UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C.  20549





Form
10-Q/A





(Mark
One)





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





For
      the quarterly period ended June 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 S  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 £
            Smaller
      reporting company S


(Do not
check if a smaller reporting company.)





Indicate
by check mark whether the Registrant is a shell company (as defined in Rule
12b-2of the Exchange Act).


Yes £   No
S





Number of
shares of the issuer’s common stock, without par value, outstanding as of August
12, 2009: 4,090,432.








1




Explanatory
Note:
  We
are filing this Amendment No. 1 to our Quarterly Report on Form 10-Q for the
quarter ended June 30, 2009, as filed with the Securities and Exchange
Commission on August 12, 2009, solely to include a presentment of earnings per
share on the face of the income statement.  No other changes have been
made to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2009,
except for the signature block and certification dates, which are dated
currently.








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 at June 30, 2009
      (unaudited) and December 31, 2008
            4Consolidated Condensed Statements of Operations for the three
      and six months ended June 30, 2009 and June 30, 2008
      (unaudited)
            5Consolidated Condensed Statements of Changes in Stockholders’
      Equity for  the six months ended June 30, 2009 and June 30, 2008
      (unaudited)
            6Consolidated Condensed Statements of Cash Flows for the six
      months ended June 30, 2009 and June 30, 2008 (unaudited)
            7Notes to Consolidated Condensed Financial Statements
      (unaudited)
            8Item
      2.
            Management’s Discussion and Analysis of Financial
      Condition andResults 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
            35




3
 Table of Contents





PART
I.  FINANCIAL INFORMATION


Item
1.  FINANCIAL STATEMENTS


Tower
Financial Corporation


Consolidated Condensed Balance Sheets


At June
30, 2009 and December 31, 2008





(unaudited)June
      30,
            
            
            December
      31,2009
            
            
            2008ASSETSCash
      and due from banks
            
            $
            11,692,671
            
            
            $
            19,418,905Short-term
      investments and interest-earning deposits
            
            
            486,924
            
            
            
            9,525,414Federal
      funds sold
            
            
            3,702,334
            
            
            
            2,632,054Total
      cash and cash equivalents
            
            
            15,881,929
            
            
            
            31,576,373Securities
      available for sale, at fair value
            
            
            77,959,647
            
            
            
            77,792,255Securities
      held to maturity, at cost
            
            
            4,720,914
            
            
            
            -FHLB
      and FRB stock
            
            
            4,032,446
            
            
            
            4,032,446Loans
      held for sale
            
            
            3,513,721
            
            
            
            151,614Loans
            
            
            557,529,990
            
            
            
            561,011,675Allowance
      for loan losses
            
            
            (14,105,074
            )
            
            
            (10,654,879
            )Net
      loans
            
            
            543,424,916
            
            
            
            550,356,796Premises
      and equipment, net
            
            
            7,592,201
            
            
            
            8,010,596Accrued
      interest receivable
            
            
            2,462,880
            
            
            
            2,615,260Bank
      owned life insurance
            
            
            12,809,168
            
            
            
            12,589,699Other
      Real Estate Owned
            
            
            4,060,025
            
            
            
            2,660,310Other
      assets
            
            
            9,849,162
            
            
            
            6,798,774Total
      assets
            
            $
            686,307,009
            
            
            $
            696,584,123LIABILITIES
      AND STOCKHOLDERS' EQUITYLIABILITIESDeposits:Noninterest-bearing
            
            $
            105,667,772
            
            
            $
            82,107,483Interest-bearing
            
            
            488,925,976
            
            
            
            504,129,631Total
      deposits
            
            
            594,593,748
            
            
            
            586,237,114Short-term
      borrowings
            
            
            2,800,000
            
            
            
            -Federal
      Home Loan Bank (FHLB) advances
            
            
            21,200,000
            
            
            
            39,200,000Junior
      subordinated debt
            
            
            17,527,000
            
            
            
            17,527,000Accrued
      interest payable
            
            
            539,193
            
            
            
            658,956Other
      liabilities
            
            
            3,684,819
            
            
            
            3,342,913Total
      liabilities
            
            
            640,344,760
            
            
            
            646,965,983STOCKHOLDERS'
      EQUITYPreferred
      stock, no par value, 4,000,000 shares authorized; no shares issued and
      outstanding
            
            
            -
            
            
            
            -Common
      stock and paid-in-capital, no par value, 6,000,000 4,090,432 and 4,084,432
      shares outstanding at at June 30, 2009 and December 31,
    2008
            
            
            39,803,592
            
            
            
            39,766,742Treasury
      stock, at cost, 65,000 shares at June 30, 2009 and December 31,
      2008
            
            
            (884,376
            )
            
            
            (884,376
            )Retained
      earnings
            
            
            7,210,469
            
            
            
            10,895,724Accumulated
      other comprehensive income(loss), net of tax of ($86,254) at June 30, 2009
      and ($82,399) at December 31, 2008
            
            
            (167,436
            )
            
            
            ((159,950
            )Total
      stockholders' equity
            
            
            45,962,249
            
            
            
            49,618,140Total
      liabilities and stockholders' equity
            
            $
            686,307,009
            
            
            $
            696,584,123





The
following notes are an integral part of the financial statements.





4
 Table of Contents





Tower
Financial Corporation


Consolidated Condensed Statements of Operations


For the
three and six months ended June 30, 2009 and 2008




(unaudited)
            
            
            (unaudited)Three Months ended
            
            
            Six Months EndedJune 30
            
            
            June 302009
            
            
            2008
            
            
            2009
            
            
            2008Interest income:Loans, including fees
            
            $
            7,099,710
            
            
            $
            8,348,159
            
            
            $
            14,147,664
            
            
            $
            17,615,558Securities - taxable
            
            
            781,080
            
            
            
            648,256
            
            
            
            1,414,797
            
            
            
            1,262,770Securities - tax exempt
            
            
            243,046
            
            
            
            223,312
            
            
            
            469,329
            
            
            
            437,346Other interest income
            
            
            2,708
            
            
            
            89,634
            
            
            
            9,553
            
            
            
            271,986Total interest income
            
            
            8,126,544
            
            
            
            9,309,361
            
            
            
            16,041,343
            
            
            
            19,587,660Interest expense:Deposits
            
            
            2,803,694
            
            
            
            3,433,023
            
            
            
            5,646,584
            
            
            
            8,075,158Short-term borrowings
            
            
            1,082
            
            
            
            -
            
            
            
            990
            
            
            
            -FHLB advances
            
            
            216,680
            
            
            
            298,637
            
            
            
            467,028
            
            
            
            572,777Junior subordinated debt
            
            
            283,071
            
            
            
            283,071
            
            
            
            563,297
            
            
            
            564,720Total interest expense
            
            
            3,304,527
            
            
            
            4,014,731
            
            
            
            6,677,899
            
            
            
            9,212,655Net interest income
            
            
            4,822,017
            
            
            
            5,294,630
            
            
            
            9,363,444
            
            
            
            10,375,005Provision for loan losses
            
            
            6,550,000
            
            
            
            875,000
            
            
            
            7,510,000
            
            
            
            1,175,000Net interest income (loss) after provision for loan
      losses
            
            
            (1,727,983
            )
            
            
            4,419,630
            
            
            
            1,853,444
            
            
            
            9,200,005Noninterest income:Trust and brokerage fees
            
            
            806,067
            
            
            
            938,634
            
            
            
            1,673,956
            
            
            
            1,833,026Service charges
            
            
            283,483
            
            
            
            314,144
            
            
            
            541,316
            
            
            
            635,354Loan broker fees
            
            
            195,403
            
            
            
            66,812
            
            
            
            333,681
            
            
            
            127,870Gain (Loss) on sale of
    securities
            
            
            3,861
            
            
            
            -
            
            
            
            195,012
            
            
            
            59,837Impairment on available-for-sale securities (See Note
      4 for more detail)
            
            
            (47,656
            )
            
            
            -
            
            
            
            (47,656
            )
            
            
            -Other fees
            
            
            357,790
            
            
            
            148,879
            
            
            
            691,942
            
            
            
            453,156Total noninterest income
            
            
            1,598,948
            
            
            
            1,468,469
            
            
            
            3,388,251
            
            
            
            3,109,243Noninterest expense:Salaries and benefits
            
            
            2,644,960
            
            
            
            3,051,846
            
            
            
            5,367,409
            
            
            
            6,138,244Occupancy and equipment
            
            
            692,810
            
            
            
            731,588
            
            
            
            1,391,402
            
            
            
            1,489,903Marketing
            
            
            134,215
            
            
            
            224,014
            
            
            
            278,872
            
            
            
            374,216Data processing
            
            
            327,443
            
            
            
            220,172
            
            
            
            621,452
            
            
            
            500,930Loan and professional costs
            
            
            383,196
            
            
            
            386,418
            
            
            
            695,140
            
            
            
            630,068Office supplies and postage
            
            
            73,489
            
            
            
            81,947
            
            
            
            170,546
            
            
            
            195,979Courier services
            
            
            58,472
            
            
            
            75,070
            
            
            
            119,907
            
            
            
            164,535Business development
            
            
            165,765
            
            
            
            173,959
            
            
            
            266,762
            
            
            
            328,832Communication Expense
            
            
            44,321
            
            
            
            80,931
            
            
            
            88,239
            
            
            
            151,723FDIC Insurance Premiums
            
            
            679,308
            
            
            
            200,241
            
            
            
            958,798
            
            
            
            367,755Write-down on Other Real Estate
      Owned
            
            
            950,000
            
            
            
            -
            
            
            
            950,000
            
            
            
            50,000Other expense
            
            
            303,902
            
            
            
            394,239
            
            
            
            542,625
            
            
            
            707,024Total noninterest expense
            
            
            6,457,881
            
            
            
            5,620,425
            
            
            
            11,451,152
            
            
            
            11,099,209Income (Loss) before income
    taxes
            
            
            (6,586,916
            )
            
            
            267,674
            
            
            
            (6,209,457
            )
            
            
            1,210,039Income tax expense (benefit)
            
            
            (2,491,436
            )
            
            
            (75,033
            )
            
            
            (2,524,202
            )
            
            
            156,160Net income (loss)
            
            $
            (4,095,480
            )
            
            $
            342,707
            
            
            $
            (3,685,255
            )
            
            $
            1,053,879Basic earnings per common share
            
            $
            (1.00
            )
            
            $
            0.08
            
            
            $
            (0.90
            )
            
            $
            0.26Diluted earnings per common share
            
            $
            (1.00
            )
            
            $
            0.08
            
            
            $
            (0.90
            )
            
            $
            0.26Average common shares outstanding
            
            
            4,090,432
            
            
            
            4,073,582
            
            
            
            4,090,399
            
            
            
            4,066,864Average common shares and dilutive potential common
      shares outstanding
            
            
            4,090,432
            
            
            
            4,075,871
            
            
            
            4,090,399
            
            
            
            4,080,137Dividends declared
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            0.044





The
following notes are an integral part of the financial statements





5
 Table of Contents





Tower
Financial Corporation


Consolidated
Condensed Statements of Changes in Stockholders’
Equity


For the
six months ended June 30, 2009 and 2008




Common
            
            
            
            
            
            AccumulatedStock
      and
            
            
            
            
            
            OtherPaid-in
            
            
            Retained
            
            
            Comprehensive
            
            
            TreasuryCapital
            
            
            Earnings
            
            
            Income
      (Loss)
            
            
            Stock
            
            
            TotalBalance,
      January 1, 2008
            
            $
            39,482,669
            
            
            $
            9,208,719
            
            
            $
            274,993
            
            
            $
            (758,827
            )
            
            $
            48,207,554Net
      income for 2008
            
            
            
            
            
            
            1,053,879
            
            
            
            
            
            
            
            
            
            
            
            1,053,879Other
      Comprehensive Income (See Note 5)
            
            
            
            
            
            
            
            
            
            
            (378,112
            )
            
            
            
            
            
            
            (378,112
            )Total
      Comprehensive Income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            675,767Cash
      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
            
            
            32,007
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            32,007Repurchase
      of 11,964 shares of common stock
            
            
            -
            
            
            
            
            
            
            
            
            
            
            
            (125,549
            )
            
            
            (125,549
            )Balance,
      June 30, 2008
            
            $
            39,735,315
            
            
            $
            10,083,494
            
            
            $
            (103,119
            )
            
            $
            (884,376
            )
            
            $
            48,831,314Balance,
      January 1, 2009
            
            $
            39,766,742
            
            
            $
            10,895,724
            
            
            $
            (159,950
            )
            
            $
            (884,376
            )
            
            $
            49,618,140Net
      income(loss) for 2009
            
            
            
            
            
            
            (3,685,255
            )
            
            
            
            
            
            
            
            
            
            
            (3,685,255
            )Other
      Comprehensive Income (Loss) (See Note 5)
            
            
            
            
            
            
            
            
            
            
            (7,486
            )
            
            
            
            
            
            
            (7,486
            )Total
      Comprehensive Income (Loss)
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (3,692,741
            )Stock
      based compensation expense
            
            
            36,850
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            36,850Balance,
      June 30, 2009
            
            $
            39,803,592
            
            
            $
            7,210,469
            
            
            $
            (167,436
            )
            
            $
            (884,376
            )
            
            $
            45,962,249





The
following notes are an integral part of the financial statements


6
 Table of Contents
  Tower
Financial Corporation


Consolidated
Condensed Statements of Cash Flows


For the
six months ended June 30, 2009 and 2008




(unaudited)
            
            
            (unaudited)Six
      Months Ended
            
            
            Six
      Months EndedJune
      30, 2009
            
            
            June
      30, 2008Cash
      flows from operating activities:Net
      income (loss)
            
            $
            (3,685,255
            )
            
            $
            1,053,879Adjustments
      to reconcile net income (loss) to net cash from operating
      activities:Depreciation
      and amortization
            
            
            687,346
            
            
            
            701,825Provision
      for loan losses
            
            
            7,510,000
            
            
            
            1,175,000Stock
      based compensation expense
            
            
            36,850
            
            
            
            32,007Earnings
      on life insurance
            
            
            (219,469
            )
            
            
            (209,813
            )Gain
      on sale of securities AFS
            
            
            (195,012
            )
            
            
            (59,837
            )Impairment
      on available-for-sale securities
            
            
            47,656
            
            
            
            -Gain
      on settlement of interest rate floor
            
            
            (312,656
            )
            
            
            (156,327
            )Loss
      on disposal of premises and equipment
            
            
            231
            
            
            
            7,492Loans
      originated for sale
            
            
            (14,961,125
            )
            
            
            (4,654,333
            )(Gain)Loss
      on sale of other real estate owned
            
            
            59,151
            
            
            
            -Proceeds
      on sale of other real estate owned
            
            
            630,788
            
            
            
            -Write-down
      on other real estate owned
            
            
            950,000
            
            
            
            50,000Proceeds
      from sale of loans
            
            
            11,599,018
            
            
            
            6,974,570Change
      in accrued interest receivable
            
            
            152,380
            
            
            
            610,483Change
      in other assets
            
            
            (3,046,532
            )
            
            
            856,127Change
      in accrued interest payable
            
            
            (119,763
            )
            
            
            (886,316
            )Change
      in other liabilities
            
            
            341,906
            
            
            
            825,209Net
      cash from operating activities
            
            
            (524,486
            )
            
            
            6,319,966Cash
      flows from investing activities:Net
      change in loans
            
            
            (3,617,775
            )
            
            
            9,054,201Purchase
      of securities AFS
            
            
            (14,029,392
            )
            
            
            (21,129,663
            )Purchase
      of securities HTM
            
            
            (4,720,914
            )
            
            
            -Proceeds
      from calls and maturities of securities AFS
            
            
            8,108,024
            
            
            
            8,070,800Proceeds
      from settlement of interest rate floor
            
            
            -
            
            
            
            833,750Proceeds
      from sale of securities AFS
            
            
            6,022,315
            
            
            
            3,476,412Proceeds
      from sale of participation loans
            
            
            -
            
            
            
            11,000,231Purchase
      of premises and equipment
            
            
            (88,850
            )
            
            
            (421,278
            )Net
      cash from investing activities
            
            
            (8,326,592
            )
            
            
            10,884,453Cash
      flows from financing activities:Net
      change in deposits
            
            
            8,356,634
            
            
            
            (571,856
            )Cash
      dividends paid
            
            
            -
            
            
            
            (179,104
            )Proceeds
      from issuance of common stock from exercise of stock
    options
            
            
            -
            
            
            
            220,639Net
      change in short-term borrowings
            
            
            2,800,000
            
            
            
            -Proceeds
      from FHLB advances
            
            
            -
            
            
            
            54,450,000Repayment
      of FHLB advances
            
            
            (18,000,000
            )
            
            
            (65,350,000
            )Repurchase
      of common stock
            
            
            -
            
            
            
            (125,549
            )Net
      cash from (used in) financing activities
            
            
            (6,843,366
            )
            
            
            (11,555,870
            )Net
      change in cash and cash equivalents
            
            
            (15,694,444
            )
            
            
            5,648,549Cash
      and cash equivalents, beginning of period
            
            
            31,576,373
            
            
            
            33,830,389Cash
      and cash equivalents, end of period
            
            $
            15,881,929
            
            
            $
            39,478,938Supplemental
      disclosures of cash flow informationCash
      paid during the year for:Interest
            
            $
            6,797,662
            
            
            $
            10,098,971Income
      taxes
            
            
            1,265,000
            
            
            
            -Noncash
      items:Transfer
      of loans to other real estate owned
            
            
            3,039,655
            
            
            
            1,437,745





The
following notes are an integral part of the financial statements.




7
 Table of Contents





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 June 30, 2009 and its consolidated results of operations, comprehensive
income, changes in stockholders’ equity and cash flows for the six-month periods
ended June 30, 2009 and June 30, 2008.   The results for the
period ended June 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.





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 FASB Interpretation
48, Accounting for Uncertainty in Income Taxes (“FIN 48”), 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.





8
 Table of Contents




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 the fair value hierarchy established
in FAS 157 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





Effect of Recently Adopted Accounting
Standards: In April 2009, the FASB issued Staff Position (FSP) No. 115-2
and No. 124-2, Recognition and Presentation of Other-Than-Temporary Impairments,
which amends existing guidance for determining whether impairment is
other-than-temporary for debt securities.  The FSP requires an entity
to assess whether it intends to sell, or it is more likely than not that it will
be required to sell a security in an unrealized loss position before recovery of
its amortized cost basis.  If either of these criteria is met, the
entire difference between amortized cost and fair value is recognized in
earnings.  For securities that do not meet the aforementioned
criteria, the amount of impairment recognized in earnings is limited to the
amount related to credit losses, while impairment related to other factors is
recognized in other comprehensive income.    Additionally,
the FSP expands and increases the frequency of existing disclosures about
other-than-temporary impairments for debt and equity securities.  This
FSP is effective for interim and annual reporting periods ending after June 15,
2009, with early adoption permitted for periods ending after March 15,
2009.  The Company adopted FSP 115-2 and 124-2 as of January 1, 2009,
see Note 4 for impact to the financial statements.





In April
2009, the FASB issued Staff Position (FSP) No. 157-4, Determining Fair Value
When the Volume and Level of Activity for the Asset and Liability Have
Significantly Decreased and Identifying Transactions That Are Not
Orderly.  This FSP emphasizes that even if there has been a
significant decrease in the volume and level of activity, the objective of a
fair value measurement remains the same.  Fair value is the price that
would be received to sell an asset or paid to transfer a liability in an orderly
transaction (that is, not a forced liquidation or distressed sale) between
market participants.  The FSP provides a number of factors to consider
when evaluating whether there has been a significant decrease in the volume and
level of activity for an asset or liability in relation to normal market
activity.  In addition, when transactions or quoted prices are not
considered orderly, adjustments to those prices based on the weight of available
information may be needed to determine the appropriate fair
value.  The FSP also requires increased disclosures.  This
FSP is effective for interim and annual reporting periods ending after June 15,
2009, and shall be applied prospectively.  Early adoption is permitted
for periods ending after March 15, 2009.  The Company adopted this FSP
as of January 1, 2009 and there was no material effect on the results of
operations or financial position.





In April
2009, the FASB issued Staff Position (FSP) No. 107-1 and APB 28-1, Interim
Disclosures about Fair Value of Financial Instruments.  This FSP
amends FASB Statement No. 107, Disclosures about Fair Value of Financial
Instruments, to require disclosures about fair value of financial instruments
for interim reporting periods of publicly traded companies that were previously
only required in annual financial statements.  This FSP is effective
for interim reporting periods ending after June 15, 2009, with early adoption
permitted for periods ending after March 15, 2009.  The Company
adopted this FSP as of the period ending March 31, 2009.





In May
2009, the FASB issued Statement No. 165, Subsequent Events. The objective of
this Statement is to establish principles and requirements for subsequent
events. Subsequent events are events or transactions that occur after the
balance sheet date but before financial statements are issued or are available
to be issued. There are two types of subsequent events: a) The first type
consists of events or transactions that provide additional evidence about
conditions that existed at the date of the balance sheet, including the
estimates inherent in the process of preparing financial statements (that is,
recognized subsequent events). b) The second type consists of events that
provide evidence about conditions that did not exist at the date of the balance
sheet but arose after that date (that is, nonrecognized subsequent events). This
Statement is effective for interim or annual financial periods ending after June
15, 2009, and shall be applied prospectively. The adoption of this standard did
not have a material effect on the Company's consolidated results of operations
or financial condition.





9
 Table of Contents




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 June 30, 2009
and December 31, 2008 and the corresponding amounts of unrealized gains and
losses therein:




June
      30, 2009Amortized
      Cost
            
            
            Gross
      Unrealized Gains
            
            
            Gross
      Unrealized Losses
            
            
            Fair
      ValueAvailable
      for Sale:U.S.
      Government agency debt obligations
            
            $
            8,241,489
            
            
            $
            172,187
            
            
            $
            (9,701
            )
            
            $
            8,403,975Obligations
      of states and political subdivisions
            
            
            25,289,367
            
            
            
            161,115
            
            
            
            (715,617
            )
            
            
            24,734,865Mortgage-backed
      securities
            
            
            43,810,056
            
            
            
            1,231,677
            
            
            
            (294,979
            )
            
            
            44,746,754Trust
      Preferred securities
            
            
            913,686
            
            
            
            -
            
            
            
            (839,633
            )
            
            
            74,053Total
            
            $
            78,254,598
            
            
            $
            1,564,979
            
            
            $
            (1,859,930
            )
            
            $
            77,959,647Held
      to Maturity:
            
            Amortized
      Cost
            
            
            Gross Unrecognized
      Gains
            
            
            Gross Unrecognized
      Losses
            
            
            Fair
      ValueMortgage-backed
      securities
            
            $
            4,720,914
            
            
            $
            29,113
            
            
            $
            (22,908
            )
            
            $
            4,727,119Total
            
            $
            4,720,914
            
            
            $
            29,113
            
            
            $
            (22,908
            )
            
            $
            4,727,119December
      31, 2008Amortized
      Cost
            
            
            Gross Unrecognized
      Gains
            
            
            Gross Unrecognized
      Losses
            
            
            Fair
      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
 Table of Contents





The fair
values of debt securities available for sale and held to maturity at June 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.





6/30/2009
            
            
            6/30/2009
            
            
            12/31/2008
            
            
            12/31/2008Weighted
      Average Yield
            
            
            Fair
      Value
            
            
            Weighted
      Average Yield
            
            
            Fair
      ValueAvailable
      for sale:Agencies:Due
      in one year or less
            
            
            0.00
            %
            
            $
            -
            
            
            
            0.00
            %
            
            $
            -Due
      after one to five years
            
            
            3.90
            %
            
            
            5,115,282
            
            
            
            4.45
            %
            
            
            5,739,408Due
      after five years
            
            
            4.07
            %
            
            
            1,782,753
            
            
            
            4.10
            %
            
            
            2,529,724Due
      after ten years
            
            
            3.53
            %
            
            
            1,505,940
            
            
            
            0.00
            %
            
            
            -Total
      Agencies
            
            
            3.87
            %
            
            $
            8,403,975
            
            
            
            4.35
            %
            
            $
            8,269,132Mortgage-backed
      securities:Mortgage-backed
      securities
            
            
            4.93
            %
            
            $
            44,746,754
            
            
            
            4.66
            %
            
            $
            48,034,593Obligations
      of state and political subdivisions:Due
      in one year or less
            
            
            4.30
            %
            
            $
            45,801
            
            
            
            4.30
            %
            
            $
            110,790Due
      after one to five years
            
            
            4.72
            %
            
            
            1,696,582
            
            
            
            5.07
            %
            
            
            806,104Due
      after five to ten years
            
            
            5.82
            %
            
            
            6,721,278
            
            
            
            5.87
            %
            
            
            5,180,237Due
      after ten years
            
            
            6.14
            %
            
            
            16,271,204
            
            
            
            6.15
            %
            
            
            15,160,499Total
      Obligations of state and political subdivisions
            
            
            5.96
            %
            
            $
            24,734,865
            
            
            
            6.03
            %
            
            $
            21,257,630Trust
      Preferred SecuritiesDue
      after ten years
            
            
            1.70
            %
            
            $
            74,053
            
            
            
            3.11
            %
            
            $
            230,900Held
      to maturity:Mortgage-backed
      securities:Mortgage-backed
      securities
            
            
            9.21
            %
            
            $
            4,727,119
            
            
            
            0.00
            %
            
            $
            -





Proceeds
from securities sold classified as available for sale totaled $6.0 million and
$3.5 million as of June 30, 2009 and June 30, 2008,
respectively.  Gross gains realized were $195,012 and $59,837, with an
approximate tax expense of $66,304 and $20,345, as of June 30, 2009 and June 30,
2008, respectively.  There were no gross losses realized on the sale
of available for sale securities during the six month periods ending June 30,
2009 and June 30, 2008.  Also impacting earnings during the second
quarter of 2009 is an other-than-temporary impairment charge related to a credit
loss on one trust preferred security in the amount of $47,656, described
below.





Securities
with a carrying value of $3.2 million and $7.7 million were pledged to secure
borrowings from the FHLB at June 30, 2009 and December 31, 2008,
respectively.  Securities with a carrying value of $11.5 million and
$5.1 million were pledged to the Federal Reserve to secure potential borrowings
at the Discount Window at June 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 $3.7 million and $0 were pledged at the First
Tennessee Bank to secure federal funds lines of credit at June 30, 2009 and
December 31, 2008, respectively.  At June 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
 Table of Contents





Securities
with unrealized losses at June 30, 2009 not recognized in income are as
follows:





Continuing
      Unrealized
            
            
            Continuing
      UnrealizedLosses
      for
            
            
            Losses
      forLess
      than 12 months
            
            
            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
            
            $
            2,002,810
            
            
            $
            (9,701
            )
            
            $
            -
            
            
            $
            -
            
            
            $
            2,002,810
            
            
            $
            (9,701
            )Obligations
      of states and political subdivisions
            
            
            15,173,337
            
            
            
            (426,238
            )
            
            
            2,855,641
            
            
            
            (289,379
            )
            
            
            18,028,978
            
            
            
            (715,617
            )Mortgage-backed
      securities
            
            
            3,904,462
            
            
            
            (5,325
            )
            
            
            471,174
            
            
            
            (289,654
            )
            
            
            4,375,636
            
            
            
            (294,979
            )Trust
      preferred securities
            
            
            -
            
            
            
            -
            
            
            
            74,053
            
            
            
            (839,633
            )
            
            
            74,053
            
            
            
            (839,633
            )Total
      temporarily impaired
            
            $
            21,080,609
            
            
            $
            (441,264
            )
            
            $
            3,400,868
            
            
            $
            (1,418,666
            )
            
            $
            24,481,477
            
            
            $
            (1,859,930
            )Fair
      Value
            
            
            Gross
      Unrecognized Losses
            
            
            Fair
      Value
            
            
            Gross
      Unrecognized Losses
            
            
            Fair
      Value
            
            
            Gross
      Unrecognized LossesHeld
      to maturity:Mortgage-backed
      securities
            
            
            4,727,119
            
            
            
            (22,908
            )
            
            
            -
            
            
            
            -
            
            
            
            4,727,119
            
            
            
            (22,908
            )Total
      temporarily impaired
            
            $
            4,727,119
            
            
            $
            (22,908
            )
            
            $
            -
            
            
            $
            -
            
            
            $
            4,727,119
            
            
            $
            (22,908
            )





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 the issuers’ bonds are of high credit
quality and management has the intent and ability to hold for the foreseeable
future.  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 model. Investment securities classified as available for sale
are generally evaluated for OTTI under Statement of Financial Accounting
Standards (“SFAS”) No. 115, Accounting 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 EITF Issue No. 99-20, 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.





In
determining OTTI under the SFAS No. 115 model, 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.





12
 Table of Contents




The
second segment of the portfolio uses the OTTI guidance provided by EITF 99-20
that is specific to purchased beneficial interests that, on the purchase date,
were rated below AA. Under the EITF 99-20 model, 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
June 30, 2009, Tower Financial Corporation’s security portfolio consisted of 175
securities, 70 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 June
30, 2009, approximately 85% 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 June 30, 2009.





The
Company’s mortgage-backed securities portfolio did contain one non-agency
collateralized mortgage obligations with a market value of $471,173 which had
unrealized losses of $289,655 at June 30, 2009. This non-agency mortgage-backed
security was rated AAA at the time of purchase and is not within the scope of
EITF 99-20. The Company monitors to insure it has adequate credit support and as
of June 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 $4.7million 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 11% 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 June 30, 2009.


Trust
Preferred Securities


The
Company has one investment in a pooled trust preferred security with a book
value of $913,686 and a fair value of $74,053. The decline in value is primarily
attributable to temporary illiquidity and the financial crisis affecting these
markets.  Due to the illiquidity in the market, it is unlikely that
the Company would be able to recover its investment in these securities if the
Company sold the securities at this time.





Our
analysis of this investment fell within the scope of EITF 99-20.  This
investment is a Preferred Term Security Ltd and is held by our investment
subsidiary.  The investment is collateralized by underlying
investments in trust preferred securities issued by many different banks and
insurance companies.  This security was rated A3 at inception, but as
of June 30, 2009, Moody’s has downgraded the security to Ca.  The
Company uses the OTTI evaluation model to compare the present value of expected
cash flows to the previous estimate to ensure there are no adverse changes in
cash flows during the quarter. The OTTI model considers the structure and term
of the CDO and the financial condition of the underlying issuers. Specifically,
the model details interest rates, principalbalances 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.  Based on the information available at
March 31, 2009, we assumed no recoveries on defaults and treated all interest
payment deferrals as defaults. In addition, we used 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 Financial Corporation’s note class. Upon
completion of the March 31, 2009 analysis, our model indicated
other-than-temporary impairment on this security as a result of additional
deferrals and defaults during the first quarter and the impact those had on
expected cashflows.  This security had an
other-than-temporary-impairment loss of which $47,656 was recorded as expense in
the second quarter of 2009 based on the calculation at March 31,
2009.  Although the first quarter impairment was recorded in the
second quarter, we do not believe the impact to the financial statements was
material.  For the second quarter, the method used for predicting
future interest payments in the cash flow model was enhanced. At March 31, 2009,
the model used the current bond coupon and assumed interest rates stayed flat
over the remainder of the security’s life. The new model uses forward interest
rates as embedded in the LIBOR curve at quarter end. This process produces a
coupon forecast that is tied directly to market expectations at quarter
end.  We believe this is more indicative of what will happen with
interest rates versus rates remaining steady for the next 20 or more years. The
new coupon calculations allow for more realistic cash flow calculations going
forward.  This model doubles the average bank defaults per year going
forward and holds the insurance company default static.Upon
completion of the June 30, 2009 analysis, our model indicated no additional
other-than-temporary impairment credit charge to be reported in
earnings.





13
 Table of Contents




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 six months ended
June, 2009 and 2008:





Three
      months ended June 302009
            
            
            2008Net
      Income (Loss)
            
            $
            (4,095,480
            )
            
            $
            342,707Change
      in securities available-for-sale:Other-than-temporary
      impairment on available-for-sale securities
            
            
            30,690
            
            
            
            -Other-than-temporary
      impairment on available-for-sale securities associated with credit losses
      realized in income
            
            
            47,656
            
            
            
            -Other-than-temporary
      impairment on available-for-sale securities, recorded in
    OCI
            
            
            78,346
            
            
            
            -Unrealized
      gains (losses) on interest rate floor
            
            
            (132,134
            )
            
            
            (139,834
            )Unrealized
      holding gains (losses) on available-for-sale securities arising during the
      period
            
            
            (278,354
            )
            
            
            (1,534,969
            )Reclassification
      adjustment for (gains) losses realized in income on interest rate
      floor
            
            
            219,343
            
            
            
            (139,832
            )Reclassification
      adjustment for (gains) losses realized in income on available-for-sale
      securities
            
            
            (3,861
            )
            
            
            -Net
      unrealized (gains) losses
            
            
            (195,006
            )
            
            
            (1,814,635
            )Income
      tax expense (benefit)
            
            
            123,949
            
            
            
            563,632Total
      other comprehensive income (loss)
            
            
            (240,609
            )
            
            
            (1,251,003
            )Comprehensive
      Income (Loss)
            
            $
            (4,336,089
            )
            
            $
            (908,296
            )





14
 Table of Contents





Six
      months ended June 302009
            
            
            2008Net
      Income (Loss)
            
            $
            (3,685,255
            )
            
            $
            1,053,879Change
      in securities available-for-sale:Other-than-temporary
      impairment on available-for-sale securities
            
            
            (169,899
            )
            
            
            -Other-than-temporary
      impairment on available-for-sale securities associated with credit losses
      realized in income
            
            
            47,656
            
            
            
            -Other-than-temporary
      impairment on available-for-sale securities, recorded in
    OCI
            
            
            (122,243
            )
            
            
            -Unrealized
      gains (losses) on interest rate floor
            
            
            445,505
            
            
            
            304,936Unrealized
      holding gains (losses) on available-for-sale securities arising during the
      period
            
            
            128,785
            
            
            
            (678,158
            )Reclassification
      adjustment for (gains) losses realized in income on interest rate
      floor
            
            
            (268,376
            )
            
            
            (139,832
            )Reclassification
      adjustment for (gains) losses realized in income on available-for-sale
      securities
            
            
            (195,012
            )
            
            
            (59,837
            )Net
      unrealized (gains) losses
            
            
            (11,341
            )
            
            
            (572,891
            )Income
      tax expense (benefit)
            
            
            3,855
            
            
            
            194,779Total
      other comprehensive income (loss)
            
            
            (7,486
            )
            
            
            (378,112
            )Comprehensive
      Income (Loss)
            
            $
            (3,692,741
            )
            
            $
            675,767








Note
6 - Earnings Per Share





The
following table reflects the calculation of basic and diluted earnings per
common share for the six-month periods ended June 30, 2009 and June 30,
2008.  Options not considered in the calculation of diluted earnings
per common share because they were antidilutive, totaled 123,934 and 45,886 for
the three-month period and 123,934 and 45,660 for the six-month period ended
June 30, 2009 and 2008, respectively.





Three
      Months Ended
            
            
            Six
      Months EndedJune
      30
            
            
            June
      302009
            
            
            2008
            
            
            2009
            
            
            2008BasicNet
      income (loss)
            
            $
            (4,095,480
            )
            
            $
            342,707
            
            
            $
            (3,685,255
            )
            
            $
            1,053,879Weighted
      average common shares outstanding
            
            
            4,090,432
            
            
            
            4,073,582
            
            
            
            4,090,399
            
            
            
            4,066,864Basic
      earnings (loss) per common share
            
            $
            (1.00
            )
            
            $
            0.08
            
            
            $
            (0.90
            )
            
            $
            0.26DilutedNet
      income (loss)
            
            $
            (4,095,480
            )
            
            $
            342,707
            
            
            $
            (3,685,255
            )
            
            $
            1,053,879Weighted
      average common shares outstanding
            
            
            4,090,432
            
            
            
            4,073,582
            
            
            
            4,090,399
            
            
            
            4,066,864Add:  dilutive
      effect of assumed stock option exercises
            
            
            -
            
            
            
            2,289
            
            
            
            -
            
            
            
            13,273Weighted
      average common shares and dilutive potential common shares
      outstanding
            
            
            4,090,432
            
            
            
            4,075,871
            
            
            
            4,090,399
            
            
            
            4,080,137Diluted
      earnings (loss) per common share
            
            $
            (1.00
            )
            
            $
            0.08
            
            
            $
            (0.90
            )
            
            $
            0.26







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 123,934 remain outstanding as of June 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 in
accordance with FAS123(R) was $13,394 and $29,195 for the six months ended June
30, 2009 and June 30, 2008, respectively.  No income tax benefit was
recognized in the income statement for the share-based compensation
arrangements.





15
 Table of Contents





A summary
of the option activity under the Plans as of June 30, 2009 and changes during
the six-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
            
            
            (42,741
            )
            
            
            10.03
            
            
            
            -
            
            
            
            -Outstanding
      at June 30, 2009
            
            
            123,934
            
            
            
            12.52
            
            
            
            3.37
            
            
            
            -Vested
      or expected to vest at June 30, 2009
            
            
            123,330
            
            
            
            12.51
            
            
            
            3.36
            
            
            
            -Exercisable
      at June 30, 2009
            
            
            119,707
            
            
            
            12.40
            
            
            
            3.27
            
            
            
            -





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 June
30, 2009, the unrecognized compensation expense for the 1998 and 2001 Stock
Options plan per the requirements of FAS123(R) was $8,599, 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 June 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 in accordance with FAS123(R) was $23,456 and $2,812 for the six months
ended June 30, 2009 and June 30, 2008, respectively.  Future expense
related to this award will be $23,455 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.





In
accordance with SFAS No 133, 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
 Table of Contents





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 $41,260 remains in accumulated other
comprehensive income, net of tax, as our hedged risk, exposure to changes in
cash flows from the designated prime-rate based loans with a spread of zero
payment remains.  The unrealized gain has been and will continue to be
reclassified out of accumulated other comprehensive income into earnings using
the straightline method over the term of the original floor agreement, which
expires on August 1, 2009.  If the Company’s exposure to the original
hedged risk ceases to exist, then the entire remaining deferred gain will be
immediately recognized on the consolidated statements of
operations.





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 June 30, 2009Wealth
            
            
            Corporate
      &Bank
            
            
            Management
            
            
            Intercompany
            
            
            Eliminations
            
            
            TotalIncome
      Statement InformationNet
      interest income
            
            $
            5,081,444
            
            
            $
            23,644
            
            
            $
            (283,071
            )
            
            $
            -
            
            
            $
            4,822,017Non-interest
      income
            
            
            776,511
            
            
            
            812,741
            
            
            
            (3,718,656
            )
            
            
            3,728,352
            
            
            
            1,598,948Non-interest
      expense
            
            
            5,559,187
            
            
            
            589,199
            
            
            
            309,495
            
            
            
            -
            
            
            
            6,457,881Noncash
      itemsProvision
      for loan losses
            
            
            6,550,000
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            6,550,000Depreciation/Amortization
            
            
            323,260
            
            
            
            9,921
            
            
            
            -
            
            
            
            -
            
            
            
            333,181Income
      tax expense(benefit)
            
            
            (2,347,966
            )
            
            
            72,272
            
            
            
            (215,742
            )
            
            
            -
            
            
            
            (2,491,436
            )Segment
      Profit (Loss)
            
            
            (3,903,266
            )
            
            
            174,914
            
            
            
            (4,095,480
            )
            
            
            3,728,352
            
            
            
            (4,095,480
            )Balance
      Sheet InformationSegment
      Assets
            
            
            682,144,241
            
            
            
            6,284,513
            
            
            
            67,859,336
            
            
            
            (69,981,081
            )
            
            
            686,307,009




17
 Table of Contents




As
      of and for the six months ending June 30, 2009Wealth
            
            
            Corporate
      &Bank
            
            
            Management
            
            
            Intercompany
            
            
            Eliminations
            
            
            TotalIncome
      Statement InformationNet
      interest income
            
            $
            9,878,814
            
            
            $
            47,927
            
            
            $
            (563,297
            )
            
            $
            -
            
            
            $
            9,363,444Non-interest
      income
            
            
            1,737,926
            
            
            
            1,685,797
            
            
            
            (2,962,404
            )
            
            
            2,926,932
            
            
            
            3,388,251Non-interest
      expense
            
            
            9,685,144
            
            
            
            1,192,264
            
            
            
            573,744
            
            
            
            -
            
            
            
            11,451,152Noncash
      itemsProvision
      for loan losses
            
            
            7,510,000
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            7,510,000Depreciation/Amortization
            
            
            667,473
            
            
            
            19,873
            
            
            
            -
            
            
            
            -
            
            
            
            687,346Income
      tax expense(benefit)
            
            
            (2,301,535
            )
            
            
            191,523
            
            
            
            (414,190
            )
            
            
            -
            
            
            
            (2,524,202
            )Segment
      Profit (Loss)
            
            
            (3,276,869
            )
            
            
            349,937
            
            
            
            (3,685,255
            )
            
            
            2,926,932
            
            
            
            (3,685,255
            )Balance
      Sheet InformationSegment
      Assets
            
            
            682,144,241
            
            
            
            6,284,513
            
            
            
            67,859,336
            
            
            
            (69,981,081
            )
            
            
            686,307,009






As
      of and for the three months ending June 30, 2008Wealth
            
            
            Corporate
      &Bank
            
            
            Management
            
            
            Intercompany
            
            
            Eliminations
            
            
            TotalIncome
      Statement InformationNet
      interest income
            
            $
            5,551,759
            
            
            $
            25,942
            
            
            $
            (283,071
            )
            
            $
            -
            
            
            $
            5,294,630Non-interest
      income
            
            
            704,064
            
            
            
            938,763
            
            
            
            577,496
            
            
            
            (751,854
            )
            
            
            1,468,469Non-interest
      expense
            
            
            4,704,058
            
            
            
            697,799
            
            
            
            218,568
            
            
            
            -
            
            
            
            5,620,425Noncash
      itemsProvision
      for loan losses
            
            
            875,000
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            875,000Depreciation/Amortization
            
            
            343,723
            
            
            
            10,512
            
            
            
            -
            
            
            
            -
            
            
            
            354,235Income
      tax expense(benefit)
            
            
            55,407
            
            
            
            136,411
            
            
            
            (266,851
            )
            
            
            -
            
            
            
            (75,033
            )Segment
      Profit
            
            
            621,358
            
            
            
            130,495
            
            
            
            342,708
            
            
            
            (751,854
            )
            
            
            342,707Balance
      Sheet InformationSegment
      Assets
            
            
            691,288,156
            
            
            
            6,422,677
            
            
            
            69,234,163
            
            
            
            (71,361,057
            )
            
            
            695,583,939





18
 Table of Contents




As
      of and for the six months ending June 30, 2008Wealth
            
            
            Corporate
      &Bank
            
            
            Management
            
            
            Intercompany
            
            
            Eliminations
            
            
            TotalIncome
      Statement InformationNet
      interest income
            
            $
            10,881,189
            
            
            $
            58,536
            
            
            $
            (564,720
            )
            
            $
            -
            
            
            $
            10,375,005Non-interest
      income
            
            
            1,468,198
            
            
            
            1,833,394
            
            
            
            1,546,563
            
            
            
            (1,738,912
            )
            
            
            3,109,243Non-interest
      expense
            
            
            9,329,297
            
            
            
            1,402,627
            
            
            
            367,285
            
            
            
            -
            
            
            
            11,099,209Noncash
      itemsProvision
      for loan losses
            
            
            1,175,000
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            1,175,000Depreciation/Amortization
            
            
            681,367
            
            
            
            20,458
            
            
            
            -
            
            
            
            -
            
            
            
            701,825Income
      tax expense(benefit)
            
            
            358,920
            
            
            
            236,561
            
            
            
            (439,321
            )
            
            
            -
            
            
            
            156,160Segment
      Profit
            
            
            1,486,170
            
            
            
            252,742
            
            
            
            1,053,879
            
            
            
            (1,738,912
            )
            
            
            1,053,879Balance
      Sheet InformationSegment
      Assets
            
            
            691,288,156
            
            
            
            6,422,677
            
            
            
            69,234,163
            
            
            
            (71,361,057
            )
            
            
            695,583,939








Note
10 – Loans and Allowance for Loan Losses





Loans at
June 30, 2009 and December 31, 2008 were as follows:





June
      30, 2009
            
            
            December
      31, 2008Balance
            
            
            %
            
            
            Balance
            
            
            %Commercial
            
            $
            265,103,331
            
            
            
            47.5
            %
            
            $
            255,027,227
            
            
            
            45.5
            %Commercial
      real estate
            
            
            142,062,873
            
            
            
            25.5
            %
            
            
            152,417,413
            
            
            
            27.2
            %Residential
      real estate
            
            
            89,055,868
            
            
            
            16.0
            %
            
            
            98,431,638
            
            
            
            17.5
            %Home
      equity
            
            
            42,773,441
            
            
            
            7.6
            %
            
            
            34,957,139
            
            
            
            6.2
            %Consumer
            
            
            18,744,966
            
            
            
            3.4
            %
            
            
            20,329,830
            
            
            
            3.6
            %Total
      loans
            
            
            557,740,479
            
            
            
            100.0
            %
            
            
            561,163,247
            
            
            
            100.0
            %Net
      deferred loan costs/(fees)
            
            
            (210,489
            )
            
            
            
            
            
            
            (151,572
            )Allowance
      for loan losses
            
            
            (14,105,074
            )
            
            
            
            
            
            
            (10,654,879
            )Net
      loans
            
            $
            543,424,916
            
            
            
            
            
            
            $
            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
            
            
            7,510,000
            
            
            
            1,175,000Charge-offs
            
            
            (4,236,678
            )
            
            
            (1,657,598
            )Recoveries
            
            
            176,873
            
            
            
            1,248,488Ending
      balance, June 30
            
            $
            14,105,074
            
            
            $
            8,974,052Net
      charge-offs to average loans (annualized)
            
            
            1.46
            %
            
            
            0.14
            %




19
 Table of Contents





The table
below summarizes the allowance allocations by type as of the indicated
dates:





June
      30, 2009
            
            
            December
      31, 2008Specific
      allocations
            
            $
            6,085,000
            
            
            $
            3,101,000Loan
      pool percentage allocations
            
            
            7,990,000
            
            
            
            7,497,000Unallocated
            
            
            30,074
            
            
            
            56,879Total
      allowance for loan losses
            
            $
            14,105,074
            
            
            $
            10,654,879





The
following table summarizes the Company’s nonperforming assets at the dates
indicated:




June
      30, 2009
            
            
            December
      31, 2008Loans
      past due over 90 days and still accruing
            
            $
            2,508,961
            
            
            $
            1,019,857Restructured
      loans
            
            
            184,457
            
            
            
            327,967Nonaccrual
      loans
            
            
            19,015,529
            
            
            
            15,675,334Total
      nonperforming loans
            
            $
            21,708,947
            
            
            $
            17,023,158Other
      real estate owned
            
            
            4,060,025
            
            
            
            2,660,310Total
      nonperforming assets
            
            $
            25,768,972
            
            
            $
            19,683,468Nonperforming
      assets to total assets
            
            
            3.75
            %
            
            
            2.83
            %Nonperforming
      loans to total loans
            
            
            3.89
            %
            
            
            3.03
            %





Impaired
loans were as follows:




June
      30, 2009
            
            
            December
      31, 2008Loans
      with no allocated allowance for loan losses
            
            $
            8,648,691
            
            
            $
            6,462,113Loans
      with allocated allowance for loan losses
            
            
            19,589,371
            
            
            
            16,898,392Total
      Impaired
            
            $
            28,238,062
            
            
            $
            23,360,505Amount
      of allowance for loan losses allocated
            
            $
            6,085,000
            
            
            $
            3,101,000Average
      impaired loans during the period
            
            $
            24,587,800
            
            
            $
            22,414,645Interest
      recognized on impaired loans
            
            $
            374,353
            
            
            $
            244,703Cash-basis
      interest income recognized
            
            $
            436,803
            
            
            $
            244,703




20
 Table of Contents





Note
11 – Federal Home Loan Bank Advances





Advances
from the Federal Home Loan Bank (“FHLB”) were:


June
      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
            
            
            4,000,000
            
            
            
            4,000,0003.08%
      bullet advance, principal due at maturity August 27, 2009
            
            
            1,000,000
            
            
            
            1,000,0002.29%
      bullet advance, principal due at maturity March 22, 2010
            
            
            2,000,000
            
            
            
            2,000,0003.26%
      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$
            21,200,000
            
            
            $
            39,200,000





Of the
total FHLB borrowings at June 30, 2009 and December 31, 2008 no advances had
callable options.




At June
30, 2009 scheduled principal reductions on these FHLB advances were as
follows:




Year
            
            Advances2009
            
            
            5,000,0002010
            
            
            8,700,0002011
            
            
            3,500,0002012
            
            
            2,000,0002013
            
            
            2,000,000$
            21,200,000








Note
12 – Fair Value Measurement





Statement
157 establishes 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. 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 June 30, 2009 and December 31, 2008 using Level 3
inputs.





21
 Table of Contents





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.


June
      30, 2009Level
      1
            
            
            Level
      2
            
            
            Level
      3
            
            
            TotalAvailable
      for Sale:U.S.
      Government agency debt obligations
            
            $
            6,341,475
            
            
            $
            2,062,500
            
            
            $
            -
            
            
            $
            8,403,975Obligations
      of states and political subdivisions
            
            
            -
            
            
            
            24,734,865
            
            
            
            -
            
            
            
            24,734,865Mortgage-backed
      securities
            
            
            44,746,754
            
            
            
            -
            
            
            
            -
            
            
            
            44,746,754Trust
      Preferred securities
            
            
            -
            
            
            
            -
            
            
            
            74,053
            
            
            
            74,053Total
            
            $
            51,088,229
            
            
            $
            26,797,365
            
            
            $
            74,053
            
            
            $
            77,959,647








December
      31, 2008Level
      1
            
            
            Level
      2
            
            
            Level
      3
            
            
            TotalAvailable for
      Sale:U.S.
      Government agency debt obligations
            
            $
            6,262,932
            
            
            $
            2,006,200
            
            
            $
            -
            
            
            $
            8,269,132Obligations
      of states and political subdivisions
            
            
            -
            
            
            
            21,257,630
            
            
            
            -
            
            
            
            21,257,630Mortgage-backed
      securities
            
            
            48,034,593
            
            
            
            -
            
            
            
            -
            
            
            
            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 June 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 six month periods ended June 30,
2009.





Available-for-sale
              securitiesFor
      the three months ended
            
            June
      30, 2009Beginning
      Balance, April 1
            
            $
            37,655Net
      realized/unrealized gains (losses)Included
      in earnings:Interest
      income on securities
            
            
            5,708Credit
      loss recognized in earnings
            
            
            (47,656
            )Included
      in other comprehensive income
            
            
            78,346Ending
      Balance, June 30
            
            $
            74,053




22
 Table of Contents




Available-for-sale
              securitiesFor
      the six months ended
            
            June
      30, 2009Beginning
      Balance, January 1
            
            $
            230,900Net
      realized/unrealized gains (losses)Included
      in earnings:Interest
      income on securities
            
            
            13,052Credit
      loss recognized in earnings
            
            
            (47,656
            )Included
      in other comprehensive income
            
            
            (122,243
            )Ending
      Balance, June 30
            
            $
            74,053




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 (evaluated under FAS 114), 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.




June
      30, 2009Level
      1
            Level
      2
            Level
      3
            TotalImpaired
      loans
            -
            -
            13,504,371
            13,504,371Other
      real estate owned
            -
            -
            4,060,025
            4,060,025




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 $19.6 million, with a valuation allowance of $6.1 million at June 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 $3.0 million relating to
these loans for the second quarter of 2009.  The increase inthevaluation
allowance during the first six months of 2009 was primarily due to the
depreciation in value of the collateral on three impaired commercial real estate
loan relationships causing an increase in specific reserves by $3.6
million.  The decrease in carrying value is due to charging down three
commercial and two commercial real estate loan relationships by $3.9
million.  The increase in other real estate owned from December 31,
2008 to June 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
 Table of Contents





In
accordance with FSP FAS 107-1, the carrying values and estimated fair values of
our financial instruments, not previously presented, at June 30, 2009 and
December 31, 2008 are as follows:




June
      30, 2009
            
            
            December
      31, 2008Carrying
      Value
            
            
            Fair
      Value
            
            
            Carrying
      Value
            
            
            Fair
      ValueFinancial
      assets:Cash
      and cash equivalents
            
            $
            15,881,929
            
            
            $
            15,881,929
            
            
            $
            31,576,373
            
            
            $
            31,576,373Securities
      available for sale
            
            
            77,959,647
            
            
            
            77,959,647
            
            
            
            77,792,255
            
            
            
            77,792,255Securities
      held to maturity
            
            
            4,720,914
            
            
            
            4,727,119
            
            
            
            -
            
            
            
            -FHLBI
      and FRB stock
            
            
            4,032,446
            
            
            
            N/A
            
            
            
            4,032,446
            
            
            
            N/ALoans
      held for sale
            
            
            3,513,721
            
            
            
            3,513,721
            
            
            
            151,614
            
            
            
            151,614Loans,
      net
            
            
            543,424,916
            
            
            
            543,270,357
            
            
            
            550,356,796
            
            
            
            555,695,490Accrued
      interest receivable
            
            
            2,462,880
            
            
            
            2,462,880
            
            
            
            2,615,260
            
            
            
            2,615,260Financial
      liabilities:Deposits
            
            
            (594,593,748
            )
            
            
            (597,430,369
            )
            
            
            (586,237,114
            )
            
            
            (589,369,429
            )Short-term
      borrowings
            
            
            (2,800,000
            )
            
            
            (2,800,000
            )
            
            
            -
            
            
            
            -FHLB
      advances
            
            
            (21,200,000
            )
            
            
            (21,620,823
            )
            
            
            (39,200,000
            )
            
            
            (39,870,750
            )Junior
      subordinated debt
            
            
            (17,527,000
            )
            
            
            (17,025,235
            )
            
            
            (17,527,000
            )
            
            
            (14,532,211
            )Accrued
      interest payable
            
            
            (539,193
            )
            
            
            (539,193
            )
            
            
            (658,956
            )
            
            
            (658,956
            )





Estimated
fair value for securities available for sale is consistent with the hierarchy of
FAS 157 “Fair Value Measurements” as described in Note 12.  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 August 12, 2009 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 June 30, 2009 and December 31, 2008 and
results of operations for the six-month periods ended June 30, 2009 and June 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 $4.1 million and $3.7 million for the second quarter 2009 and year-to-date,
a increase of $4.4 million and $4.7 million from the same periods in
2008.  The increase was due to an increase in loan loss provision
expense bringing the quarterly expense to $6.6 million and a write-down in value
of an other real estate owned property of $950,000.  Provision
expenses increased by $5.7 million from the $875,000 recorded in the second
quarter 2008 due to the continual decline in environmental conditions, to place
specific reserves on three commercial real estate loan relationships, and to
replace charge-downs on three commercial and two commercial real estate loan
relationships.  Upon the receipt of new appraisals, we were required
to write down the value of an other real estate owned property to fair value,
thus recording an expense of $950,000 through operating
expenses.  Also adding to the decrease in earnings was an
industry-wide increase in FDIC insurance premiums coupled with an industry-wide
FDIC special assessment to which our share was $315,000. These two FDIC charges
accounted for a total increase of $479,067 from the second quarter 2008 to the
second quarter 2009.





24
 Table of Contents




Net
interest income decreased as it was negatively impacted by the decline in the
year-to-date net interest margin from 3.26% at June 30, 2008 to 2.93% at June
30, 2009.  Operating expenses increased by $351,943, or 3.2%, in the
first half of 2009 compared to the first half of 2008 due to the FDIC Special
Assessment of $315,000 and a write-down of the value of an other real estate
owned property of $950,000.  Offsetting this increase was a decrease
of $770,835 in employment expenses and an approximate $320,000 aggregate
decrease in occupancy and equipment, marketing, business development, and
communication expenses.





Total
assets decreased by $10.3 million from December 31, 2008 to June 30,
2009.  The decrease in total assets was primarily due to a decrease of
$15.7 million in cash and cash equivalents.  The decrease in cash was
due to net paydown of borrowings between  FHLB advances and the
Federal Reserve Discount Window of $15.2 million. Net loans decreased by $6.9
million from December 31, 2008 to $543.4 million primarily due to charge-downs
of $4.2 million on impaired loans and $950,000 on other real estate owned of
$2.7 million.





Total
deposits increased $8.4 million, or 1.4%, during the first half of 2009. The
increase was primarily driven by increases in non-interest bearing checking
accounts and money market accounts of $23.6 million and $10.3 million,
respectively.  This increase was offset by decreases non-core deposits
of $29.2 million, which includes decreases in certificate of deposits greater
than $100,000 and brokered certificate of deposits in the amounts of $14.1 and
$15.1 million, respectively.  In an effort to decrease our
out-of-market funding, the Company remained liquid during the first half of 2009
to pay off FHLB advances that have matured.  FHLB advances decreased
by $18.0 million from December 31, 2008 to June 30, 2009, while Federal Funds
Purchased from the Federal Reserve Bank Discount Window increased by $2.8
million.





Financial
Condition





Total
assets were $686.3 million at June 30, 2009 compared to total assets at December
31, 2008 of $696.6 million.  The 1.5% decrease in assets was primarily
due to a decrease in cash and cash equivalents by $15.7 million, which was used
to pay off maturing FHLB advances in the amount of $18.0 million.  We
have experienced growth in our non-interest bearing checking accounts and money
markets by $23.6 million and $10.3 million, respectively, during the first six
months of 2009.





Cash and
Investments.   Cash and cash equivalents, which include
federal funds sold, were $15.9 million at June 30, 2009, a decrease of $15.7
million, or 49.7%.  Securities available for sale and held to maturity
were $78.0 million and $4.7 million at the end of the second quarter of 2009, an
increase of $4.9 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 $557.5 million at June 30, 2009 reflecting a 0.6% decrease from total loans
of $561.0 million at December 31, 2008.   The decline in loans
during the first six months of 2009 occurred mainly in the commercial real
estate and residential portfolios, offset by increase in the commercial and home
equity 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 half 2009, we originated 95
loans compared to 23 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 73.0% at June 30, 2009 and 72.7% at December 31,
2008.





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 June 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 $3.3 million
primarily due to three commercial loan relationships and two commercial real
estate loan relationships being downgraded to non-accrual and charged-down by
$3.9 million to a total value of $7.9 million. Total impaired loans at June 30,
2009 were $28.2 million, compared to $23.4 million at December 31,
2008.  At June 30, 2009, management believes it has allocated adequate
specific reserves for these risks.  Other real estate owned increased
by $1.4 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 a 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.





25
 Table of Contents





The
allowance for loan losses at June 30, 2009 was $14.1 million, or 2.53% of total
loans outstanding, an increase of $3.5 million from $10.7 million, or 1.90% of
total loans outstanding, at December 31, 2008.  The provision for loan
losses during the first six months of 2009 was $7.5 million compared to $1.2
million in the first six months of 2008.  The increase in loan loss
provision incurred in the second quarter of 2009 compared to the second quarter
2008 was due to an increase of $3.6 million in specific allocations reserved on
three commercial real estate loan relationships amounting to $10.8 million,
charge-offs of $3.9 million of which only $1.5 million was previously
specifically reserved, and the continuing decline in the economic
environment.





For the
first six-months of 2009 we were in a net charge-off position of $4.1 million
compared to a net charge-off position of $409,110 for the first six-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 $4.7 million during the first six-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 $5.3 million to $6.1 million in the second quarter of 2009
primarily due to becoming more granular in our allowance for loan and lease loss
calculation.  During the second 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 $4.5 million increase in other assets was
primarily attributable to the increase in the deferred tax asset of $4.0
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 foreclosure of a commercial real estate loan in the
amount of $2.7 million during the first quarter also added to the increase, but
was written down by $950,000 to fair value during the second quarter based on an
updated appraisal received in June 2009.  The increase 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
$95,045 will be distributed in accordance with the limited partnership
agreement.





Deposits.   Total
deposits were $594.6 million at June 30, 2009 compared to total deposits at
December 31, 2008 of $586.2 million. The increase of $8.4 million, or 1.4%,
during the first six months of 2009 was reflective of the $37.6 million increase
in core deposits, including increases of $23.6 million in non-interest bearing
checking accounts and $10.3 million in money market accounts.  The
increase was offset by a $29.2 million decrease in non-core deposits, which
includes a decrease of $14.1 million and $15.1 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 second quarter allowed us to let out-of-market funding mature without being
replaced.  Brokered certificate of deposits were $69.4 million and
$84.5 million at June 30, 2009 and December 31, 2008, respectively.




26
 Table of Contents





The
following table summarizes the Company’s deposit balances at the dates
indicated:





June
      30, 2009
            
            
            December
      31, 2008Balance
            
            
            %
            
            
            Balance
            
            
            %Core
      deposits:Noninterest-bearing
      demand
            
            $
            105,667,772
            
            
            
            17.8
            %
            
            $
            82,107,483
            
            
            
            14.0
            %Interest-bearing
      checking
            
            
            77,808,746
            
            
            
            13.1
            %
            
            
            73,452,486
            
            
            
            12.5
            %Money
      market
            
            
            150,645,511
            
            
            
            25.3
            %
            
            
            140,384,566
            
            
            
            24.0
            %Savings
            
            
            16,843,785
            
            
            
            2.8
            %
            
            
            17,049,660
            
            
            
            2.9
            %Time,
      under $100,000
            
            
            93,394,748
            
            
            
            15.7
            %
            
            
            93,764,792
            
            
            
            16.0
            %Total
      core deposits
            
            
            444,360,562
            
            
            
            74.7
            %
            
            
            406,758,987
            
            
            
            69.4
            %Non-core
      deposits:In-market
      core deposits:Time,
      $100,000 and over
            
            
            80,790,172
            
            
            
            13.6
            %
            
            
            94,926,801
            
            
            
            16.2
            %Out-of-market
      non-core deposits:Brokered
      certificate of deposits
            
            
            69,443,014
            
            
            
            11.7
            %
            
            
            84,551,326
            
            
            
            14.4
            %Total
      non-core deposits
            
            
            150,233,186
            
            
            
            25.3
            %
            
            
            179,478,127
            
            
            
            30.6
            %Total
      deposits
            
            $
            594,593,748
            
            
            
            100.0
            %
            
            $
            586,237,114
            
            
            
            100.0
            %





Borrowings.   The
Company had borrowings in the amount of $21.2 million in Federal Home Loan Bank
(“FHLB”) advances at June 30, 2009 and $39.2 million at December 31,
2008.  All FHLB advances are bullet advances and mature in a range
from August 2009 through March 2013.





Other
Liabilities.Other liabilities increased slightly by $341,906
to $3.7 million from December 31, 2008 to June 30, 2009.  The increase
was primarily due to an increase in FDIC insurance premiums that are accrued
during the quarter to be paid during the third quarter 2009.  This
accrual also includes the FDIC special assessment in the amount of
$315,000.





Results
of Operations





For The Three-Month Periods
Ended June 30





Results
of operations for the three-month period ended June 30, 2009 reflected net loss
of $4.1 million, or ($1.00) per diluted share.   This was a $4.4
million decrease from 2008’s second quarter net income of $342,707, or $0.08 per
diluted share.  The operating results for the three-month period ended
June 30, 2009 were unfavorable as we were faced with a decrease in the net
interest margin, recording an additional $5.7 million to provision expense
compared to the same period in 2008, and increases in FDIC insurance premiums of
$479,067 compared to the amount recorded as of June 30, 2008.  Our
non-interest income grew by $130,479 primarily due to an increase in loan broker
fees of $128,591 from an increase in mortgage originations.  As
interest rates began dropping dramatically in 2008 causing a compression of our
net interest margin, we continually looked for ways to decrease our non-interest
expenses.  While our non-interest expenses increased by $837,456, the
increase was primarily due a write-down of $950,000 on an other real estate
owned property and a special assessment from the FDIC of $315,000. Most
non-interest expenses decreased, including employment expenses by $406,886,or
13.3%, and marketing by $89,799, or 40.1%.





Total
revenue, defined as net interest income plus total noninterest income, declined
by $342,134 from the second quarter 2008 to the second quarter 2009 primarily
due to the drop in net interest margin over the same period of
time.  The 4.0% decrease in short-term interest rates during 2008, of
which 75 basis points of the 4.0% drop occurred in December 2008, was the
primary reason for the decline in the net interest margin.  For the
three-month period ended June 30, 2009, net interest income decreased 8.9%,
while total noninterest income increased 8.9% from the same period one year ago
primarily due to an increase in loan broker fees.





Performance
      Ratios
            
            June
      302009
            2008Return
      on average assets *
            
            -2.32%
            0.20%Return
      on average equity *
            
            -32.66%
            2.78%Net
      interest margin (TEY) *
            
            3.02%
            3.37%Efficiency
      ratio
            
            100.57%
            83.10%*
      annualized


27
 Table of Contents




Net Interest
Income.   Interest income for the three-month periods
ended June 30, 2009 and 2008 was $8.1 million and $9.3 million, respectively,
while interest expense for the second quarter was $3.3 million in 2009 and $4.0
million in 2008, resulting in net interest income of $4.8 million for the second
quarter of 2009 and $5.3 million for the second quarter of
2008.  While average earning assets increased slightly, short-term
interest rates decreased 400 basis points in 2008 and continue to remain low
during the second quarter of 2009, 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
second quarter of 2009 was 3.02%, while the tax equivalent net interest margin
for the second quarter of 2008 was 3.37%.  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 Three Month Period EndedJune
      30, 2009
            
            
            June
      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
            
            $
            2,438
            
            
            $
            -
            
            
            
            0.00
            %
            
            $
            5,264
            
            
            $
            41
            
            
            
            3.13
            %Federal
      funds sold
            
            
            4,849
            
            
            
            3
            
            
            
            0.25
            %
            
            
            4,781
            
            
            
            48
            
            
            
            4.04
            %Securities
      - taxable
            
            
            62,826
            
            
            
            781
            
            
            
            4.99
            %
            
            
            52,706
            
            
            
            648
            
            
            
            4.94
            %Securities
      - tax exempt (1)
            
            
            23,421
            
            
            
            368
            
            
            
            6.30
            %
            
            
            21,830
            
            
            
            344
            
            
            
            6.34
            %Loans
      held for sale
            
            
            2,190
            
            
            
            -
            
            
            
            0.00
            %
            
            
            551
            
            
            
            -
            
            
            
            0.00
            %Loans
            
            
            561,814
            
            
            
            7,100
            
            
            
            5.07
            %
            
            
            561,647
            
            
            
            8,348
            
            
            
            5.98
            %Total
      interest-earning assets
            
            
            657,538
            
            
            
            8,252
            
            
            
            5.03
            %
            
            
            646,779
            
            
            
            9,429
            
            
            
            5.87
            %Allowance
      for loan losses
            
            
            (11,294
            )
            
            
            
            
            
            
            
            
            
            
            (9,299
            )Cash
      and due from banks
            
            
            26,683
            
            
            
            
            
            
            
            
            
            
            
            15,845Other
      assets
            
            
            35,355
            
            
            
            
            
            
            
            
            
            
            
            32,221Total
      assets
            
            $
            708,282
            
            
            
            
            
            
            
            
            
            
            $
            685,546Liabilities
      and Stockholders' EquityInterest-bearing
      checking
            
            $
            83,597
            
            
            $
            172
            
            
            
            0.83
            %
            
            $
            66,866
            
            
            $
            199
            
            
            
            1.20
            %Savings
            
            
            16,940
            
            
            
            16
            
            
            
            0.38
            %
            
            
            16,777
            
            
            
            45
            
            
            
            1.08
            %Money
      market
            
            
            157,684
            
            
            
            436
            
            
            
            1.11
            %
            
            
            135,542
            
            
            
            747
            
            
            
            2.22
            %Certificates
      of deposit
            
            
            265,507
            
            
            
            2,180
            
            
            
            3.29
            %
            
            
            289,527
            
            
            
            2,442
            
            
            
            3.39
            %Short-term
      borrowings
            
            
            453
            
            
            
            1
            
            
            
            0.89
            %
            
            
            -
            
            
            
            -
            
            
            
            0.00
            %FHLB
      Advances
            
            
            23,133
            
            
            
            217
            
            
            
            3.76
            %
            
            
            34,041
            
            
            
            299
            
            
            
            3.53
            %Junior
      subordinated debt
            
            
            17,527
            
            
            
            283
            
            
            
            6.49
            %
            
            
            17,527
            
            
            
            283
            
            
            
            6.49
            %Total
      interest-bearing liabilities
            
            
            564,841
            
            
            
            3,305
            
            
            
            2.35
            %
            
            
            560,280
            
            
            
            4,015
            
            
            
            2.90
            %Noninterest-bearing
      checking
            
            
            88,921
            
            
            
            
            
            
            
            
            
            
            
            71,851Other
      liabilities
            
            
            4,217
            
            
            
            
            
            
            
            
            
            
            
            4,164Stockholders'
      equity
            
            
            50,303
            
            
            
            
            
            
            
            
            
            
            
            49,251Total
      liabilities and stockholders' equity
            
            $
            708,282
            
            
            
            
            
            
            
            
            
            
            $
            685,546Net
      interest income
            
            
            
            
            
            $
            4,947
            
            
            
            
            
            
            
            
            
            
            $
            5,414Rate
      spread
            
            
            
            
            
            
            
            
            
            
            2.68
            %
            
            
            
            
            
            
            
            
            
            
            2.97
            %Net
      interest income as a percent of average earning assets
            
            
            
            
            
            
            
            
            
            
            3.02
            %
            
            
            
            
            
            
            
            
            
            
            3.37
            %





(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 $6.6 million, or 471 basis points (annualized) on average loans during
second quarter of 2009 as compared to $875,000, or 62 basis points (annualized)
on average loans for the second quarter of 2008.  The cause for the
increase in provision recorded for the second quarter of 2009 was
twofold.  First, three commercial real estate loan relationships were
reserved to fair value after receiving updated appraisals which increased the
specific reserves by $3.6 million.  Second, we charged-down three
commercial loan relationships and two commercial real estate loan relationship
by $3.9 million of which only $1.5 million was reserved for prior to the
charge-down.  We realize that during times of economic declines that a
properly structured and performing loan could struggle; therefore, we account
for this when the loan is being rated.  The allowance for loan losses
at June 30, 2009 totaled $14.1 million and was 2.53% of total loans outstanding
on that date.  For the three-month period ended June 30, 2009, we were
in a net charge-off position of $3.9 million, or 281 basis points (annualized)
on average loans compared to net charge-offs of $936,318, or 67 basis points
(annualized) on average loans during the same period a year ago.





28
 Table of Contents





Noninterest
Income.   Noninterest income was $1.6 million during the
second quarter of 2009.  This was a $130,479, or 8.9%, increase
compared to the second quarter of 2008.  The majority of the increase
relates to an increase in loan broker fees of $128,591.  While there
was not a significant increase in residential mortgage balances, we experienced
a significant increase in mortgage originations in the second quarter 2009 at 95
compared to the second quarter 2008 of approximately 35 loans.  Trust
and brokerage fees have decreased compared to June 30, 2008 as the stock market
has not 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 $6.5 million for the
second quarter of 2009 while noninterest expense for the six-month period ended
June 30, 2008 was $5.6 million.  The main components of noninterest
expense for the second quarter of 2009 were salaries and benefits of $2.6
million, occupancy and equipment costs of $692,810, FDIC insurance premiums and
FDIC special assessment totaling $679,308, and loan and professional expenses in
the amount of $383,196.  While our total non-interest expenses
increased by $837,456, the majority of the increase is due to a write-down of a
property in other real estate owned by $950,000 and an increase in FDIC
insurance premiums coupled with a special assessment totaling
$479,067.  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.  Without those two expenses, we would have experienced a
decrease as several operating expense accounts showed declines in the second
quarter 2009 compared to the second quarter 2008, including employment expenses
of $408,886, marketing of $89,799, and communication of $36,610.  We
experienced an increase of $107,271 in our processing charges as we have
implemented consumer and business on-line banking in an effort to reduce costs
in the future.





Income
Taxes. During the quarters ended June 30, 2009 and
2008, the Company recorded ($2.5 million) and ($75,033), in income taxes
benefit. The effective tax rate recorded was (37.8%) for the second quarter 2009
as compared to (28%) for the second 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 Six-Month Periods
Ended June 30





Results
of operations for the six-month period ended June 30, 2009 reflected net loss of
$3.7 million, or ($0.90) per diluted share.   This was a $4.7
million decrease from 2008’s second quarter net income of $1.1 million, or $0.26
per diluted share.  The operating results for the six-month period
ended June 30, 2009 were unfavorable as we were faced with a low net interest
margin, recording an additional $6.3 million in provision expense compared to
the same period in 2008, and FDIC insurance premiums increased by $591,043
compared to the amount recorded as of June 30, 2008.  Our non-interest
income grew by $279,008 primarily due to a net gain on sale of available for
securities and an increase in brokered loan fees.  Non-interest
expenses increased by $351,943, or 3.2%, from June 30, 2008 to June 30, 2009
primarily due an increase in FDIC insurance premiums and a write-down in other
real estate owned.





Total revenue, defined as net interest
income plus total noninterest income, declined by $732,553 from the second
quarter 2008 to the second quarter 2009 primarily due to the drop in net
interest margin over the same period of time.  The 4.0% decrease in
short-term interest rates during 2008, of which 75 basis points of the 4.0% drop
occurred in December 2008, was the primary reason for the decline in the net
interest margin.  For the six-month period ended June 30, 2009, net
interest income decreased 9.7%, while total noninterest income increased 9.0%
from the same period one year ago primarily due to a net gain recognized on the
sale of available for sale securities of $195,012 and an increase in loan
brokered fees of $205,811.





Performance
      Ratios
            
            June
      302009
            2008Return
      on average assets *
            
            -1.06%
            0.31%Return
      on average equity *
            
            -14.83%
            4.34%Net
      interest margin (TEY) *
            
            2.93%
            3.26%Efficiency
      ratio
            
            89.80%
            82.31%*
      annualized





Net Interest
Income.   Interest income for the six-month periods ended
June 30, 2009 and 2008 was $16.0 million and $19.6 million, respectively, while
interest expense for the second quarter was $6.7 million in 2009 and $9.2
million in 2008, resulting in net interest income of $9.4 million for the second
quarter of 2009 and $10.4 million for the second quarter of
2008.  While average earning assets increased slightly, short-term
interest rates decreased 400 basis points in 2008 and continue to remain low
during the second quarter of 2009, 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
second quarter of 2009 was 2.93%, while the tax equivalent net interest margin
for the second quarter of 2008 was 3.26%.  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.





29
 Table of Contents





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 Six Month Period EndedJune
      30, 2009
            
            
            June
      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
            
            $
            1,996
            
            
            $
            -
            
            
            
            0.00
            %
            
            $
            10,383
            
            
            $
            156
            
            
            
            3.02
            %Federal
      funds sold
            
            
            12,106
            
            
            
            9
            
            
            
            0.15
            %
            
            
            6,104
            
            
            
            116
            
            
            
            3.82
            %Securities
      - taxable
            
            
            61,206
            
            
            
            1,416
            
            
            
            4.67
            %
            
            
            51,255
            
            
            
            1,263
            
            
            
            4.96
            %Securities
      - tax exempt (1)
            
            
            22,580
            
            
            
            709
            
            
            
            6.33
            %
            
            
            21,190
            
            
            
            673
            
            
            
            6.39
            %Loans
      held for sale
            
            
            1,527
            
            
            
            -
            
            
            
            0.00
            %
            
            
            391
            
            
            
            -
            
            
            
            0.00
            %Loans
            
            
            560,710
            
            
            
            14,148
            
            
            
            5.09
            %
            
            
            566,104
            
            
            
            17,616
            
            
            
            6.26
            %Total
      interest-earning assets
            
            
            660,125
            
            
            
            16,282
            
            
            
            4.97
            %
            
            
            655,427
            
            
            
            19,824
            
            
            
            6.07
            %Allowance
      for loan losses
            
            
            (11,121
            )
            
            
            
            
            
            
            
            
            
            
            (8,911
            )Cash
      and due from banks
            
            
            18,959
            
            
            
            
            
            
            
            
            
            
            
            14,652Other
      assets
            
            
            34,393
            
            
            
            
            
            
            
            
            
            
            
            32,317Total
      assets
            
            $
            702,356
            
            
            
            
            
            
            
            
            
            
            $
            693,485Liabilities
      and Stockholders' EquityInterest-bearing
      checking
            
            $
            84,109
            
            
            $
            348
            
            
            
            0.83
            %
            
            $
            64,631
            
            
            $
            419
            
            
            
            1.30
            %Savings
            
            
            17,170
            
            
            
            38
            
            
            
            0.45
            %
            
            
            16,010
            
            
            
            90
            
            
            
            1.13
            %Money
      market
            
            
            155,073
            
            
            
            917
            
            
            
            1.19
            %
            
            
            133,017
            
            
            
            1,702
            
            
            
            2.57
            %Certificates
      of deposit
            
            
            268,403
            
            
            
            4,344
            
            
            
            3.26
            %
            
            
            309,752
            
            
            
            5,864
            
            
            
            3.81
            %Short-term
      borrowings
            
            
            226
            
            
            
            1
            
            
            
            0.89
            %
            
            
            -
            
            
            
            -
            
            
            
            0.00
            %FHLB
      advances
            
            
            24,645
            
            
            
            467
            
            
            
            3.82
            %
            
            
            29,115
            
            
            
            573
            
            
            
            3.96
            %Junior
      subordinated debt
            
            
            17,527
            
            
            
            563
            
            
            
            6.48
            %
            
            
            17,527
            
            
            
            565
            
            
            
            6.48
            %Total
      interest-bearing liabilities
            
            
            567,153
            
            
            
            6,678
            
            
            
            2.37
            %
            
            
            570,052
            
            
            
            9,213
            
            
            
            3.26
            %Noninterest-bearing
      checking
            
            
            80,973
            
            
            
            
            
            
            
            
            
            
            
            70,573Other
      liabilities
            
            
            4,108
            
            
            
            
            
            
            
            
            
            
            
            4,021Stockholders'
      equity
            
            
            50,122
            
            
            
            
            
            
            
            
            
            
            
            48,839Total
      liabilities and stockholders' equity
            
            $
            702,356
            
            
            
            
            
            
            
            
            
            
            $
            693,485Net
      interest income
            
            
            
            
            
            $
            9,604
            
            
            
            
            
            
            
            
            
            
            $
            10,611Rate
      spread
            
            
            
            
            
            
            
            
            
            
            2.60
            %
            
            
            
            
            
            
            
            
            
            
            2.81
            %Net
      interest income as a percent of average earning assets
            
            
            
            
            
            
            
            
            
            
            2.93
            %
            
            
            
            
            
            
            
            
            
            
            3.26
            %





(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 $7.5 million, 270 basis points (annualized) on average loans during
first half of 2009 as compared to $1.2 million, or 42 basis points, annualized,
on average loans for the first half of 2008.  The cause for the
increase in provision recorded for the second quarter of 2009 was
twofold.  First, three commercial real estate loan relationships were
reserved to fair value after receiving updated appraisals which increased the
specific reserves by $3.6 million.  Second, we charged-down three
commercial loan relationships and two commercial real estate loan relationship
by $3.9 million of which only $1.5 million was reserved for prior to the
charge-down.  We realize that during times of economic declines that a
properly structured and performing loan could struggle; therefore, we account
for this when the loan is being rated.  The allowance for loan losses
at June 30, 2009 totaled $14.1 million and was 2.53% of total loans outstanding
on that date.  For the six-month period ended June 30, 2009, we were
in a net charge-off position of $4.1 million, or 146 basis points (annualized)
on average loans compared to net charge-offs of $409,110, or 15 basis points
(annualized) on average loans during the same period a year ago.





30
 Table of Contents





Noninterest
Income.   Noninterest income was $3.4 million during the
first half of 2009.  This was a $279,008, or 9.0%, increase compared
to the first half of 2008.  The majority of the increase relates to
the increase in a net gain on sale of available for sale securities of $135,175
and an increase in loan broker fees of $205,811.  These increases were
offset by a decline in service charges of $94,038 and trust and brokerage fees
of $159,070.  Service charge income decreased 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 June 30, 2008 as the stock market has not 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 $11.5 million for the
first six months of 2009 while noninterest expense for the six-month period
ended June 30, 2008 was $11.1 million.  The main components of
noninterest expense for the second quarter of 2009 were salaries and benefits of
$5.4 million, occupancy and equipment costs of $1.4 million, and FDIC insurance
premiums with a special assessment totaling $958,798.  There was a
significant increase in FDIC insurance premiums as the FDIC has continued to
increase the premiums and has added a special assessment based on the balance
sheet at June 30, 2009 and payable September 30, 2009 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 six months in 2008 to the first
six month in 2009 was $591,043.  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.  While total non-interest expenses increased,
we experienced a decrease in several operating expense accounts in the second
quarter 2009 compared to the second quarter 2008, including decreases in
employment expenses of $770,835, occupancy and equipment of $98,501, and
business development of $62,070.





Income
Taxes. During the quarters ended June 30, 2009 and
2008, the Company recorded ($2.5 million) and $156,160, in income taxes benefit
and income tax expense, respectively. The effective tax rate recorded was
(40.7%) for 2009 as compared to 12.9% 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 six months showed an increase
in deposits of $8.4 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 $69.4 million, or 11.7% of our total
deposits, at June 30, 2009.  This was up slightly from $64.4 million,
or 10.7% at June 30, 2008. Total deposits at June 30, 2009 were $594.6 million
and the loan to deposit ratio was 93.8%.  Total borrowings at June 30,
2009 were $41.5 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.


Capital
Resources. Stockholders’ equity is a
noninterest-bearing source of funds, which provides support for asset
growth.  Stockholders’ equity was $46.0 million and $49.6 million at
June 30, 2009 and December 31, 2008, respectively. Affecting the decrease in
stockholders’ equity during the first half of 2009 was a $3,685,255 net
loss.  Additionally, we recorded $36,850 of stock option and
restricted stock compensation expense per FAS123R.


During
the first half of 2009, we made no dividend payments.  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 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 and write down of a
foreclosed land development during the quarter, offset by a reduction in total
assets.  Although the Company’s capital ratios decreased, the second
quarter results were well within the stress testing of existing capital
performed by the Company earlier this year.





31
 Table of Contents





The
following table summarizes the capital ratios of the Company and the Bank at the
dates indicated:





June
      30, 2009
            
            
            December
      31, 2008Actual
            
            
            Well-
      Capitalized
            
            
            Minimum
      Required
            
            
            Actual
            
            
            Well-
      Capitalized
            
            
            Minimum
      RequiredThe
      CompanyLeverage
      capital
            
            
            8.56
            %
            
            
            5.00
            %
            
            
            4.00
            %
            
            
            9.69
            %
            
            
            5.00
            %
            
            
            4.00
            %Tier
      1 risk-based
            
            
            10.38
            %
            
            
            6.00
            %
            
            
            4.00
            %
            
            
            11.66
            %
            
            
            6.00
            %
            
            
            4.00
            %Total
      risk-based
            
            
            11.96
            %
            
            
            10.00
            %
            
            
            8.00
            %
            
            
            12.99
            %
            
            
            10.00
            %
            
            
            8.00
            %The
      BankLeverage
      capital
            
            
            8.31
            %
            
            
            5.00
            %
            
            
            4.00
            %
            
            
            9.04
            %
            
            
            5.00
            %
            
            
            4.00
            %Tier
      1 risk-based
            
            
            10.04
            %
            
            
            6.00
            %
            
            
            4.00
            %
            
            
            10.87
            %
            
            
            6.00
            %
            
            
            4.00
            %Total
      risk-based
            
            
            11.30
            %
            
            
            10.00
            %
            
            
            8.00
            %
            
            
            12.12
            %
            
            
            10.00
            %
            
            
            8.00
            %





32
 Table of Contents





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 June 30, 2009, the rates on
existing off-balance-sheet instruments were equivalent to current market rates,
considering the underlying credit standing of the counterparties.





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 six
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
 Table of Contents





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
4.       SUBMISSION OF
MATTERS TO A VOTE OF SECURITY HOLDERS





(a)
            The
      annual meeting of the shareholders of the Company was held on April 28,
      2009.





(b)
            The
      following directors were elected at the meeting to serve until the annual
      meeting of the shareholders in the year
2012:





Votes
      For
            Votes
      WithheldKathryn
      D Callen
            3,177,916
            74,654Jerome
      F. Henry, Jr.
            3,201,226
            51,344Debra
      A. Niezer
            2,971,514
            281,056Joseph
      D. Ruffolo
            3,078,810
            173,760








In
addition, the following directors continue in office until the annual meeting of
the shareholders in the year indicated:





Keith
      E. Busse
            2011
            
            
            Donald
      F. Schenkel
            2011Michael
      D. Cahill
            2011
            
            
            Charles
      J. Surack
            2010Michael
      S. Gouloff
            2011
            
            
            Robert
      N. Taylor
            2010Scott
      A. Glaze
            2010
            
            
            John
      V. Tippmann, Sr.
            2010R.V.
      Prasad Mantravadi M.D.
            2010
            
            
            Irene
      A. Walters
            2011William
      G. Niezer
            2010








(c)
            Other
      matters voted upon and the results of the voting were as
      follows:





The
shareholders voted 3,224,747 in the affirmative and 22,341 in the negative, with
5,482 abstentions, to ratify the appointment of Crowe Horwath LLP as auditors of
the Company for 2009.








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.




34
 Table of Contents





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:  January
      29, 2010
            /
      s /  Michael D. CahillMichael
      D. Cahill, Presidentand
      Chief Executive OfficerDated:  January
      29, 2010
            /
      s /  Richard R. SawyerRichard
      R. SawyerChief
      Financial Officer






35