income of $1.4 million, or
$0.34 per diluted share.  The year-to-date net loss for the third
quarter 2009 compared to year-to-date net income for the third quarter 2008 was
due primarily to the following:
 
 ·
                Increased
      loan loss provisions of $6.3
million
 ·
                Letter
      of credit claim totaling $325,000 that was recorded as a contingent
      liability
 ·
                Write
      down in value of a foreclosed property totaling
  $950,000
 ·
                Increased
      FDIC assessments totaling $453,145
 ·
                One-time,
      industry imposed, special FDIC assessment of
  $315,000
 ·
                Impairment
      charge on a security totaling
$525,000
 ·
                Margin
      compression lowered net interest income by $1.4
  million
  Total revenue, defined as net interest
income plus total noninterest income, declined by $1.7 million from the third
quarter 2008 to the third quarter 2009 primarily due to the drop in net interest
margin over the same period of time and an other-than-temporary-impairment
recorded on a trust preferred security.  The 4.0% decrease in
short-term interest rates during 2008, of which 175 basis points of the 4.0%
drop occurred in the fourth quarter of 2008, was the primary reason for the
decline in the net interest margin.  For the nine-month period ended
September 30, 2009, net interest income decreased 8.6%, while total noninterest
income decreased 6.6% from the same period one year ago primarily due to an
other-than-temporary-impairment on a trust preferred security of $525,000 and a
decrease in trust and brokerage fees of $276,921.  The decrease in
non-interest income was offset by an increase in a net gain recognized on the
sale of available for sale securities of $144,051 and an increase in loan
brokered fees of $359,606.
  29
 Index
 
 Performance
      Ratios
                  
                  September
      302009
                  
                  
                  2008Return
      on average assets *
                  
                  
                  -0.85
                  %
                  
                  
                  0.27
                  %Return
      on average equity *
                  
                  
                  -12.03
                  %
                  
                  
                  3.77
                  %Net
      interest margin (TEY) *
                  
                  
                  3.03
                  %
                  
                  
                  3.31
                  %Efficiency
      ratio
                  
                  
                  88.87
                  %
                  
                  
                  77.90
                  %
  Net Interest
Income.   Interest income for the nine-month periods ended
September 30, 2009 and 2008 was $24.0 million and $28.9 million, respectively,
while interest expense for the third quarter was $9.6 million in 2009 and $13.1
million in 2008, resulting in net interest income of $14.4 million for the first
nine months of 2009 and $15.8 million for the first nine months of
2008.  While average earning assets increased slightly, short-term
interest rates decreased 400 basis points in 2008, thus negatively impacting net
interest margin and causing a decrease in our net interest income.  In
a declining interest-rate environment, our variable rate assets re-price
immediately, but our variable rate liabilities typically re-price over a time
period of thirty to forty-five days.  The tax equivalent net interest
margin for the third quarter of 2009 was 3.03%, while the tax equivalent net
interest margin for the third quarter of 2008 was 3.31%.  If there are
no changes in the current Federal Funds rate of 0.00% - 0.25% in the near
future, we expect our net interest margin to begin leveling out.
 
 The
following table reflects the average balance, interest earned or paid, and
yields or costs of the Company’s assets, liabilities and stockholders’ equity at
and for the dates indicated:
 
 As
      of and For The Nine Month Period EndedSeptember
      30, 2009
                
                
                September
      30 2008($
      in thousands)
                
                Average
      Balance
                
                
                Interest
      Earned or Paid
                
                
                Annualized
      Yield or Cost
                
                
                Average
      Balance
                
                
                Interest
      Earned or Paid
                
                
                Annualized
      Yield or CostAssetsShort-term
      investments and interest-earning deposits
                
                $
                1,922
                
                
                $
                1
                
                
                
                0.07
                %
                
                $
                8,802
                
                
                $
                182
                
                
                
                2.76
                %Federal
      funds sold
                
                
                9,352
                
                
                
                11
                
                
                
                0.16
                %
                
                
                6,281
                
                
                
                150
                
                
                
                3.19
                %Securities
      - taxable
                
                
                61,947
                
                
                
                2,240
                
                
                
                4.83
                %
                
                
                53,869
                
                
                
                1,997
                
                
                
                4.95
                %Securities
      - tax exempt (1)
                
                
                22,898
                
                
                
                1,077
                
                
                
                6.29
                %
                
                
                21,148
                
                
                
                997
                
                
                
                6.30
                %Loans
      held for sale
                
                
                2,217
                
                
                
                -
                
                
                
                0.00
                %
                
                
                497
                
                
                
                -
                
                
                
                0.00
                %Loans
                
                
                554,781
                
                
                
                21,108
                
                
                
                5.09
                %
                
                
                561,205
                
                
                
                25,919
                
                
                
                6.17
                %Total
      interest-earning assets
                
                
                653,117
                
                
                
                24,437
                
                
                
                5.00
                %
                
                
                651,802
                
                
                
                29,245
                
                
                
                5.99
                %Allowance
      for loan losses
                
                
                (12,215
                )
                
                
                
                
                
                
                
                
                
                
                (8,939
                )Cash
      and due from banks
                
                
                21,226
                
                
                
                
                
                
                
                
                
                
                
                14,841Other
      assets
                
                
                35,027
                
                
                
                
                
                
                
                
                
                
                
                32,271Total
      assets
                
                $
                697,155
                
                
                
                
                
                
                
                
                
                
                $
                689,975Liabilities
      and Stockholders' EquityInterest-bearing
      checking
                
                $
                83,128
                
                
                $
                472
                
                
                
                0.76
                %
                
                $
                66,038
                
                
                $
                619
                
                
                
                1.25
                %Savings
                
                
                17,180
                
                
                
                55
                
                
                
                0.43
                %
                
                
                16,418
                
                
                
                133
                
                
                
                1.08
                %Money
      market
                
                
                159,061
                
                
                
                1,310
                
                
                
                1.10
                %
                
                
                137,161
                
                
                
                2,493
                
                
                
                2.43
                %Certificates
      of deposit
                
                
                257,549
                
                
                
                6,301
                
                
                
                3.27
                %
                
                
                298,569
                
                
                
                8,152
                
                
                
                3.65
                %Short-term
      borrowings
                
                
                293
                
                
                
                2
                
                
                
                0.91
                %
                
                
                151
                
                
                
                3
                
                
                
                2.65
                %FHLB
      advances
                
                
                23,056
                
                
                
                644
                
                
                
                3.73
                %
                
                
                29,866
                
                
                
                858
                
                
                
                3.84
                %Junior
      subordinated debt
                
                
                17,527
                
                
                
                846
                
                
                
                6.45
                %
                
                
                17,527
                
                
                
                848
                
                
                
                6.46
                %Total
      interest-bearing liabilities
                
                
                557,794
                
                
                
                9,630
                
                
                
                2.31
                %
                
                
                565,730
                
                
                
                13,106
                
                
                
                3.09
                %Noninterest-bearing
      checking
                
                
                86,164
                
                
                
                
                
                
                
                
                
                
                
                71,331Other
      liabilities
                
                
                4,223
                
                
                
                
                
                
                
                
                
                
                
                3,857Stockholders'
      equity
                
                
                48,974
                
                
                
                
                
                
                
                
                
                
                
                49,057Total
      liabilities and stockholders' equity
                
                $
                697,155
                
                
                
                
                
                
                
                
                
                
                $
                689,975Net
      interest income
                
                
                
                
                
                $
                14,807
                
                
                
                
                
                
                
                
                
                
                $
                16,139Rate
      spread
                
                
                
                
                
                
                
                
                
                
                2.69
                %
                
                
                
                
                
                
                
                
                
                
                2.90
                %Net
      interest income as a percent of average earning assets
                
                
                
                
                
                
                
                
                
                
                3.03
                %
                
                
                
                
                
                
                
                
                
                
                3.31
                %
 
 (1)
Computed on a tax equivalent basis for tax exempt securities using a 34%
statutory tax rate.
  30
 Index
  Provision for Loan
Losses.   A provision for loan losses was recorded in the
amount of $9.5 million, 229 basis points (annualized) on average loans during
first nine months of 2009 as compared to $3.2 million, or 76 basis points,
annualized, on average loans for the first nine months of 2008.  The
cause for the increase in provision recorded for the third quarter of 2009 came
from six lending relationships.  Three commercial real estate loan
relationships were reserved to fair value after receiving updated appraisals
which increased the specific reserves by $3.6 million and three relationships
had cashflow and collateral deficiencies requiring increased reserves of $1.6
million.  Additionally, we charged-down five lending relationships by
$4.9 million of which only $1.7 million was reserved for prior to the
charge-down.  The allowance for loan losses at September 30, 2009
totaled $14.9 million and was 2.78% of total loans outstanding on that
date.  For the nine-month period ended September 30, 2009, we were in
a net charge-off position of $5.3 million, or 127 basis points (annualized) on
average loans compared to net charge-offs of $2.1, or 50 basis points
(annualized) on average loans during the same period a year ago.
 
 Noninterest
Income.   Noninterest income was $4.6 million during the
first nine months of 2009.  This was a $323,368, or 6.6%, decrease
compared to the first nine months of 2008.  The majority of the
decrease relates to an other-than-temporary-impairment recorded on a trust
preferred security of $525,000 and a decrease in trust and brokerage fees of
$276,921.  The other-than-temporary-impairment brought the value of
the security down to 43.2% of its par value; therefore, only $436,341 of book
value remains on the security.  The decrease in noninterest income was
offset by an increase in a net gain on sale of available for sale securities of
$144,051 and an increase in loan broker fees of
$359,606.    Service charge income decreased by $96,562 due
to reconfiguring our fee structure on our Health Savings Account product, as we
eliminated the service charges and reduced interest rates. Trust and brokerage
fees have decreased compared to September 30, 2008 as the stock market has only
started recovered from its rapid decline of approximately 40% in
2008.  The market decline directly impacts trust and brokerage fees as
they are typically determined by the amount of assets under
management.
 
 Noninterest
Expense.   Noninterest expense was $16.9 million for the
first nine months of 2009 while noninterest expense for the nine-month period
ended September 30, 2008 was $16.1 million.  The main components of
noninterest expense for the third quarter of 2009 were salaries and benefits of
$8.0 million, occupancy and equipment costs of $2.2 million, FDIC insurance
premiums with a special assessment totaling $1.3 million, a write-down on an
other real estate owned property of $950,000, $1.2 million in other expenses
which included an expected loss due to a claim made on a commercial letter of
credit in the amount of $325,000, and $1.1 million in loan and professional
costs.  There was a significant increase in FDIC insurance premiums as
the FDIC has continued to increase the premiums and added a special assessment
for all banks in order to replenish the depleting insurance reserve due to an
increasing number of bank failures across the nation and increased FDIC
insurance limits to $250,000 for interest-bearing accounts and unlimited
insurance for non-interest bearing accounts from the previous $100,000 insurance
limit on all deposit accounts.  The increase from the first nine
months in 2008 to the first nine months in 2009 was $768,145.  We also
recorded a write-down of $950,000 on a commercial property in other real estate
owned based on a new appraisal received in June 2009 comprising of the majority
of the balance in the other expense category.  The increase in loan
and professional costs was due to increased professional expenses to comply with
Sarbanes Oxley 404 standards, increased legal costs related to asset quality and
collections, and a fee from a consulting firm engaged to increase efficiency
within the Bank.  While total non-interest expenses increased, we
experienced a decrease in some operating expenses in the first nine months of
2009 compared to the first nine months of 2008, including decreases in
employment expenses of $932,521, marketing of $138,831, and business development
of $114,545.  Employment expenses decreased due to a reduction in the
number of full-time employees from September 30, 2008 and a decrease in bonus
expense.  Marketing expenses decreased to an amount similar to years
prior to 2008, as 2008 incurred marketing costs for the production of two
television commercials.
 
 Income
Taxes. During the quarters ended September 30, 2009 and
2008, the Company recorded ($3.0 million) and $22,528, in income tax (benefit)
and income tax expense, respectively. The effective tax rate recorded was
(40.3%) for 2009 as compared to 1.6% for 2008.  The tax benefit in
2009 is the result of a net loss and excess tax-exempt income over net income
from bank owned life insurance income and municipal bond income.
  
 Liquidity
and Capital Resources
 
 Liquidity.   Our
general liquidity strategy is to fund growth with deposits and to maintain an
adequate level of short- and medium-term investments to meet typical daily loan
and deposit activity needs.  The first nine months showed an increase
in deposits of $6.5 million from December 31, 2008.  While we
continued to show steady in-market deposit growth, we positioned ourselves to
allow our out-of-market brokered certificate of deposits and FHLB advances to
mature without replacing those funds through the use of out-of-market
products.  Currently, all of FHLB advances are fixed rate bullet
advances with no callable options; therefore, we must wait until maturity to
repay.  Included in our out-of-market funding base are borrowings from
the FHLB and trust preferred securities and, beginning with the second quarter
of 2003, brokered CDs.  In the aggregate these out-of-market brokered
certificate of deposits represented $71.0 million, or 12.0% of our total
deposits, at September 30, 2009.  This was up slightly from $62.3
million, or 10.9% at September 30, 2008. Total deposits at September 30, 2009
were $592.7 million and the loan to deposit ratio was 90.4%.  Total
borrowings at September 30, 2009 were $33.7 million.  We expect to
experience more moderate loan growth in the near-term due to a shift in
management’s strategy, which focuses more on profitability, rather than growth.
Funding for the loan growth will continue to come from in-market
sources.
  31
 Index
  Capital
Resources. Stockholders’ equity is a
noninterest-bearing source of funds, which provides support for asset
growth.  Stockholders’ equity was $48.5 million and $49.6 million at
September 30, 2009 and December 31, 2008, respectively. Affecting the decrease
in stockholders’ equity during the first nine months of 2009 was a $4.4 million
net loss.  Additionally, we recorded $55,028 of stock option and
restricted stock compensation expense.  We also increased capital
through an internal capital raise by issuing 18,300 shares of series A
convertible preferred stock in the amount of $1.8 million.  Each share
was sold for $100 each and is convertible into Tower Financial Corporation
common stock at a price per share of $6.02, which is a 30% premium on the common
stock market price on the purchase date, September 25, 2009.  The
series A convertible preferred stock has no expiration date; however, Tower
Financial Corporation has the right to call the shares on or after September 25,
2012 until September 24, 2013 at 110% of par, after September 25, 2013 until
September 24, 2014 at 105% of par, and at par after September 25,
2014.  The series A convertible stock pays quarterly dividends at a
rate of 5.25%.
  During
the first nine months of 2009, we made no common stock dividend payments and
accrued one preferred stock payment in the amount of $1,579.  In the
second quarter of 2008, the Company issued a press release stating that we
elected to forego the declaration of a dividend on its common stock
indefinitely. The decision was based on the desire to retain capital and hedge
against challenging economic and banking industry conditions as well as to
maintain Tower Bank’s current “well capitalized” status within the Federal
Reserve System.  Our ability to pay future cash and stock dividends on
common stock is subject to limitations under various laws and regulations and to
prudent and sound banking practices.
 
 The
Company’s regulatory capital ratios continue to remain above the
“well-capitalized” levels of 6 percent for tier 1 capital and 10 percent for
risked-based capital.  The reduction in capital ratios is the direct
result of a large loan loss provision during the first nine months of 2009, the
write down of a foreclosed land development during the quarter, and an
other-than-temporary impairment on a trust preferred
security.  Offsetting these negative impacts was a reduction in total
assets and an internal capital raise in series A convertible preferred
stock.  Although the Company’s capital ratios decreased from December
31, 2008, the third quarter results were well within the stress testing of
existing capital performed by the Company earlier this year.
 
 The
following table summarizes the capital ratios of the Company and the Bank at the
dates indicated:
  September
      30, 2009
                  
                  
                  December
      31, 2008Well-
                  
                  
                  Minimum
                  
                  
                  
                  
                  
                  Well-
                  
                  
                  MinimumActual
                  
                  
                  Capitalized
                  
                  
                  Required
                  
                  
                  Actual
                  
                  
                  Capitalized
                  
                  
                  RequiredThe
      CompanyLeverage
      capital
                  
                  
                  9.04
                  %
                  
                  
                  5.00
                  %
                  
                  
                  4.00
                  %
                  
                  
                  9.69
                  %
                  
                  
                  5.00
                  %
                  
                  
                  4.00
                  %Tier
      1 risk-based
                  
                  
                  11.00
                  %
                  
                  
                  6.00
                  %
                  
                  
                  4.00
                  %
                  
                  
                  11.66
                  %
                  
                  
                  6.00
                  %
                  
                  
                  4.00
                  %Total
      risk-based
                  
                  
                  12.53
                  %
                  
                  
                  10.00
                  %
                  
                  
                  8.00
                  %
                  
                  
                  12.99
                  %
                  
                  
                  10.00
                  %
                  
                  
                  8.00
                  %The
      BankLeverage
      capital
                  
                  
                  8.49
                  %
                  
                  
                  5.00
                  %
                  
                  
                  4.00
                  %
                  
                  
                  9.04
                  %
                  
                  
                  5.00
                  %
                  
                  
                  4.00
                  %Tier
      1 risk-based
                  
                  
                  10.30
                  %
                  
                  
                  6.00
                  %
                  
                  
                  4.00
                  %
                  
                  
                  10.87
                  %
                  
                  
                  6.00
                  %
                  
                  
                  4.00
                  %Total
      risk-based
                  
                  
                  11.57
                  %
                  
                  
                  10.00
                  %
                  
                  
                  8.00
                  %
                  
                  
                  12.12
                  %
                  
                  
                  10.00
                  %
                  
                  
                  8.00
                  %
  32
 Index
 Commitments
and Off-Balance Sheet Risk
 
 The Bank
maintains off-balance-sheet instruments in the normal course of business to meet
the financing needs of its customers.   These financial
instruments include commitments to extend credit and standby letters of
credit.  These instruments involve, to varying degrees, elements of
credit risk in excess of the amount recognized, if any, in the balance
sheet.  The Bank’s maximum exposure to loan loss in the event of
nonperformance by the other party to the financial instruments for commitments
to extend credit and standby letters of credit is represented by the contractual
notional amount of these instruments.  Such financial instruments are
recorded when they are funded.  Fair value of the Bank’s
off-balance-sheet instruments (commitments to extend credit and standby letters
of credit) is based on rates currently charged to enter into similar agreements,
taking into account the remaining terms of the agreements and the
counterparties’ credit standing.  At September 30, 2009, the rates on
existing off-balance-sheet instruments were equivalent to current market rates,
considering the underlying credit standing of the counterparties.  As
of September 30, 2009, there was one claim made on a commercial letter of credit
that could not be paid by the customer.  Of the $325,000 claim was
recorded to reflect the amount expected to be paid in the fourth quarter of 2009
or the first quarter 2010.
 
 Tabular
disclosure of the Company’s contractual obligations as of the end of our latest
fiscal year was provided in our Annual Report on Form 10-K for the year ended
December 31, 2008.  There have been no material changes outside the
ordinary course of business in such contractual obligations during the first
nine months of 2009.
 
 
 Item
4.   CONTROLS AND PROCEDURES
 
 a.  Evaluation
of disclosure controls and procedures
 
 As of the
end of the period covered by this report, we carried out an evaluation of the
effectiveness of our disclosure controls and procedures (as defined in Rules
13a-15(e) and 15d-15(e) under the Securities and Exchange Act of 1934), under
the supervision and the participation of management, including our Chief
Executive Officer and Chief Financial Officer.  Based upon their
evaluation, our Chief Executive Officer and our Chief Financial Officer
concluded that our disclosure controls and procedures, and our internal control
over financial reporting, are effective to provide reasonable assurance that
information required to be disclosed by us in reports we file or submit under
the Exchange Act is recorded, processed, summarized and reported within the time
periods specified by Securities and Exchange Commission rules and
forms.  In designing and evaluating the disclosure controls and
procedures, our management recognizes that any controls and procedures, no
matter how well designed and operated, can provide only reasonable assurance of
achieving the desired control objectives, and our management necessarily is
required to apply its judgment in evaluating the cost-benefit relationship of
possible controls and procedures.
 
 c.  Changes in internal control over
financial reporting
 
 There
were no changes in our internal control over financial reporting or in our
procedures during our most recent fiscal quarter that have materially affected,
or are reasonably likely to materially affect, our internal control over
financial reporting, nor were we required to take nor did we take any corrective
actions with regard to any significant deficiencies or material weaknesses in
internal control over financial reporting.
  33
 Index
  PART
II.  OTHER INFORMATION
 
 Item
1.    LEGAL PROCEEDINGS
 
 No
material litigation
 
 Item
1a.   RISK FACTORS
 
 No
material changes from the Risk Factors disclosed in our Annual Report on Form
10-K for the year ended December 31, 2008.
 
 Item
6.   EXHIBITS
 
 (a)
                Exhibits.
 
 31.1 Rule 13a-14(a) /15-14(a) Certification of Chief
Executive Officer.
 31.2 Rule 13a-14(a) /15-14(a) Certification of Chief
Financial Officer.
 
 32.1 Certification of Chief Executive Officer pursuant to
18 U.S.C. Section 1350.
 32.2 Certification of Chief Financial Officer pursuant to
18 U.S.C. Section 1350.
  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.
 
  TOWER
      FINANCIAL CORPORATIONDated:  November
      13, 2009
                  / s /  Michael D.
      CahillMichael
      D. Cahill, President and Chief Executive OfficerDated:  November
      13, 2009
                  / s /  Richard R.
      SawyerRichard
      R. SawyerChief
      Financial Officer
   34