UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C.  20549





Form
10-Q


(Mark
One)





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





For the
quarterly period ended September 30,
2008





£
            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 T  No
£





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer (See definition of “accelerated
filer or large accelerated filer as defined in Rule 12b-2 of the
Act).


Large
      accelerated filer £
                Accelerated
      filer £Non-accelerated
      filer   £
                Smaller
      reporting company T





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


Yes £   No
T





Number of
shares of the issuer’s common stock, without par value, outstanding as of
November 11, 2008: 4,084,432.







1
 Index





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. Typically, forward-looking statements are predictive and are
not statements of historical fact and the words "anticipates," "believes,"
"estimates," "seeks," "expects," "plans," "intends," and similar 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 key management
personnel;


·
            the
      risk of losses due to loan defaults by larger commercial loan customers or
      a significant number of borrowers;


·
            Our
      dependence on a favorable local economy in our primary service
      area;


·
            the
      effect of government regulation on our ability to grow and
      compete;


·
            the
      effect of changes in federal economic and monetary policies and local
      competition on our ability to attract deposits, make loans and achieve
      satisfactory interest spreads;


·
            general
      changes in economic conditions, including interest rates, interest rate
      spreads, and real estate values;
and


·
            restrictions
      imposed on the our by regulators or regulations of the financial services
      industry.





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 INFORMATIONItem
      1.
                              Financial
      Statements
                              page
      no.Consolidated
      Condensed Balance Sheets at September 30, 2008 (unaudited) and December
      31, 2007
                              4Consolidated
      Condensed Statements of Operations for the three and nine months ended
      September 30, 2008 and September 30, 2007 (unaudited)
                              5Consolidated
      Condensed Statements of Changes in Stockholders’ Equity for the nine
      months ended September 30, 2008 and September 30, 2007
      (unaudited)
                              7Consolidated
      Condensed Statements of Cash Flows for the nine months ended September 30,
      2008 and September 30, 2007 (unaudited)
                              8Notes
      to Consolidated Condensed Financial Statements
                              10Item
      2.
                              Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                              19Item
      4.
                              Controls
      and Procedures
                              27PART
      II. OTHER INFORMATIONItem
      1.
                              Legal
      Proceedings
                              28Item
      1a.
                              Risk
      Factors
                              28Item
      2.
                              Unregistered
      Sales of Equity Securities and Use of Proceeds
                              28Item
      6.
                              Exhibits
                              28SIGNATURES
                              29




3
 Index




PART
I.  FINANCIAL INFORMATION





Item 1.  FINANCIAL STATEMENTS





Tower Financial Corporation


Consolidated
Condensed Balance Sheets


At
September 30, 2008 and December 31, 2007





(unaudited)
                          
                          
                          (unaudited)September 30,
                            2008
                          
                          
                          December 31,
                            2007ASSETSCash
      and due from banks
                          
                          $
                          12,847,912
                          
                          
                          $
                          25,913,449Short-term
      investments and interest-earning deposits
                          
                          
                          812,700
                          
                          
                          
                          1,781,161Federal
      funds sold
                          
                          
                          21,191,867
                          
                          
                          
                          6,135,779Total
      cash and cash equivalents
                          
                          
                          34,852,479
                          
                          
                          
                          33,830,389Securities
      available for sale, at fair value
                          
                          
                          78,165,941
                          
                          
                          
                          65,227,694FHLB
      and FRB stock
                          
                          
                          4,032,446
                          
                          
                          
                          3,589,700Loans
      held for sale
                          
                          
                          698,899
                          
                          
                          
                          3,189,545Loans
                          
                          
                          554,760,310
                          
                          
                          
                          575,744,207Allowance
      for loan losses
                          
                          
                          (9,277,839
                          )
                          
                          
                          (8,208,162
                          )Net
      loans
                          
                          
                          545,482,471
                          
                          
                          
                          567,536,045Premises
      and equipment, net
                          
                          
                          8,187,885
                          
                          
                          
                          9,549,233Accrued
      interest receivable
                          
                          
                          2,801,882
                          
                          
                          
                          3,246,455Bank
      owned life insurance
                          
                          
                          11,579,500
                          
                          
                          
                          11,258,517Other
      assets
                          
                          
                          10,259,582
                          
                          
                          
                          9,065,564Total
      assets
                          
                          $
                          696,061,085
                          
                          
                          $
                          706,493,142LIABILITIES
      AND STOCKHOLDERS' EQUITYLIABILITIESDeposits:Noninterest-bearing
                          
                          $
                          86,542,430
                          
                          
                          $
                          71,705,395Interest-bearing
                          
                          
                          486,678,851
                          
                          
                          
                          528,984,076Total
      deposits
                          
                          
                          573,221,281
                          
                          
                          
                          600,689,471Federal
      Home Loan Bank (FHLB) advances
                          
                          
                          52,700,000
                          
                          
                          
                          35,100,000Junior
      subordinated debt
                          
                          
                          17,527,000
                          
                          
                          
                          17,527,000Accrued
      interest payable
                          
                          
                          785,047
                          
                          
                          
                          1,721,972Other
      liabilities
                          
                          
                          3,378,988
                          
                          
                          
                          3,247,145Total
      liabilities
                          
                          
                          647,612,316
                          
                          
                          
                          658,285,588STOCKHOLDERS'
      EQUITYPreferred
      stock, no par value, 4,000,000 shares authorized; no shares issued and
      outstandingCommon
      stock and paid-in-capital, no par value, 6,000,000 shares authorized;
      4,149,432 shares issued and 4,084,432 shares outstanding at September 30,
      2008 and 4,113,805 shares issued and 4,060,769 shares oustanding at
      December 31, 2007
                          
                          
                          39,758,513
                          
                          
                          
                          39,482,669Treasury
      stock, at cost, 65,000 and 53,036 shares at September 30, 2008 and
      December 31, 2007
                          
                          
                          (884,376
                          )
                          
                          
                          (758,827
                          )Retained
      earnings
                          
                          
                          10,413,095
                          
                          
                          
                          9,208,719Accumulated
      other comprehensive income, net of tax of ($431,936) at September 30, 2008
      and $141,663 at December 31, 2007
                          
                          
                          (838,463
                          )
                          
                          
                          274,993Total
      stockholders' equity
                          
                          
                          48,448,769
                          
                          
                          
                          48,207,554Total
      liabilities and stockholders' equity
                          
                          $
                          696,061,085
                          
                          
                          $
                          706,493,142








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





4
 Index





Tower Financial Corporation


Consolidated
Condensed Statements of Operations


For the
three and nine months ended September 30, 2008 and 2007





(unaudited)
                    
                    
                    (unaudited)Three
      Months ended
                      September
      30
                    
                    
                    Nine
      Months Ended
                      September
      302008
                    
                    
                    2007
                    
                    
                    2008
                    
                    
                    2007Interest
      income:Loans,
      including fees
                    
                    $
                    8,303,686
                    
                    
                    $
                    11,085,796
                    
                    
                    $
                    25,919,244
                    
                    
                    $
                    32,492,233Securities
      - taxable
                    
                    
                    734,502
                    
                    
                    
                    660,063
                    
                    
                    
                    1,997,272
                    
                    
                    
                    1,991,226Securities
      - tax exempt
                    
                    
                    220,715
                    
                    
                    
                    202,210
                    
                    
                    
                    658,061
                    
                    
                    
                    598,151Other
      interest income
                    
                    
                    59,938
                    
                    
                    
                    128,032
                    
                    
                    
                    331,924
                    
                    
                    
                    368,686Total
      interest income
                    
                    
                    9,318,841
                    
                    
                    
                    12,076,101
                    
                    
                    
                    28,906,501
                    
                    
                    
                    35,450,296Interest
      expense:Deposits
                    
                    
                    3,322,465
                    
                    
                    
                    5,863,839
                    
                    
                    
                    11,397,623
                    
                    
                    
                    17,252,182Short-term
      borrowings
                    
                    
                    2,776
                    
                    
                    
                    15
                    
                    
                    
                    2,776
                    
                    
                    
                    532FHLB
      advances
                    
                    
                    284,982
                    
                    
                    
                    436,366
                    
                    
                    
                    857,759
                    
                    
                    
                    1,025,421Junior
      subordinated debt
                    
                    
                    283,071
                    
                    
                    
                    287,647
                    
                    
                    
                    847,791
                    
                    
                    
                    849,253Total
      interest expense
                    
                    
                    3,893,294
                    
                    
                    
                    6,587,867
                    
                    
                    
                    13,105,949
                    
                    
                    
                    19,127,388Net
      interest income
                    
                    
                    5,425,547
                    
                    
                    
                    5,488,234
                    
                    
                    
                    15,800,552
                    
                    
                    
                    16,322,908Provision
      for loan losses
                    
                    
                    1,999,000
                    
                    
                    
                    5,246,000
                    
                    
                    
                    3,174,000
                    
                    
                    
                    8,171,000Net
      interest income after provision for loan losses
                    
                    
                    3,426,547
                    
                    
                    
                    242,234
                    
                    
                    
                    12,626,552
                    
                    
                    
                    8,151,908Noninterest
      income:Trust
      and brokerage fees
                    
                    
                    936,689
                    
                    
                    
                    790,002
                    
                    
                    
                    2,769,715
                    
                    
                    
                    2,354,492Service
      charges
                    
                    
                    288,186
                    
                    
                    
                    234,657
                    
                    
                    
                    923,540
                    
                    
                    
                    720,483Loan
      broker fees
                    
                    
                    65,075
                    
                    
                    
                    58,310
                    
                    
                    
                    192,945
                    
                    
                    
                    144,598Gain
      (Loss) on sale of securities
                    
                    
                    6,004
                    
                    
                    
                    (40,804
                    )
                    
                    
                    65,841
                    
                    
                    
                    (42,564
                    )Other
      fees
                    
                    
                    516,267
                    
                    
                    
                    366,214
                    
                    
                    
                    969,423
                    
                    
                    
                    1,150,478Total
      noninterest income
                    
                    
                    1,812,221
                    
                    
                    
                    1,408,379
                    
                    
                    
                    4,921,464
                    
                    
                    
                    4,327,487Noninterest
      expense:Salaries
      and benefits
                    
                    
                    2,813,399
                    
                    
                    
                    2,627,862
                    
                    
                    
                    8,951,643
                    
                    
                    
                    8,600,285Occupancy
      and equipment
                    
                    
                    719,498
                    
                    
                    
                    676,222
                    
                    
                    
                    2,209,401
                    
                    
                    
                    2,024,966Marketing
                    
                    
                    131,147
                    
                    
                    
                    138,499
                    
                    
                    
                    505,363
                    
                    
                    
                    316,922Data
      processing
                    
                    
                    246,198
                    
                    
                    
                    230,508
                    
                    
                    
                    747,128
                    
                    
                    
                    688,684Loan
      and professional costs
                    
                    
                    326,588
                    
                    
                    
                    266,687
                    
                    
                    
                    956,656
                    
                    
                    
                    992,521Office
      supplies and postage
                    
                    
                    92,452
                    
                    
                    
                    96,045
                    
                    
                    
                    288,431
                    
                    
                    
                    336,888Courier
      services
                    
                    
                    64,858
                    
                    
                    
                    97,204
                    
                    
                    
                    229,393
                    
                    
                    
                    292,975Business
      development
                    
                    
                    140,317
                    
                    
                    
                    174,503
                    
                    
                    
                    469,149
                    
                    
                    
                    516,253Communication
      Expense
                    
                    
                    90,856
                    
                    
                    
                    61,641
                    
                    
                    
                    242,579
                    
                    
                    
                    187,866FDIC
      Insurance Premiums
                    
                    
                    180,036
                    
                    
                    
                    116,260
                    
                    
                    
                    547,791
                    
                    
                    
                    351,439Other
      expense
                    
                    
                    237,450
                    
                    
                    
                    455,412
                    
                    
                    
                    994,474
                    
                    
                    
                    1,096,916Total
      noninterest expense
                    
                    
                    5,042,799
                    
                    
                    
                    4,940,843
                    
                    
                    
                    16,142,008
                    
                    
                    
                    15,405,715Income
      (Loss) before income taxes
                    
                    
                    195,969
                    
                    
                    
                    (3,290,230
                    )
                    
                    
                    1,406,008
                    
                    
                    
                    (2,926,320
                    )Income
      tax expense (benefit)
                    
                    
                    (133,632
                    )
                    
                    
                    (1,081,984
                    )
                    
                    
                    22,528
                    
                    
                    
                    (1,111,800
                    )Net
      income (Loss)
                    
                    $
                    329,601
                    
                    
                    $
                    (2,208,246
                    )
                    
                    $
                    1,383,480
                    
                    
                    $
                    (1,814,520
                    )








The
following notes are an integral part of the financial
statements





5
 Index





Tower
Financial Corporation


Consolidated
Condensed Statements of Operations


For the
three and nine months ended September 30, 2008 and 2007





(unaudited)
                    
                    
                    (unaudited)Three
      Months Ended
                      September
      30
                    
                    
                    Nine
      Months Ended
                      September
      302008
                    
                    
                    2007
                    
                    
                    2008
                    
                    
                    2007Other
      comprehensive income (loss) net of tax:Unrealized
      appreciation (depreciation) on available for sale
    securities
                    
                    
                    (644,583
                    )
                    
                    
                    559,775
                    
                    
                    
                    (1,223,953
                    )
                    
                    
                    (127,169
                    )Unrealized
      gain (loss) on cash flow hedge
                    
                    
                    (90,761
                    )
                    
                    
                    115,343
                    
                    
                    
                    110,497
                    
                    
                    
                    52,312Total
      comprehensive income (loss)
                    
                    $
                    (405,743
                    )
                    
                    $
                    (1,533,128
                    )
                    
                    $
                    270,024
                    
                    
                    $
                    (1,889,377
                    )Basic
      earnings per common share
                    
                    $
                    0.08
                    
                    
                    $
                    (0.54
                    )
                    
                    $
                    0.34
                    
                    
                    $
                    (0.45
                    )Diluted
      earnings per common share
                    
                    $
                    0.08
                    
                    
                    $
                    (0.54
                    )
                    
                    $
                    0.34
                    
                    
                    $
                    (0.45
                    )Average
      common shares outstanding
                    
                    
                    4,084,432
                    
                    
                    
                    4,063,750
                    
                    
                    
                    4,072,762
                    
                    
                    
                    4,068,677Average
      common shares and dilutive potential common shares
    outstanding
                    
                    
                    4,086,757
                    
                    
                    
                    4,063,750
                    
                    
                    
                    4,081,441
                    
                    
                    
                    4,068,677Dividends
      declared per share
                    
                    $
                    -
                    
                    
                    $
                    0.044
                    
                    
                    $
                    0.044
                    
                    
                    $
                    0.132








The
following notes are an integral part of the financial statements





6
 Index





Tower Financial Corporation


Consolidated
Condensed Statements of Changes in Stockholders’ Equity


For the
nine months ended September 30, 2008 and 2007


(unaudited)





Common
                                                      Stock and
                                                      Paid-in
                                                      Capital
                                                    
                                                    
                                                    Retained
                                                      Earnings
                                                    
                                                    
                                                    Accumulated
                                                      Other
                                                      Comprehensive
                                                      Income (Loss)
                                                    
                                                    
                                                    Treasury
                                                      Stock
                                                    
                                                    
                                                    TotalBalance,
      January 1, 2007
                                                    
                                                    $
                                                    38,536,406
                                                    
                                                    
                                                    $
                                                    12,523,750
                                                    
                                                    
                                                    $
                                                    (102,317
                                                    )
                                                    
                                                    $
                                                    -
                                                    
                                                    
                                                    $
                                                    50,957,839Net
      income (loss) for 2007
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    (1,814,520
                                                    )
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    (1,814,520
                                                    )Change
      in net unrealized appreciation (depreciation) on securities available for
      sale, net of tax of ($73,141)
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    (127,169
                                                    )
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    (127,169
                                                    )Change
      in net unrealized gain (loss) on cash flow hedge, net of tax of
      $26,949
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    52,312
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    52,312Total
      Comprehensive Income
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    (1,889,377
                                                    )Cash
      dividends paid ($0.132 per share)
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    (537,185
                                                    )
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    (537,185
                                                    )Issuance
      of 71,923 shares of common stock for stock options exercised, including
      tax benefit
                                                    
                                                    
                                                    871,383
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    871,383Stock
      compensation expense
                                                    
                                                    
                                                    61,689
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    61,689Repurchase
      42,736 shares of common stock
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    $
                                                    (634,119
                                                    )
                                                    
                                                    $
                                                    (634,119
                                                    )Balance,
      September 30, 2007
                                                    
                                                    $
                                                    39,469,478
                                                    
                                                    
                                                    $
                                                    10,172,045
                                                    
                                                    
                                                    $
                                                    (177,174
                                                    )
                                                    
                                                    $
                                                    (634,119
                                                    )
                                                    
                                                    $
                                                    48,830,230Balance,
      January 1, 2008
                                                    
                                                    $
                                                    39,482,669
                                                    
                                                    
                                                    $
                                                    9,208,719
                                                    
                                                    
                                                    $
                                                    274,993
                                                    
                                                    
                                                    $
                                                    (758,827
                                                    )
                                                    
                                                    $
                                                    48,207,554Net
      income for 2008
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    1,383,480
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    1,383,480Change
      in net unrealized appreciation (depreciation) on securities available for
      sale, net of tax of ($630,522)
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    (1,223,953
                                                    )
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    (1,223,953
                                                    )Change
      in net unrealized gain (loss) on cash flow hedge, net of tax of
      $56,923
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    110,497
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    110,497Total
      Comprehensive Income
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    270,024Cash
      dividends paid ($0.044 per share)
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    (179,104
                                                    )
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    (179,104
                                                    )Issuance
      of 22,127 shares of common stock for stock options exercised, including
      tax benefit
                                                    
                                                    
                                                    220,639
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    220,639Stock
      compensation expense
                                                    
                                                    
                                                    55,205
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    55,205Repurchase
      11,964 shares of common stock
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    (125,549
                                                    )
                                                    
                                                    
                                                    (125,549
                                                    )Balance,
      September 30, 2008
                                                    
                                                    $
                                                    39,758,513
                                                    
                                                    
                                                    $
                                                    10,413,095
                                                    
                                                    
                                                    $
                                                    (838,463
                                                    )
                                                    
                                                    $
                                                    (884,376
                                                    )
                                                    
                                                    $
                                                    48,448,769








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





7
 Index





Tower Financial Corporation


Consolidated
Condensed Statements of Cash Flows


For the
nine months ended September 30, 2008 and 2007





(unaudited)
                  
                  
                  (unaudited)Nine Months ended
                    September 30, 2008
                  
                  
                  Nine Months ended
                    September 30, 2007Cash
      flows from operating activities:Net
      income (loss)
                  
                  $
                  1,383,480
                  
                  
                  $
                  (1,814,520
                  )Adjustments
      to reconcile net income to net cash from operating
    activities:Depreciation
      and amortization
                  
                  
                  1,043,847
                  
                  
                  
                  729,747Provision
      for loan losses
                  
                  
                  3,174,000
                  
                  
                  
                  8,171,000Stock
      based compensation expense
                  
                  
                  55,205
                  
                  
                  
                  61,689Earnings
      on life insurance
                  
                  
                  (320,983
                  )
                  
                  
                  (301,578
                  )(Gain)
      Loss on sale of securities AFS
                  
                  
                  (65,841
                  )
                  
                  
                  42,564(Gain)
      Loss on disposal of premises and equipment
                  
                  
                  (36,697
                  )
                  
                  
                  10,520Loans
      originated for sale
                  
                  
                  (6,475,527
                  )
                  
                  
                  (817,221
                  )Proceeds
      from sale of loans
                  
                  
                  8,966,173
                  
                  
                  
                  5,472,799Change
      in accrued interest receivable
                  
                  
                  444,573
                  
                  
                  
                  10,553Proceeds
      from settlement of interest rate floor
                  
                  
                  833,750
                  
                  
                  
                  -Gain
      on settlement of interest rate floor
                  
                  
                  (312,656
                  )
                  
                  
                  -Tax
      benefit from exercise of stock options
                  
                  
                  -
                  
                  
                  
                  (112,264
                  )Change
      in other assets
                  
                  
                  796,797
                  
                  
                  
                  (1,402,777
                  )Change
      in accrued interest payable
                  
                  
                  (936,925
                  )
                  
                  
                  99,380Change
      in other liabilities
                  
                  
                  131,843
                  
                  
                  
                  (496,326
                  )Net
      cash from operating activities
                  
                  
                  8,681,039
                  
                  
                  
                  9,653,566Cash
      flows from investing activities:Net
      change in loans
                  
                  
                  (3,178,475
                  )
                  
                  
                  (54,702,229
                  )Purchase
      of loans
                  
                  
                  -
                  
                  
                  
                  (3,869,618
                  )Purchase
      of securities AFS
                  
                  
                  (29,907,366
                  )
                  
                  
                  (6,487,229
                  )Proceeds
      from calls and maturities of securities AFS
                  
                  
                  9,910,750
                  
                  
                  
                  3,847,191Proceeds
      from sale of securities AFS
                  
                  
                  5,184,945
                  
                  
                  
                  2,884,311Purchase
      of FHLB and FRB Stock
                  
                  
                  (442,746
                  )
                  
                  
                  (376,300
                  )Proceeds
      from sale of participation loans
                  
                  
                  20,238,743
                  
                  
                  
                  12,068,126Purchase
      of premises and equipment, net
                  
                  
                  487,404
                  
                  
                  
                  (3,813,448
                  )Net
      cash from (used in) investing activities
                  
                  
                  2,293,255
                  
                  
                  
                  (50,449,196
                  )Cash
      flows from financing activities:Net
      change in deposits
                  
                  
                  (27,468,190
                  )
                  
                  
                  6,083,522Cash
      dividends paid
                  
                  
                  (179,104
                  )
                  
                  
                  (537,185
                  )Proceeds
      from issuance of common stock
                  
                  
                  -
                  
                  
                  
                  -from
      exercise of stock options
                  
                  
                  220,639
                  
                  
                  
                  759,119Tax
      benefit from issuance of common stock
                  
                  
                  -
                  
                  
                  
                  112,264Proceeds
      from FHLB advances
                  
                  
                  82,950,000
                  
                  
                  
                  115,893,000Repayment
      of FHLB advances
                  
                  
                  (65,350,000
                  )
                  
                  
                  (83,693,000
                  )Repurchase
      of common stock
                  
                  
                  (125,549
                  )
                  
                  
                  (634,119
                  )Net
      cash from (used in) financing activities
                  
                  
                  (9,952,204
                  )
                  
                  
                  37,983,601Net
      change in cash and cash equivalents
                  
                  
                  1,022,090
                  
                  
                  
                  (2,812,029
                  )Cash
      and cash equivalents, beginning of period
                  
                  
                  33,830,389
                  
                  
                  
                  28,864,966Cash
      and cash equivalents, end of period
                  
                  $
                  34,852,479
                  
                  
                  $
                  26,052,937




8
 Index





Tower
Financial Corporation


Consolidated
Condensed Statements of Cash Flows


For the
nine months ended September 30, 2008 and 2007





(unaudited)
                
                
                (unaudited)Nine Months ended
                  September 30, 2008
                
                
                Nine Months ended
                  September 30, 2007Supplemental
      disclosures of cash flow informationCash
      paid during the year for:Interest
                
                $
                14,042,874
                
                
                $
                19,028,009Income
      taxes
                
                
                -
                
                
                
                -Noncash
      items:Transfer
      of loans to other real estate owned
                
                
                1,819,306
                
                
                
                8,662,701








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




9
 Index





Tower Financial Corporation


Notes
to Consolidated Condensed Financial Statements








Note
1 – Basis of Presentation





The
accompanying unaudited consolidated financial statements are filed for Tower
Financial Corporation and its wholly-owned subsidiaries, Tower Bank & Trust
(or the “Bank” or “Tower Bank”), Tower Trust Company (or the “Trust Company”),
and two unconsolidated subsidiary guarantor trusts, Tower Capital Trust 2, and
Tower Capital Trust 3.  Also included is the Bank’s wholly-owned
subsidiary, Tower Capital Investments, which owns Tower Funding Corporation, a
real estate investment trust.





The
accompanying unaudited consolidated condensed financial statements were prepared
in accordance with generally accepted accounting principles for interim periods
and with instructions for Form 10-Q and, therefore, do not include all
disclosures required by generally accepted accounting principles for complete
presentation of the Company’s financial statements.  In the opinion of
management, the unaudited consolidated condensed financial statements contain
all adjustments necessary to present fairly its consolidated financial position
at September 30, 2008 and its consolidated results of operations, comprehensive
income, changes in stockholders’ equity and cash flows for the nine-month
periods ended September 30, 2008 and September 30, 2007.   The
results for the period ended September 30, 2008 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, 2007, 2006, and 2005 and
related notes included in the Company’s Annual Report on Form 10-K for the year
ended December 31, 2007.








Note
2 – Summary of Critical Accounting Policies





A
comprehensive discussion of our critical accounting policies is disclosed in
Note 1 of our financial statements contained in our Annual Report for the year
ended December 31, 2007.  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.   Effective January 1, 2008 we adopted FAS
157, which established new rules and disclosures in the determination of fair
value for financial instruments.  We made changes accordingly to our
accounting policy (see below).  There were no other material changes
in the information regarding our critical accounting policies since December 31,
2007.





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.





10
 Index




Income Taxes:Income tax
expense is the sum of the current year income tax due or refundable and the
change in deferred tax assets and liabilities.  Deferred tax assets
and liabilities are the expected future tax consequences of the temporary
differences between carrying amounts and tax bases of assets and liabilities,
computed using enacted tax rates.  A valuation allowance, if needed,
reduces deferred tax assets to the amount expected to be realized.  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.





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 2003.  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 determine 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 - Earnings Per Share





The
following table reflects the calculation of basic and diluted earnings per
common share for the three- and nine-month periods ended September 30, 2008 and
September 30, 2007.  Options not considered in the calculation of
diluted earnings per common share because they were antidilutive, totaled
187,925 and 240,802 and 99,804 and 240,802 for the three- and nine-month periods
ended September 30, 2008 and 2007, respectively.





Three Months Ended
                                                                                                                                          September 30
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        Nine Months Ended
                                                                                                                                          September 302008
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        2007
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        2008
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        2007BasicNet
      income (loss)
                                                                                                                                        
                                                                                                                                        $
                                                                                                                                        329,601
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        $
                                                                                                                                        (2,208,246
                                                                                                                                        )
                                                                                                                                        
                                                                                                                                        $
                                                                                                                                        1,383,480
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        $
                                                                                                                                        (1,814,520
                                                                                                                                        )Weighted
      average common shares outstanding
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        4,084,432
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        4,063,750
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        4,072,762
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        4,068,677Basic
      earnings per common share
                                                                                                                                        
                                                                                                                                        $
                                                                                                                                        0.08
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        $
                                                                                                                                        (0.54
                                                                                                                                        )
                                                                                                                                        
                                                                                                                                        $
                                                                                                                                        0.34
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        $
                                                                                                                                        (0.45
                                                                                                                                        )DilutedNet
      income (loss)
                                                                                                                                        
                                                                                                                                        $
                                                                                                                                        329,601
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        $
                                                                                                                                        (2,208,246
                                                                                                                                        )
                                                                                                                                        
                                                                                                                                        $
                                                                                                                                        1,383,480
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        $
                                                                                                                                        (1,814,520
                                                                                                                                        )Weighted
      average common shares outstanding
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        4,084,432
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        4,063,750
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        4,072,762
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        4,068,677Add:  dilutive
      effect of assumed stock option exercises
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        2,325
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        8,679Weighted
      average common shares and dilutive potential common shares
      outstanding
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        4,086,757
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        4,063,750
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        4,081,441
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        4,068,677Diluted
      earnings per common share
                                                                                                                                        
                                                                                                                                        $
                                                                                                                                        0.08
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        $
                                                                                                                                        (0.54
                                                                                                                                        )
                                                                                                                                        
                                                                                                                                        $
                                                                                                                                        0.34
                                                                                                                                        
                                                                                                                                        
                                                                                                                                        $
                                                                                                                                        (0.45
                                                                                                                                        )




11
 Index




Note
4 – 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 206,675 remain outstanding as of September 30, 2008.  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 $43,955 and $61,689 for the nine-months ended
September 30, 2008 and September 30, 2007, respectively.





A summary
of the option activity under the Plans as of September 30, 2008 and changes
during the three-month period then ended are presented below:





Options
                                                            
                                                            Shares
                                                            
                                                            
                                                            Weighted Average Exercise
    Price
                                                            
                                                            
                                                            Weighted Average Remaining Contractual
      Term
                                                            
                                                            
                                                            Aggregate Intrinsic ValueOutstanding
      at January 1, 2008
                                                            
                                                            
                                                            239,802
                                                            
                                                            
                                                            $
                                                            11.52
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            $
                                                            -Granted
                                                            
                                                            
                                                            -Exercised
                                                            
                                                            
                                                            (22,127
                                                            )
                                                            
                                                            $
                                                            9.96
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            -Forfeited
      or Expired
                                                            
                                                            
                                                            (11,000
                                                            )
                                                            
                                                            $
                                                            14.69
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            -Oustanding
      at September 30, 2008
                                                            
                                                            
                                                            206,675
                                                            
                                                            
                                                            $
                                                            11.52
                                                            
                                                            
                                                            
                                                            2.58Vested
      or expected to vest at September 30, 2008
                                                            
                                                            
                                                            205,212
                                                            
                                                            
                                                            $
                                                            11.49
                                                            
                                                            
                                                            
                                                            2.34
                                                            
                                                            
                                                            $
                                                            -Exercisable
      at September 30, 2008
                                                            
                                                            
                                                            195,908
                                                            
                                                            
                                                            $
                                                            11.29
                                                            
                                                            
                                                            
                                                            2.55
                                                            
                                                            
                                                            $
                                                            -








The total
intrinsic value of options exercised during the nine-months ended September 30,
2008 and 2007 was $0 and $344,685.





No
further options will be granted under either of these Plans, but the Plans will
remain in effect for purposes of administering already existing options
previously granted and still outstanding under the Plans.  As of
September 30, 2008, the unrecognized compensation expense for the 1998 and 2001
Stock Options plan per the requirements of FAS123(R) was $21,426.  The
remaining expense of $5,860 and $15,566 will be recorded in 2008 and 2009,
respectively.





On April
19, 2006, at the Company’s annual meeting of stockholders, the stockholders
approved Tower Financial Corporations 2006 Equity Incentive Plan, under which
150,000 shares have been reserved for issuance as incentive stock options,
nonstatutory stock options, restricted stock awards, unrestricted stock awards,
performance awards, or stock appreciation rights.  As of September 30,
2008, 13,500 restricted shares had been 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 become
fully vested and not subject to forfeiture after four years of service from the
date of award 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 $11,250 for the
nine-months ended September 30, 2008.





12
 Index





A summary
of the status of the Company’s nonvested restricted shares issued as of
September 30, 2008, and changes during the nine-month period ended September 30,
2008, is presented below.








Nonvested Restricted Shares
                                                      
                                                      Shares
                                                      
                                                      
                                                      Weighted Average Grant Date Fair
      ValueNonvested
      at January 1, 2008
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      $
                                                      -Granted
                                                      
                                                      
                                                      13,500
                                                      
                                                      
                                                      
                                                      135,000Vested
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      -Forfeited
      or expired
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      -Outstanding
      at September 30, 2008
                                                      
                                                      
                                                      13,500
                                                      
                                                      
                                                      
                                                      135,000Vested
      or expected to vest at September 30, 2008
                                                      
                                                      
                                                      11,665
                                                      
                                                      
                                                      
                                                      116,650Nonvested
      at September 30, 2008
                                                      
                                                      
                                                      13,500





Note
5 – Interest Rate Floor





We
purchased an interest rate floor in July of 2006 as part of our asset liability
management strategy to help manage our interest rate risk
position.  The notional amount of the floor is $30 million, with a
term of three years and a strike price of 7.5%.  The purchase price of
$147,000 was amortized to earnings in the same period the hedged item affected
earnings.  This instrument is designated as a cash flow hedge as
changes in the cash flows of the floor were expected to be highly effective in
offsetting the variability in the expected future cashflows of the hedged loans
attributed to fluctuations in Prime rates below 7.5% (strike price of the
floor).





In March
of 2008, we settled the interest rate floor agreement with our counterparty and
received a payment of $833,750.  The unrealized gain of $723,000 at
the time of settlement 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 will 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
6 – 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 locations in Allen County and
one in Warsaw.





The
Wealth Management segment is made up of Tower Trust
Company.    On January 1, 2006, the Trust Company was formed
as a wholly-owned subsidiary of the Company.   Prior to January
1, 2006, the Trust Company operated as a division of the
Bank.   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.





13
 Index




As of and for the three months ended September 30,
      2008Bank
                                                          
                                                          
                                                          Wealth
                                                            Management
                                                          
                                                          
                                                          Corporate &
                                                            Intercompany
                                                          
                                                          
                                                          Eliminations
                                                          
                                                          
                                                          TotalIncome
      Statement InformationNet
      interest income
                                                          
                                                          $
                                                          5,683,803
                                                          
                                                          
                                                          $
                                                          24,815
                                                          
                                                          
                                                          $
                                                          (283,071
                                                          )
                                                          
                                                          $
                                                          -
                                                          
                                                          
                                                          $
                                                          5,425,547Non-interest
      income
                                                          
                                                          
                                                          721,888
                                                          
                                                          
                                                          
                                                          936,956
                                                          
                                                          
                                                          
                                                          671,747
                                                          
                                                          
                                                          
                                                          (518,370
                                                          )
                                                          
                                                          $
                                                          1,812,221Non-interest
      expense
                                                          
                                                          
                                                          4,230,260
                                                          
                                                          
                                                          
                                                          682,207
                                                          
                                                          
                                                          
                                                          130,332
                                                          
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          $
                                                          5,042,799Noncash
      itemsProvision
      for loan losses
                                                          
                                                          
                                                          1,999,000
                                                          
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          $
                                                          1,999,000Depreciation/Amortization
                                                          
                                                          
                                                          198,311
                                                          
                                                          
                                                          
                                                          10,505
                                                          
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          $
                                                          208,816Income
      tax expense (benefit)
                                                          
                                                          
                                                          (139,639
                                                          )
                                                          
                                                          
                                                          77,264
                                                          
                                                          
                                                          
                                                          (71,257
                                                          )
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          $
                                                          (133,632
                                                          )Segment
      Profit/(Loss)
                                                          
                                                          
                                                          316,070
                                                          
                                                          
                                                          
                                                          202,300
                                                          
                                                          
                                                          
                                                          329,601
                                                          
                                                          
                                                          
                                                          (518,370
                                                          )
                                                          
                                                          $
                                                          329,601Balance
      Sheet InformationSegment
      Assets
                                                          
                                                          
                                                          691,632,202
                                                          
                                                          
                                                          
                                                          5,896,555
                                                          
                                                          
                                                          
                                                          69,008,900
                                                          
                                                          
                                                          
                                                          (70,476,572
                                                          )
                                                          
                                                          $
                                                          696,061,085





As of and for the nine months ended September 30,
      2008Bank
                                                          
                                                          
                                                          Wealth
                                                            Management
                                                          
                                                          
                                                          Corporate &
                                                            Intercompany
                                                          
                                                          
                                                          Eliminations
                                                          
                                                          
                                                          TotalIncome
      Statement InformationNet
      interest income
                                                          
                                                          $
                                                          16,564,992
                                                          
                                                          
                                                          $
                                                          83,351
                                                          
                                                          
                                                          $
                                                          (847,791
                                                          )
                                                          
                                                          $
                                                          -
                                                          
                                                          
                                                          $
                                                          15,800,552Non-interest
      income
                                                          
                                                          
                                                          2,190,086
                                                          
                                                          
                                                          
                                                          2,770,350
                                                          
                                                          
                                                          
                                                          2,218,310
                                                          
                                                          
                                                          
                                                          (2,257,282
                                                          )
                                                          
                                                          $
                                                          4,921,464Non-interest
      expense
                                                          
                                                          
                                                          13,559,557
                                                          
                                                          
                                                          
                                                          2,084,834
                                                          
                                                          
                                                          
                                                          497,617
                                                          
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          $
                                                          16,142,008Noncash
      itemsProvision
      for loan losses
                                                          
                                                          
                                                          3,174,000
                                                          
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          $
                                                          3,174,000Depreciation/Amortization
                                                          
                                                          
                                                          879,678
                                                          
                                                          
                                                          
                                                          30,963
                                                          
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          $
                                                          910,641Income
      tax expense (benefit)
                                                          
                                                          
                                                          219,281
                                                          
                                                          
                                                          
                                                          313,825
                                                          
                                                          
                                                          
                                                          (510,578
                                                          )
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          $
                                                          22,528Segment
      Profit/(Loss)
                                                          
                                                          
                                                          1,802,240
                                                          
                                                          
                                                          
                                                          455,042
                                                          
                                                          
                                                          
                                                          1,383,480
                                                          
                                                          
                                                          
                                                          (2,257,282
                                                          )
                                                          
                                                          $
                                                          1,383,480Balance
      Sheet InformationSegment
      Assets
                                                          
                                                          
                                                          691,632,202
                                                          
                                                          
                                                          
                                                          5,896,555
                                                          
                                                          
                                                          
                                                          69,008,900
                                                          
                                                          
                                                          
                                                          (70,476,572
                                                          )
                                                          
                                                          $
                                                          696,061,085




14
 Index




As of and for the three months ended September 30,
      2007Bank
                                      
                                      
                                      Wealth
                                        Management
                                      
                                      
                                      Corporate &
                                        Intercompany
                                      
                                      
                                      Eliminations
                                      
                                      
                                      TotalIncome
      Statement InformationNet
      interest income
                                      
                                      $
                                      5,740,016
                                      
                                      
                                      $
                                      35,865
                                      
                                      
                                      $
                                      (287,647
                                      )
                                      
                                      $
                                      -
                                      
                                      
                                      $
                                      5,488,234Non-interest
      income
                                      
                                      
                                      665,403
                                      
                                      
                                      
                                      790,002
                                      
                                      
                                      
                                      (2,011,526
                                      )
                                      
                                      
                                      1,964,500
                                      
                                      
                                      
                                      1,408,379Non-interest
      expense
                                      
                                      
                                      4,208,721
                                      
                                      
                                      
                                      616,925
                                      
                                      
                                      
                                      115,197
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      4,940,843Noncash
      itemsProvision
      for loan losses
                                      
                                      
                                      5,246,000
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      5,246,000Depreciation/Amortization
                                      
                                      
                                      228,358
                                      
                                      
                                      
                                      9,787
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      238,145Income
      tax expense (benefit)
                                      
                                      
                                      (970,159
                                      )
                                      
                                      
                                      94,300
                                      
                                      
                                      
                                      (206,125
                                      )
                                      
                                      
                                      -
                                      
                                      
                                      
                                      (1,081,984
                                      )Segment
      Profit/(Loss)
                                      
                                      
                                      (2,079,143
                                      )
                                      
                                      
                                      114,642
                                      
                                      
                                      
                                      (2,208,245
                                      )
                                      
                                      
                                      1,964,500
                                      
                                      
                                      
                                      (2,208,246
                                      )Balance
      Sheet InformationSegment
      Assets
                                      
                                      
                                      704,782,242
                                      
                                      
                                      
                                      6,048,246
                                      
                                      
                                      
                                      69,392,915
                                      
                                      
                                      
                                      (73,309,624
                                      )
                                      
                                      
                                      706,913,779





As of and for the nine months ended September 30,
      2007Bank
                                        
                                        
                                        Wealth
                                          Management
                                        
                                        
                                        Corporate &
                                          Intercompany
                                        
                                        
                                        Eliminations
                                        
                                        
                                        TotalIncome
      Statement InformationNet
      interest income
                                        
                                        $
                                        17,072,039
                                        
                                        
                                        $
                                        100,122
                                        
                                        
                                        $
                                        (849,253
                                        )
                                        
                                        $
                                        -
                                        
                                        
                                        $
                                        16,322,908Non-interest
      income
                                        
                                        
                                        2,028,063
                                        
                                        
                                        
                                        2,354,602
                                        
                                        
                                        
                                        (1,071,500
                                        )
                                        
                                        
                                        1,016,322
                                        
                                        
                                        
                                        4,327,487Non-interest
      expense
                                        
                                        
                                        13,164,408
                                        
                                        
                                        
                                        1,798,145
                                        
                                        
                                        
                                        443,162
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        15,405,715Noncash
      itemsProvision
      for loan losses
                                        
                                        
                                        8,171,000
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        8,171,000Depreciation/Amortization
                                        
                                        
                                        701,165
                                        
                                        
                                        
                                        28,582
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        729,747Income
      tax expense (benefit)
                                        
                                        
                                        (860,235
                                        )
                                        
                                        
                                        297,830
                                        
                                        
                                        
                                        (549,395
                                        )
                                        
                                        
                                        -
                                        
                                        
                                        
                                        (1,111,800
                                        )Segment
      Profit/(Loss)
                                        
                                        
                                        (1,375,071
                                        )
                                        
                                        
                                        358,749
                                        
                                        
                                        
                                        (1,814,520
                                        )
                                        
                                        
                                        1,016,322
                                        
                                        
                                        
                                        (1,814,520
                                        )Balance
      Sheet InformationSegment
      Assets
                                        
                                        
                                        704,782,242
                                        
                                        
                                        
                                        6,048,246
                                        
                                        
                                        
                                        69,392,915
                                        
                                        
                                        
                                        (73,309,624
                                        )
                                        
                                        
                                        706,913,779




15
 Index





Note
8 – Loans and Allowance for Loan Losses





Loans at
September 30, 2008 and December 31, 2007 were as follows:





September
      30, 2008
                                              
                                              
                                              December
      31, 2007Balance
                                              
                                              
                                              %
                                              
                                              
                                              Balance
                                              
                                              
                                              %Commercial
                                              
                                              $
                                              247,208,892
                                              
                                              
                                              
                                              44.5
                                              %
                                              
                                              $
                                              252,256,668
                                              
                                              
                                              
                                              43.8
                                              %Commercial
      real estate
                                              
                                              
                                              153,283,500
                                              
                                              
                                              
                                              27.6
                                              %
                                              
                                              
                                              170,291,883
                                              
                                              
                                              
                                              29.6
                                              %Residential
      real estate
                                              
                                              
                                              99,267,653
                                              
                                              
                                              
                                              17.9
                                              %
                                              
                                              
                                              102,162,024
                                              
                                              
                                              
                                              17.7
                                              %Home
      equity
                                              
                                              
                                              33,034,692
                                              
                                              
                                              
                                              6.0
                                              %
                                              
                                              
                                              29,508,246
                                              
                                              
                                              
                                              5.1
                                              %Consumer
                                              
                                              
                                              22,148,149
                                              
                                              
                                              
                                              4.0
                                              %
                                              
                                              
                                              21,750,106
                                              
                                              
                                              
                                              3.8
                                              %Total
      loans
                                              
                                              
                                              554,942,886
                                              
                                              
                                              
                                              100.0
                                              %
                                              
                                              
                                              575,968,927
                                              
                                              
                                              
                                              100.0
                                              %Net
      deferred loan costs
                                              
                                              
                                              (182,576
                                              )
                                              
                                              
                                              
                                              
                                              
                                              
                                              (224,720
                                              )Allowance
      for loan losses
                                              
                                              
                                              (9,277,839
                                              )
                                              
                                              
                                              
                                              
                                              
                                              
                                              (8,208,162
                                              )Net
      loans
                                              
                                              $
                                              545,482,471
                                              
                                              
                                              
                                              
                                              
                                              
                                              $
                                              567,536,045








The
following table summarizes changes in the Company’s allowance for loan losses
for the periods indicated:





2008
                                                  
                                                  
                                                  2007Beginning
      balance, January 1
                                                  
                                                  $
                                                  8,208,162
                                                  
                                                  
                                                  $
                                                  6,870,442Provision
      charged to operating expense
                                                  
                                                  
                                                  3,174,000
                                                  
                                                  
                                                  
                                                  8,171,000Charge-offs
                                                  
                                                  
                                                  (3,460,880
                                                  )
                                                  
                                                  
                                                  (8,218,524
                                                  )Recoveries
                                                  
                                                  
                                                  1,356,557
                                                  
                                                  
                                                  
                                                  357,506Ending
      balance, September 30
                                                  
                                                  $
                                                  9,277,839
                                                  
                                                  
                                                  $
                                                  7,180,424Net
      charge-offs to average loans (annualized)
                                                  
                                                  
                                                  0.50
                                                  %
                                                  
                                                  
                                                  1.82
                                                  %





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





September 30,
      2008
                                  
                                  
                                  December
      31, 2007Specific
      allocations
                                  
                                  $
                                  1,711,000
                                  
                                  
                                  $
                                  1,983,000Loan
      pool percentage allocations
                                  
                                  
                                  7,564,000
                                  
                                  
                                  
                                  6,181,000Unallocated
                                  
                                  
                                  2,839
                                  
                                  
                                  
                                  44,162Total
      allowance for loan losses
                                  
                                  $
                                  9,277,839
                                  
                                  
                                  $
                                  8,208,162








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





September
      30, 2008
                                      
                                      
                                      December
      31, 2007Loans
      past due over 90 days and still accruing
                                      
                                      $
                                      982,106
                                      
                                      
                                      $
                                      -Troubled
      debt restructured loans
                                      
                                      
                                      365,794
                                      
                                      
                                      
                                      639,332Nonaccrual
      loans
                                      
                                      
                                      17,066,349
                                      
                                      
                                      
                                      17,954,861Total
      nonperforming loans
                                      
                                      $
                                      18,414,249
                                      
                                      
                                      $
                                      18,594,193Other
      real estate owned
                                      
                                      
                                      2,431,872
                                      
                                      
                                      
                                      1,451,573Total
      nonperforming assets
                                      
                                      $
                                      20,846,121
                                      
                                      
                                      $
                                      20,045,766Nonperforming
      assets to total assets
                                      
                                      
                                      2.99
                                      %
                                      
                                      
                                      2.84
                                      %Nonperforming
      loans to total loans
                                      
                                      
                                      3.32
                                      %
                                      
                                      
                                      3.23
                                      %




16
 Index





Note
9 – Federal Home Loan Bank Advances





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





September
      30, 2008
                                                
                                                
                                                December
      31, 20075.29%
      bullet advance, principal due at maturity January 7, 2008
                                                
                                                
                                                
                                                
                                                $
                                                3,950,0005.08%
      bullet advance, principal due at maturity March 17, 2008
                                                
                                                
                                                
                                                
                                                
                                                3,500,0004.69%
      bullet advance, principal due at maturity March 26, 2008
                                                
                                                
                                                
                                                
                                                
                                                6,000,0005.16%
      bullet advance, principal due at maturity April 28, 2008
                                                
                                                
                                                
                                                
                                                
                                                2,000,0003.75%
      variable rate advance, principal due at maturity May 13,
    2008
                                                
                                                
                                                
                                                
                                                
                                                3,000,0003.75%
      variable rate advance, principal due at maturity June 11,
    2008
                                                
                                                
                                                
                                                
                                                
                                                1,700,0003.75%
      variable rate advance, principal due at maturity June 16,
    2008
                                                
                                                
                                                
                                                
                                                
                                                750,0003.75%
      variable rate advance, principal due at maturity June 30,
    2008
                                                
                                                
                                                
                                                
                                                
                                                5,000,0001.97%
      variable rate advance, principal due at maturity February 4,
      2009
                                                
                                                
                                                3,500,000
                                                
                                                
                                                
                                                -1.97%
      variable rate advance, principal due at maturity February 9,
      2009
                                                
                                                
                                                2,000,000
                                                
                                                
                                                
                                                -1.97%
      variable rate advance, principal due at maturity March 9,
    2009
                                                
                                                
                                                3,000,000
                                                
                                                
                                                
                                                -1.97%
      variable rate advance, principal due at maturity March 16,
      2009
                                                
                                                
                                                6,000,000
                                                
                                                
                                                
                                                -1.97%
      variable rate advance, principal due at maturity March 16,
      2009
                                                
                                                
                                                4,500,000
                                                
                                                
                                                
                                                -1.97%
      variable rate advance, principal due at maturity March 17,
      2009
                                                
                                                
                                                5,000,000
                                                
                                                
                                                
                                                -1.97%
      variable rate advance, principal due at maturity March 23,
      2009
                                                
                                                
                                                3,500,000
                                                
                                                
                                                
                                                -5.00%
      bullet advance, principal due at maturity April 27, 2009
                                                
                                                
                                                4,000,000
                                                
                                                
                                                
                                                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
                                                
                                                
                                                
                                                -2.29%
      bullet advance, principal due at maturity March 22, 2010
                                                
                                                
                                                2,000,000
                                                
                                                
                                                
                                                -3.26%
      bullet advance, principal due at maturity April 28, 2010
                                                
                                                
                                                1,500,0003.63%
      bullet advance, principal due at maturity June 28, 2010
                                                
                                                
                                                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
                                                
                                                
                                                2,000,0003.60%
      bullet advance, principal due at maturity April 28, 2011
                                                
                                                
                                                1,500,000
                                                
                                                
                                                
                                                -3.55%
      bullet advance, principal due at maturity March 26, 2012
                                                
                                                
                                                2,000,000
                                                
                                                
                                                
                                                -3.81%
      bullet advance, principal due at maturity March 26, 2013
                                                
                                                
                                                2,000,000
                                                
                                                
                                                
                                                -$
                                                52,700,000
                                                
                                                
                                                $
                                                35,100,000








Of the
total FHLB borrowings at September 30, 2008 and December 31, 2007 no advances
had callable options.





At
September 30, 2008 scheduled principal reductions on these FHLB advances were as
follows:





Year
                                
                                Advances2009
                                
                                
                                36,500,0002010
                                
                                
                                8,700,0002011
                                
                                
                                3,500,0002012
                                
                                
                                2,000,0002013
                                
                                
                                2,000,000$
                                52,700,000




17
 Index





Note
10 – Fair Value Measurement





Effective
January 1, 2008 we adopted FAS 157, which defines fair value, establishes a
consistent framework for measuring fair value, and expands disclosure
requirements about fair value.  The standard establishes a hierarchy
of valuation techniques based on whether the inputs to those valuation
techniques are observable or unobservable.  Observable inputs reflect
market data obtained from independent sources, while unobservable inputs reflect
our assumptions about the assumptions market participants would use in pricing
as asset or liability.  It requires us to maximize observable inputs
and minimize the use of unobservable inputs when measuring fair
value.  These two types of inputs have created the following fair
value hierarchy:





·
            Level
      One – Quoted prices for identical instruments
      in active markets


·
            Level
      Two – Observable inputs for similar instruments in
      active markets; quoted prices for identical or similar instruments in
      markets that are not active; and model-derived valuations in which all
      significant inputs and significant value drivers are observable in active
      markets or can be corroborated by observable market
  data


·
            Level
      Three – Valuations derived from valuation techniques in which one or more
      significant inputs or significant value drivers are unobservable that
      reflect our 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 investments.  Available-for-sale
investments largely include debt securities, whose fair value is determined from
evaluations based on matrix pricing.  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.  Examples include municipal bonds, agency-backed
obligations, and mortgage-backed securities.  In certain cases where
market data is not readily available because of lack market activity or little
public disclosure, values may be based on unobservable inputs and classified in
Level 3 of the fair value hierarchy.





The
following table presents for each of the fair-value hierarchy levels our assets
that are measured at fair value on a recurring basis at September 30,
2008.





Level
      1
                                        
                                        Level
      2
                                        
                                        
                                        Level
      3
                                        
                                        
                                        TotalAvailable-for-sale
      securities
                                        
                                        
                                        $
                                        77,707,010
                                        
                                        
                                        $
                                        458,931
                                        
                                        
                                        $
                                        78,165,941





The
following table represents the changes in the Level 3 fair-value category for
the period ended September 30, 2008.  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.





Available-for-sale
      securitiesBeginning
      Balance, January 1, 2008
                                  
                                  $
                                  869,055Net
      realized/unrealized gains (losses)Included
      in earningsIncluded
      in other comprehensive income
                                  
                                  
                                  (410,124
                                  )Ending
      Balance, September 30, 2008
                                  
                                  $
                                  458,931Total
      gains (losses) for the period included in earnings attributable to the
      changes in unrealized gains (losses) relating to assets still held at the
      reporting date
                                  
                                  
                                  -




18
 Index





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.  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 table presents for each of the fair-value hierarchy levels our assets
that are measured at fair value on a non-recurring basis at September 30,
2008





Level
      1
                                Level
      2
                                
                                Level
      3
                                
                                
                                TotalImpaired
      loans
                                
                                
                                
                                
                                12,765,862
                                
                                
                                
                                12,765,862








Impaired
loans had a carrying value of $14.5 million, with a valuation allowance of $1.7
million at September 30, 2008.  This compares to a carrying value of
$9.8 million and a valuation allowance of $2.0 million at January 1,
2008.





Note
11 – 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.




Item 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS





The
following presents management’s discussion and analysis of the consolidated
financial condition of the Company as of September 30, 2008 and December 31,
2007 and results of operations for the three- and nine-month periods ended
September 30, 2008 and September 30, 2007.  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,
2007.





Critical
Accounting Policies





A
comprehensive discussion of the Company’s critical accounting policies is
disclosed in our Annual Report on Form 10-K for the year ended December 31, 2007
and included by reference in Note 2 above.  There have been no
material changes in the information regarding our critical accounting policies
since December 31, 2007.





Executive
Overview





Net
Income was $329,601 and $1.4 million for the third quarter 2008 and first nine
months of 2008, respectively.  This is an increase from a net loss of
($2,208,246) and ($1,814,520) for the third quarter 2007 and the first nine
months of 2007, respectively.  The year-to-date and quarterly change
was primarily due to a lower provision.





Net
interest income decreased $522,356 or 3.2% from the nine-month period ended
September 30, 2007 to the same period ended September 30, 2008.  The
decrease was primarily due to the rapid decrease in the prime rate in the first
quarter of 2008 coupled with the purposeful decrease of approximately $21.0
million in loan volume.  Although nonperforming assets have remained
consistent with balances at December 31, 2007, they have decreased by $3.0
million since June 30, 2008.





Noninterest
income increased approximately $593,977 from the nine-month period ended
September 30, 2007 to the same period ended September 30,
2008.  Increases were seen in nearly every area, including trust and
brokerage fees of $415,223, service charges of $203,057, loan broker fees of
$48,347, and gain on sale of securities of $108,405.





Noninterest
expenses increased by 2.1% in the third quarter of 2008 compared to third
quarter 2007 and 4.8% year-to-date 2008 compared to the same period in
2007.  The increases are due to increased marketing expenses from
television commercial production and broadcasting, data processing, employment
expenses, and increases in FDIC insurance premiums.





19
 Index





Total
assets decreased $10.4 million from December 31, 2007 to September 30,
2008.  The decrease was primarily in the loan portfolio, which
decreased $21.0 million or 3.6% and loans held-for-sale, which decreased by $2.5
million.  This was offset somewhat by the increase in investments of
$12.9 million.  The decrease in loans was a result of the sale of
certain non-performing loans, deterioration of economic conditions, and a change
in management’s strategic plan to focus on more profitable relationships verses
growth.





Total
deposits decreased by $27.5 million from December 31, 2007 to September 30, 2008
as certificates of deposits and out-of-market deposits declined by $51.1 million
and $12.8 million, respectively.  Helping to offset the decline were
non-interest bearing checking accounts, NOW accounts, and money market accounts
which grew by $14.8 million, $11.9 million, and $7.0 million,
respectively.





Financial
Condition





Total
assets were $696.1 million at September 30, 2008 compared to total assets at
December 31, 2007 of $706.5 million.  The 1.5% decrease in assets was
primarily due to a decrease in loans of $21.0 million, or 3.6%, offset by an
increase in long-term investments.





Cash and
Investments.   Cash and cash equivalents, which include
federal funds sold, were $34.9 million at September 30, 2008, a $1.0 million, or
3.0%, increase from $33.8 million at December 31, 2007. Securities available for
sale were $78.2 million at the end of the third quarter of 2008, an increase of
$12.9 million from December 31, 2007.  The increase in investments was
primarily funded by the pay downs in the loan portfolio to follow the Company’s
plan to increase liquidity and lower the loan to deposit ratio.  The
increase in long-term investments during the third quarter of 2008 was also
reflective of our strategy to increase core deposits and reduce loans
outstanding.





Loans Held for
Sale.  Loans held for sale decreased $2.5 million during the
first nine months of 2008.  These loans at December 31, 2007 were
originated by the Indianapolis loan production office.  In June of
2007, when the decision was made to defer further action on the creation of the
Indianapolis de novo bank an agreement was reached with a financial institution
in the Indianapolis market to sell theses loans at par.  The loans
from the Indianapolis loan production office reported at December 31, 2007 were
sold during the first quarter of 2008.  The loans held for sale at
September 30, 2008 were mortgage loans originated with the intent to sell to
other financial institutions.





Loans.  Total loans
were $554.8 million at September 30, 2008 reflecting a 3.6% decrease from total
loans of $575.7 million at December 31, 2007.  The decline in the loan
portfolio occurred mainly in Commercial and Commercial Real Estate loans, which
accounted for $22.1 million of the decline in the total loan portfolio since
December 31, 2007. The decline in the portfolios is primarily due to the
Company’s purposeful plan to reduce loan volume and to focus on asset quality.
The overall mix of the loan portfolio has not materially changed since year-end
as the total of commercial and commercial real estate loans of the portfolio was
72.1% at September 30, 2008 and 73.4% at December 31, 2007.





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, trouble debt restructured
loans, and all nonaccrual loans.  Nonperforming assets have increased
from $20.0 million, or 2.84% of total assets, at December 31, 2007 to $20.8
million, or 2.99% of total assets, at September 30,
2008.  Approximately $3.7 million or 17.9% of our nonperforming assets
plus delinquencies are currently performing according to the original terms of
their contracts.  Some loans have been partially charged down to
reflect deterioration in underlying project collateral values despite each
operator’s ability thus far to generate sufficient operating cash flow to
service required payments.  Management considers the original loan
amounts to be impaired justifying the adverse classification, but thinks the
current basis fairly represents amounts collectible should the borrower actually
default.  Total impaired loans at September 30, 2008 were $18.9
million compared to $21.2 million at December 31, 2007.  The decrease
was due to the paydowns received during the first nine months of 2008, loan
charge-offs, and sales of collateral.  At September 30, 2008,
management believes it has allocated adequate specific allowances for these
risks of $1.7 million.  The specific reserves for impaired loans at
December 31, 2007 were $2.0 million.





Allowance for Loan
Losses.   In each quarter the allowance for loan losses 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.





20
 Index





The
allowance for loan losses at September 30, 2008 was $9.3 million, or 1.67% of
total loans outstanding, an increase of $1.1 million from $8.2 million, or
1.43%, at December 31, 2007.   The provision for loan losses
during the first nine months of 2008 was $3.2 million compared to $8.2 million
in the first nine months of 2007.





The
expense to the allowance of $3.2 million during the first nine months of 2008
was primarily due to six commercial and commercial real estate lending
relationships being downgraded, the increase in the FAS 114 pool percentages,
and the increase in specific reserves on one commercial and two commercial real
estate lending relationships.  The downgrades made to the six
commercial and commercial real estate loans were made primarily to reflect the
change in the borrowers’ ability pay and/or the decrease in the value of
collateral reflective of the decline in the real estate market and the recent
economic downturn.  The downgrades increased the allowance by
approximately $450,000. The allowance for loan loss calculation uses a two-year
average of net charge-offs to determine the amount that should be reserved for
each loan type on regular, higher quality loans.  Due to large
charge-offs taken throughout the year in 2007, the Company has recorded
additional expense of approximately $770,000 to the allowance to reflect an
increase in the allocation percentages from 51 basis points and 30 basis points
at December 31, 2007 to 65 basis points and 79 basis points at September 30,
2008 on Commercial and Commercial Real Estate loans,
respectively.  The amount of the allowance allocated to the other
pools remained flat during the first nine months of 2008.  During the
first nine months, three lending relationships were downgraded to nonaccrual
status with specific reserves totaling $1.7 million, of which $1.0 million has
been charged off.





Other
Assets.   The $1.2 million increase in other assets was
primarily attributable to the increase in Other Real Estate Owned of $1.0
million. The increase in Other Real Estate Owned was due to foreclosure on five
commercial real estate loans and two residential real estate loan. The increase
was offset by the sale of the interest rate floor as discussed in Note
5.  The interest rate floor had a carrying value of approximately
$420,000 at the time of settlement.  There was also a deferred tax
liability of approximately $140,000 recorded relating to the gain on the
sale.  A receivable was recorded in the amount of $415,000 at
September 30, 2008 for the amount due from the money market sweep provider for
amounts previously paid to customers using that product.  The
remainder of the difference in Other Assets is an increase in deferred tax
assets.





Deposits.   Total
deposits were $573.2 million at September 30, 2008 compared to total deposits at
December 31, 2007 of $600.7 million. Along with the decrease in total deposits,
the composition of the deposit portfolio changed significantly.  Core
deposits increased by $36.4 million, or 9.8%, while non-core deposits decreased
by $63.9 million or 27.7% during the first nine months of 2008. The increase in
core deposits was primarily in the noninterest-bearing demand deposit accounts
and interest-bearing checking accounts since December 31, 2007 by $14.8 million
and $11.9 million, respectively.  The increase in the low-cost core
deposits was offset by decreases in certificate of deposits greater than
$100,000 and brokered certificate of deposits since December 31, 2007 by $51.0
million and $12.8 million, respectively.  At September 30, 2008,
brokered CD’s and out of market deposits comprised 10.9% of total deposits,
compared to 12.5% as of December 31, 2007.





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





September
      30, 2008
                                                        
                                                        
                                                        December
      31, 2007Balance
                                                        
                                                        
                                                        %
                                                        
                                                        
                                                        Balance
                                                        
                                                        
                                                        %Core
      Deposits:Noninterest-bearing
      demand
                                                        
                                                        $
                                                        86,542,430
                                                        
                                                        
                                                        
                                                        15.1
                                                        %
                                                        
                                                        $
                                                        71,705,395
                                                        
                                                        
                                                        
                                                        11.9
                                                        %Interest-bearing
      checking
                                                        
                                                        
                                                        66,826,884
                                                        
                                                        
                                                        
                                                        11.7
                                                        %
                                                        
                                                        
                                                        54,928,439
                                                        
                                                        
                                                        
                                                        9.2
                                                        %Money
      market
                                                        
                                                        
                                                        142,340,827
                                                        
                                                        
                                                        
                                                        24.8
                                                        %
                                                        
                                                        
                                                        135,304,113
                                                        
                                                        
                                                        
                                                        22.5
                                                        %Savings
                                                        
                                                        
                                                        16,444,172
                                                        
                                                        
                                                        
                                                        3.0
                                                        %
                                                        
                                                        
                                                        13,746,704
                                                        
                                                        
                                                        
                                                        2.3
                                                        %Time,
      under $100,000
                                                        
                                                        
                                                        94,554,759
                                                        
                                                        
                                                        
                                                        16.5
                                                        %
                                                        
                                                        
                                                        94,604,892
                                                        
                                                        
                                                        
                                                        15.7
                                                        %Total
      Core Deposits
                                                        
                                                        
                                                        406,709,072
                                                        
                                                        
                                                        
                                                        71.0
                                                        %
                                                        
                                                        
                                                        370,289,543
                                                        
                                                        
                                                        
                                                        61.6
                                                        %Non-core
      Deposits:In
      Market Non-core Deposits:Time,
      $100,000 and over
                                                        
                                                        
                                                        104,182,896
                                                        
                                                        
                                                        
                                                        18.2
                                                        %
                                                        
                                                        
                                                        155,224,215
                                                        
                                                        
                                                        
                                                        25.9
                                                        %Out-of-Market
      Non-Core Deposits:Brokered
      CD's
                                                        
                                                        
                                                        62,329,313
                                                        
                                                        
                                                        
                                                        10.9
                                                        %
                                                        
                                                        
                                                        75,175,713
                                                        
                                                        
                                                        
                                                        12.5
                                                        %Total
      Non-core Deposits
                                                        
                                                        
                                                        166,512,209
                                                        
                                                        
                                                        
                                                        29.0
                                                        %
                                                        
                                                        
                                                        230,399,928
                                                        
                                                        
                                                        
                                                        38.4
                                                        %Total
      deposits
                                                        
                                                        $
                                                        573,221,281
                                                        
                                                        
                                                        
                                                        100.0
                                                        %
                                                        
                                                        $
                                                        600,689,471
                                                        
                                                        
                                                        
                                                        100.0
                                                        %




21
 Index





Borrowings.   The
Company had borrowings in the amount of $52.7 million in Federal Home Loan Bank
(“FHLB”) advances at September 30, 2008 and $35.1 million at December 31,
2007.  Of the outstanding advances, 11 are bullet advances totaling
$24.2 million and maturing in a range from April 2009 through March
2013.  The other seven outstanding advances are variable rate advances
and will mature in a range from February 2009 to March 2009.





Other
Liabilities.Other liabilities increased $131,843 from
year-end 2007.  The increase was primarily due to the increases in
deferred compensation and deferred director fees totaling
$383,240.  The increase was offset by a decrease in the other accrued
expenses for the final payment on construction of the Warsaw
location.








Results
of Operations





For The Three-Month Periods
Ended September 30





Results
of operations for the three-month period ended September 30, 2008 reflected net
income of $329,601 or $.08 per diluted share.   This was a $2.5
million increase over 2007’s third quarter net loss of $2.2 million or ($0.54)
per diluted share.  While net interest income was lower in the third
quarter of 2008 by $62,687 compared to the third quarter of 2007, the provision
expense in 2008 for the same time period was $3.2 million lower than the prior
year.  Non-interest income increased by $403,842 in the third quarter
2008 compared to the third quarter 2007, primarily due to the combination of an
increase of $146,687 in trust and brokerage fees and a market value gain on an
investment held at the Holding Company.  Non-interest expense also
increased by $101,956, primarily due to the increase in the employee incentive
bonus by $59,499, the decrease in deferred loan cost by $19,400, and the
increase in FDIC premiums by $63,776 compared to the third quarter
2007.





Total
revenue, defined as net interest income plus total noninterest income, increased
from third quarter 2007 to third quarter 2008 by 5.0% to $7.2 million, up from
$6.9 million.  For the three-month period ended September 30, 2008,
net interest income decreased 1.1%, while total noninterest income increased
28.7% from the same period one year ago primarily due to an increase in trust
and brokerage fees, service charges, and loan broker fees.





Performance
      Ratios
                                      
                                      September
      302008
                                      
                                      
                                      2007Return
      on average assets *
                                      
                                      
                                      0.19
                                      %
                                      
                                      
                                      -1.25
                                      %Return
      on average equity *
                                      
                                      
                                      2.66
                                      %
                                      
                                      
                                      -17.52
                                      %Net
      interest margin (TEY) *
                                      
                                      
                                      3.42
                                      %
                                      
                                      
                                      3.31
                                      %Efficiency
      ratio
                                      
                                      
                                      69.67
                                      %
                                      
                                      
                                      71.64
                                      %*
      annualized




Net Interest
Income.   Interest income for the three-month periods
ended September 30, 2008 and 2007 was $9.3 million and $12.1 million,
respectively, while interest expense for the third quarter was $3.9 million in
2008 and $6.6 million in 2007, resulting in net interest income
of  $5.4 million for the third quarter of 2008 and $5.5 million for
the third quarter of 2007.  The tax equivalent net interest margin for
the third quarter of 2008 was 3.42%, while the tax equivalent net interest
margin for the third quarter of 2007 was 3.31%.  The decrease in net
interest income was a reflection of the elevated levels of non-performing
assets, the sharp decline in interest rates, and management’s purposeful decline
in the loan portfolio.  Although non-performing assets are higher than
the


third
quarter 2007, they have decreased $2.9 million since the quarter ending June 30,
2008.




22
 Index




The
following table reflects the average balance, interest earned or paid, and
yields or costs of the Company’s assets, liabilities and stockholders’ equity at
and for the dates indicated:





At
      and For The Three Month Period EndedSeptember
      30, 2008
                                                                    
                                                                    
                                                                    September
      30, 2007($
      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
                                                                    
                                                                    $
                                                                    5,641
                                                                    
                                                                    
                                                                    $
                                                                    27
                                                                    
                                                                    
                                                                    
                                                                    1.90
                                                                    %
                                                                    
                                                                    $
                                                                    6,545
                                                                    
                                                                    
                                                                    $
                                                                    77
                                                                    
                                                                    
                                                                    
                                                                    4.67
                                                                    %Federal
      funds sold
                                                                    
                                                                    
                                                                    6,636
                                                                    
                                                                    
                                                                    
                                                                    33
                                                                    
                                                                    
                                                                    
                                                                    1.98
                                                                    %
                                                                    
                                                                    
                                                                    4,469
                                                                    
                                                                    
                                                                    
                                                                    51
                                                                    
                                                                    
                                                                    
                                                                    4.53
                                                                    %Securities
      - taxable
                                                                    
                                                                    
                                                                    59,096
                                                                    
                                                                    
                                                                    
                                                                    735
                                                                    
                                                                    
                                                                    
                                                                    4.95
                                                                    %
                                                                    
                                                                    
                                                                    51,854
                                                                    
                                                                    
                                                                    
                                                                    660
                                                                    
                                                                    
                                                                    
                                                                    5.05
                                                                    %Securities
      - tax exempt (1)
                                                                    
                                                                    
                                                                    21,065
                                                                    
                                                                    
                                                                    
                                                                    334
                                                                    
                                                                    
                                                                    
                                                                    6.31
                                                                    %
                                                                    
                                                                    
                                                                    19,126
                                                                    
                                                                    
                                                                    
                                                                    306
                                                                    
                                                                    
                                                                    
                                                                    6.35
                                                                    %Loan
      Held for Sale
                                                                    
                                                                    
                                                                    710
                                                                    
                                                                    
                                                                    
                                                                    -
                                                                    
                                                                    
                                                                    
                                                                    0.00
                                                                    %
                                                                    
                                                                    
                                                                    70
                                                                    
                                                                    
                                                                    
                                                                    -
                                                                    
                                                                    
                                                                    
                                                                    0.00
                                                                    %Loans
                                                                    
                                                                    
                                                                    551,407
                                                                    
                                                                    
                                                                    
                                                                    8,304
                                                                    
                                                                    
                                                                    
                                                                    5.99
                                                                    %
                                                                    
                                                                    
                                                                    587,531
                                                                    
                                                                    
                                                                    
                                                                    11,086
                                                                    
                                                                    
                                                                    
                                                                    7.49
                                                                    %Total
      interest-earning assets
                                                                    
                                                                    
                                                                    644,555
                                                                    
                                                                    
                                                                    
                                                                    9,433
                                                                    
                                                                    
                                                                    
                                                                    5.82
                                                                    %
                                                                    
                                                                    
                                                                    669,595
                                                                    
                                                                    
                                                                    
                                                                    12,180
                                                                    
                                                                    
                                                                    
                                                                    7.22
                                                                    %Allowance
      for loan losses
                                                                    
                                                                    
                                                                    (8,995
                                                                    )
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    (8,731
                                                                    )Cash
      and due from banks
                                                                    
                                                                    
                                                                    15,217
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    11,546Other
      assets
                                                                    
                                                                    
                                                                    32,178
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    30,127Total
      assets
                                                                    
                                                                    $
                                                                    682,955
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    $
                                                                    702,537Liabilities
      and Stockholders' EquityInterest-bearing
      checking
                                                                    
                                                                    $
                                                                    68,851
                                                                    
                                                                    
                                                                    $
                                                                    200
                                                                    
                                                                    
                                                                    
                                                                    1.16
                                                                    %
                                                                    
                                                                    $
                                                                    47,381
                                                                    
                                                                    
                                                                    $
                                                                    183
                                                                    
                                                                    
                                                                    
                                                                    1.53
                                                                    %Savings
                                                                    
                                                                    
                                                                    17,235
                                                                    
                                                                    
                                                                    
                                                                    43
                                                                    
                                                                    
                                                                    
                                                                    0.99
                                                                    %
                                                                    
                                                                    
                                                                    14,797
                                                                    
                                                                    
                                                                    
                                                                    39
                                                                    
                                                                    
                                                                    
                                                                    1.05
                                                                    %Money
      market
                                                                    
                                                                    
                                                                    145,448
                                                                    
                                                                    
                                                                    
                                                                    791
                                                                    
                                                                    
                                                                    
                                                                    2.16
                                                                    %
                                                                    
                                                                    
                                                                    120,422
                                                                    
                                                                    
                                                                    
                                                                    1,187
                                                                    
                                                                    
                                                                    
                                                                    3.91
                                                                    %Certificates
      of deposit
                                                                    
                                                                    
                                                                    276,206
                                                                    
                                                                    
                                                                    
                                                                    2,288
                                                                    
                                                                    
                                                                    
                                                                    3.30
                                                                    %
                                                                    
                                                                    
                                                                    340,321
                                                                    
                                                                    
                                                                    
                                                                    4,455
                                                                    
                                                                    
                                                                    
                                                                    5.19
                                                                    %Short-term
      borrowings
                                                                    
                                                                    
                                                                    452
                                                                    
                                                                    
                                                                    
                                                                    3
                                                                    
                                                                    
                                                                    
                                                                    2.64
                                                                    %
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    -FHLB
      advances
                                                                    
                                                                    
                                                                    31,368
                                                                    
                                                                    
                                                                    
                                                                    285
                                                                    
                                                                    
                                                                    
                                                                    3.61
                                                                    %
                                                                    
                                                                    
                                                                    34,094
                                                                    
                                                                    
                                                                    
                                                                    436
                                                                    
                                                                    
                                                                    
                                                                    5.07
                                                                    %Junior
      subordinated debt
                                                                    
                                                                    
                                                                    17,527
                                                                    
                                                                    
                                                                    
                                                                    283
                                                                    
                                                                    
                                                                    
                                                                    6.42
                                                                    %
                                                                    
                                                                    
                                                                    17,527
                                                                    
                                                                    
                                                                    
                                                                    288
                                                                    
                                                                    
                                                                    
                                                                    6.52
                                                                    %Total
      interest-bearing liabilities
                                                                    
                                                                    
                                                                    557,087
                                                                    
                                                                    
                                                                    
                                                                    3,893
                                                                    
                                                                    
                                                                    
                                                                    2.78
                                                                    %
                                                                    
                                                                    
                                                                    574,542
                                                                    
                                                                    
                                                                    
                                                                    6,588
                                                                    
                                                                    
                                                                    
                                                                    4.55
                                                                    %Noninterest-bearing
      checking
                                                                    
                                                                    
                                                                    72,845
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    73,219Other
      liabilities
                                                                    
                                                                    
                                                                    3,529
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    4,762Stockholders'
      equity
                                                                    
                                                                    
                                                                    49,494
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    50,014Total
      liabilities and stockholders' equity
                                                                    
                                                                    $
                                                                    682,955
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    $
                                                                    702,537Net
      interest income
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    $
                                                                    5,540
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    $
                                                                    5,592Rate
      spread
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    3.04
                                                                    %
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    2.67
                                                                    %Net
      interest income as a percent of average earning assets
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    3.42
                                                                    %
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    
                                                                    3.31
                                                                    %





(1)
Computed on a tax equivalent basis for tax exempt securities using a 34%
statutory tax rate.








Provision for Loan
Losses.   A provision for loan losses was recorded in the
amount of $2.0 million or 145 basis points on average loans (annualized) during
the third quarter of 2008 as compared to $5.2 million, or 357 basis points on
average loans (annualized) for the third quarter of 2007.  The
provision recorded in the third quarter of 2008 was primarily due to downgrading
several loans from the “Watch” category to the “Special Mention” and
“Substandard” categories on the watchlist.  Due to downgrading these
loans, an additional $690,000 was recorded to increase the allowance for loan
losses.  The allowance for loan losses at September 30, 2008 totaled
$9.3 million and was 1.67% of total loans outstanding on that
date.  Total net charge-offs for the three-month period ended
September 30, 2008 were $1.6 million, or 114 basis points, annualized, on
average loans and were $5.2 million, or 354 basis points, annualized, on average
loans during the same period a year ago.





Noninterest
Income.   Noninterest income was $1.8 million during the
third quarter of 2008.   This was a $403,842, or 28.7%, increase
compared to the third quarter of 2007.  Trust services fee income,
service charges, loan broker fees, and other fee revenue all contributed to the
increase. Trust services fees increased $146,687 from the third quarter of 2007
to $936,689 for the three-month period ended September 30, 2008, reflective of
an increase of $95 million, or 11.5%, in assets under
management.  Service charge revenue increased $53,529, or 22.8%, from
$234,657 for the three-month period ending September 30, 2007 to $288,186 for
the same period ended September 30, 2008.  The increase was primarily
from an increase in over-draft fees and in service charges on deposit
accounts.  Other fee revenue increased by $150,053, or 41.0%,
primarily due to the gain of $144,708 recorded for a limited partnership
investment at the Holding Company.





23
 Index





Noninterest
Expense.   Noninterest expense was $5.0 million for the
third quarter of 2008 while noninterest expense for the three-month period ended
September 30, 2007 was $4.9 million.  The main components of
noninterest expense for the third quarter of 2008 were salaries and benefits of
$2.8 million and occupancy and equipment costs of $719,948.  Total
employment expenses increased $185,537 for the third quarter 2008 compared to
the third quarter 2007; however, the salary expense has steadily decreased
during the first nine months of 2008.  Other expenses were $237,450 in
the third quarter 2008, a $217,962 decrease from the same quarter
2007.  FDIC premiums increased $63,776, or 54.9%, from $116,260 at
September 30, 2007 to $180,036 at September 30, 2008.





Income
Taxes. During the quarters ended September 30, 2008 and
2007, we recorded $133,632 and $1.1 million in income tax benefit,
respectively.  The effective tax rate recorded was (68.2%) for third
quarter 2008 as compared to (32.9%) for third quarter 2007.  The tax
benefit in 2007 and 2008 is the result of excess tax-exempt income over net
income and carryforward losses.  Tax-exempt income includes earnings
on bank-owned life insurance and municipal securities.





For The Nine-Month Periods
Ended September 30





Results
of operations for the nine-month period ended September 30, 2008 reflected net
income of $1.4 million, or $0.34 per diluted share.   This was a
$3.2 million increase over 2007’s nine-month period net loss of $1.8 million, or
$(0.45) per diluted share.   The operating results for the
nine-month period ended September 30, 2008 were favorable compared to the same
period in 2007 primarily due to a strategic plan to improve asset quality
through a reduction of loans outstanding, a reduction of non-performing assets,
and a reduction in non-interest expenses.





Total
revenue, defined as net interest income plus total noninterest income, remained
relatively unchanged at $20.7 million in the first three quarters of 2007 and
2008.  For the nine-month period ended September 30, 2008, net
interest income decreased 3.2%, while total noninterest income increased 13.7%
from the same period one year ago primarily due to an increase in trust and
brokerage fees, loan broker fees, and service charge income.





Performance
      Ratios
                        
                        September
      302008
                        
                        
                        2007Return
      on average assets *
                        
                        
                        0.27
                        %
                        
                        
                        -0.35
                        %Return
      on average equity *
                        
                        
                        3.77
                        %
                        
                        
                        -4.78
                        %Net
      interest margin (TEY) *
                        
                        
                        3.31
                        %
                        
                        
                        3.39
                        %Efficiency
      ratio
                        
                        
                        77.90
                        %
                        
                        
                        74.60
                        %





*
annualized





Net Interest
Income.   Interest income for the nine-month periods ended
September 30, 2008 and 2007 was $28.9 million and $35.5 million, respectively,
while interest expense was $13.1 million through September 30, 2008 and $19.1
million through September 30, 2007, resulting in net interest income of $15.8
million for the first nine months of 2008 and $16.3 million for the first nine
months of 2007.  The decrease in net interest income was reflective of
the general decline in the prime rate.  The tax equivalent net
interest margin for the first nine months of 2008 was 3.31%, while the tax
equivalent net interest margin for the first nine months of 2007 was
3.39%.   The decrease in net interest margin is due to the
elevated levels of non-performing assets, the declining interest rates, and
management’s purposeful decrease in total loans.





24
 Index





The
following table reflects the average balance, interest earned or paid, and
yields or costs of the Company’s assets, liabilities and stockholders’ equity at
and for the dates indicated:





At and For The Nine Month Periods
      EndedSeptember 30, 2008
                                                                                                                    
                                                                                                                    
                                                                                                                    September 30, 2007($
      in thousands)
                                                                                                                    
                                                                                                                    Average
                                                                                                                      Balance
                                                                                                                    
                                                                                                                    
                                                                                                                    Interest
                                                                                                                      Earned
                                                                                                                      or Paid
                                                                                                                    
                                                                                                                    
                                                                                                                    Annualized
                                                                                                                      Yield
                                                                                                                      or Cost
                                                                                                                    
                                                                                                                    
                                                                                                                    Average
                                                                                                                      Balance
                                                                                                                    
                                                                                                                    
                                                                                                                    Interest
                                                                                                                      Earned
                                                                                                                      or Paid
                                                                                                                    
                                                                                                                    
                                                                                                                    Annualized
                                                                                                                      Yield
                                                                                                                      or CostAssetsShort-term
      investments andinterest-earning
      deposits
                                                                                                                    
                                                                                                                    $
                                                                                                                    8,802
                                                                                                                    
                                                                                                                    
                                                                                                                    $
                                                                                                                    182
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    2.76
                                                                                                                    %
                                                                                                                    
                                                                                                                    $
                                                                                                                    4,445
                                                                                                                    
                                                                                                                    
                                                                                                                    $
                                                                                                                    194
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    5.84
                                                                                                                    %Federal
      funds sold
                                                                                                                    
                                                                                                                    
                                                                                                                    6,281
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    150
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    3.19
                                                                                                                    %
                                                                                                                    
                                                                                                                    
                                                                                                                    4,931
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    175
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    4.74
                                                                                                                    %Securities
      - taxable
                                                                                                                    
                                                                                                                    
                                                                                                                    53,869
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    1,997
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    4.95
                                                                                                                    %
                                                                                                                    
                                                                                                                    
                                                                                                                    51,960
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    1,991
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    5.12
                                                                                                                    %Securities
      - tax exempt (1)
                                                                                                                    
                                                                                                                    
                                                                                                                    21,148
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    997
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    6.30
                                                                                                                    %
                                                                                                                    
                                                                                                                    
                                                                                                                    19,495
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    906
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    6.21
                                                                                                                    %Loans
      held for sale
                                                                                                                    
                                                                                                                    
                                                                                                                    497
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    -
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    0.00
                                                                                                                    %
                                                                                                                    
                                                                                                                    
                                                                                                                    48
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    -
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    0.00
                                                                                                                    %Loans
                                                                                                                    
                                                                                                                    
                                                                                                                    561,205
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    25,919
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    6.17
                                                                                                                    %
                                                                                                                    
                                                                                                                    
                                                                                                                    574,670
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    32,492
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    7.56
                                                                                                                    %Total
      interest-earning assets
                                                                                                                    
                                                                                                                    
                                                                                                                    651,802
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    29,245
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    5.99
                                                                                                                    %
                                                                                                                    
                                                                                                                    
                                                                                                                    655,549
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    35,758
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    7.29
                                                                                                                    %Allowance
      for loan losses
                                                                                                                    
                                                                                                                    
                                                                                                                    (8,939
                                                                                                                    )
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    (7,803
                                                                                                                    )Cash
      and due from banks
                                                                                                                    
                                                                                                                    
                                                                                                                    14,841
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    12,117Other
      assets
                                                                                                                    
                                                                                                                    
                                                                                                                    32,271
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    29,764Total
      assets
                                                                                                                    
                                                                                                                    $
                                                                                                                    689,975
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    $
                                                                                                                    689,627Liabilities
      and Stockholders' EquityInterest-bearing
      checking
                                                                                                                    
                                                                                                                    $
                                                                                                                    66,038
                                                                                                                    
                                                                                                                    
                                                                                                                    $
                                                                                                                    619
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    1.25
                                                                                                                    %
                                                                                                                    
                                                                                                                    $
                                                                                                                    44,335
                                                                                                                    
                                                                                                                    
                                                                                                                    $
                                                                                                                    482
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    1.45
                                                                                                                    %Savings
                                                                                                                    
                                                                                                                    
                                                                                                                    16,418
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    133
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    1.08
                                                                                                                    %
                                                                                                                    
                                                                                                                    
                                                                                                                    14,657
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    106
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    0.97
                                                                                                                    %Money
      market
                                                                                                                    
                                                                                                                    
                                                                                                                    137,161
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    2,493
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    2.43
                                                                                                                    %
                                                                                                                    
                                                                                                                    
                                                                                                                    124,803
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    3,443
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    3.69
                                                                                                                    %Certificates
      of deposit
                                                                                                                    
                                                                                                                    
                                                                                                                    298,569
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    8,152
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    3.65
                                                                                                                    %
                                                                                                                    
                                                                                                                    
                                                                                                                    340,121
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    13,221
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    5.20
                                                                                                                    %Federal
      funds purchased
                                                                                                                    
                                                                                                                    
                                                                                                                    -
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    -
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    0.00
                                                                                                                    %
                                                                                                                    
                                                                                                                    
                                                                                                                    48
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    1
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    2.79
                                                                                                                    %Short-term
      borrowings
                                                                                                                    
                                                                                                                    
                                                                                                                    151
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    3
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    2.65
                                                                                                                    %
                                                                                                                    
                                                                                                                    
                                                                                                                    -
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    -
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    0.00
                                                                                                                    %FHLB
      advances
                                                                                                                    
                                                                                                                    
                                                                                                                    29,866
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    858
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    3.84
                                                                                                                    %
                                                                                                                    
                                                                                                                    
                                                                                                                    26,817
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    1,025
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    5.11
                                                                                                                    %Junior
      subordinated debt
                                                                                                                    
                                                                                                                    
                                                                                                                    17,527
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    848
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    6.46
                                                                                                                    %
                                                                                                                    
                                                                                                                    
                                                                                                                    17,527
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    849
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    6.48
                                                                                                                    %Total
      interest-bearing liabilities
                                                                                                                    
                                                                                                                    
                                                                                                                    565,730
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    13,106
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    3.09
                                                                                                                    %
                                                                                                                    
                                                                                                                    
                                                                                                                    568,308
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    19,127
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    4.50
                                                                                                                    %Noninterest-bearing
      checking
                                                                                                                    
                                                                                                                    
                                                                                                                    71,331
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    65,898Other
      liabilities
                                                                                                                    
                                                                                                                    
                                                                                                                    3,857
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    4,641Stockholders'
      equity
                                                                                                                    
                                                                                                                    
                                                                                                                    49,057
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    50,780Total
      liabilities and stockholders' equity
                                                                                                                    
                                                                                                                    $
                                                                                                                    689,975
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    $
                                                                                                                    689,627Net
      interest income
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    $
                                                                                                                    16,139
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    $
                                                                                                                    16,631Rate
      spread
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    2.90
                                                                                                                    %
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    2.79
                                                                                                                    %Net
      interest income as a percent of average earning assets
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    3.31
                                                                                                                    %
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    3.39
                                                                                                                    %





(1)
Computed on a tax equivalent basis for tax exempt securities using a 34% tax
rate.








Provision for Loan
Losses.   A provision for loan losses was recorded in the
amount of $3.2 million, or 75 basis points (annualized) on average loans during
the first nine months of 2008 as compared to $8.2 million, or 190 basis points
(annualized) on average loans for the first nine months of 2007.  The
provision recorded for the first nine months of 2008 was driven by the migration
of several lending relationships down the watchlist and by net charge-offs of
$2.0 million.  During the first nine months of 2008, four commercial
and five commercial real estate lending relationships were charged off in the
amount of $2.8 million, offset by six recoveries in the same loan categories in
the amount of $1.3 million.  The recoveries were recognized in the
disposition of nonperforming loans from the commercial and commercial real
estate portfolios.  The allowance for loan losses at September 30,
2008 totaled $9.3 million and was 1.67% of total loans outstanding on that
date.  Total net charge-offs for the nine-month period ended September
30, 2008 were $2.0 million, or 47 basis points, annualized, on average loans and
were $7.9 million, or 183 basis points, annualized, on average loans during the
same period a year ago.





Noninterest
Income.   Noninterest income was $4.9 million during the
first nine months of 2008.   This was a $593,977, or 13.7%,
increase compared to the first nine months of 2007.  The majority of
the increase relates to trust services fee income and service charge income.
Trust services fees increased $415,223 from the first nine months of 2007 to
$2.8 million for the nine-month period ended September 30, 2008, reflective of
an increase of $103.6 million in assets under management. Service charge income
increased by $203,057, or 28.2%, due primarily to an increase in over-draft fees
in connection with the over-draft protection program and also due to an increase
in service charges on Health Savings deposit accounts.




25
 Index




Noninterest
Expense.   Noninterest expense was $16.1 million for the
first nine months of 2008 while noninterest expense for the first nine months of
2007 was $15.4 million.  The main components of noninterest expense
for the first nine months of 2008 were salaries and benefits of $9.0 million,
occupancy and equipment costs of $2.2 million, other expense of $994,474, and
loan and professional costs of $956,656.  The 4.1% increase in
salaries and benefits includes one-time severance payments totaling $210,000 as
a result of the downsizing that occurred in April 2008.  The $102,442
decrease in other expenses is primarily due to a decrease in expenses related to
other real estate owned.  FDIC Fees increased by $196,352 from
$351,439 at September 30, 2007 to $547,791 at September 30,
2008.  Loan and professional expenses were lower in the first nine
months of 2008 by $35,865, or 3.6%, primarily due to Indianapolis start-up costs
and legal and consulting fees for the 2007 proxy reporting relating to the new
compensation disclosure requirements that did not carryover to
2008.





Income
Taxes. During the nine-month periods ended September
30, 2008 and 2007, we recorded $22,528 and $1.1 million in income tax expense
and income tax benefit, respectively.  The effective tax rate recorded
was 1.6% through the first nine months of 2008 as compared to (38%) for the
first nine months of 2007.  The lower effective tax rate and the tax
benefit in 2007 is the result of excess tax-exempt income over net
income.  Tax-exempt income includes earnings on bank-owned life
insurance and municipal securities.





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 third quarter showed total
deposits declined by $27.5 million.  Since 1999, deposits have been
generated mainly from in-market sources; however, since 2001 we have expanded
our funding base to include national, non-brokered certificates of deposit,
borrowings from the FHLB and trust preferred securities and, beginning with the
second quarter of 2003, brokered CDs.  During the first nine months of
2008, we have focused on increasing our in-market deposits and reducing our
brokered CDs.  In the aggregate these out-of-market deposits and
borrowings represented $62.3 million, or 10.9% of our total funding, at
September 30, 2008.   Total deposits at September 30, 2008 were
$573.2 million and the loan to deposit ratio was 96.8%.   The
Company used loan pay downs to fund investment purchases during the first nine
months of 2008 bringing the balance to 11.2% of total assets, which follows its
strategy to reduce the loan to deposit ratio and increase
liquidity.  Total borrowings at September 30, 2008 were $52.7
million.  We expect loan growth to level out or slightly decline in
the near future.  Funding for the new loans will continue to come from
a combination of in-market sources as funds are available through the marketing
of products and the development of branch locations and out-of market brokered
CDs.





Capital
Resources. Stockholders’ equity is a
noninterest-bearing source of funds, which provides support for asset
growth.  Stockholders’ equity was $48.4 million and $48.2 million at
September 30, 2008 and December 31, 2007, respectively. Affecting the change in
stockholders’ equity during the first nine months of 2008 were dividend payments
of $179,104, or $0.044 per share, a $1.2 million increase in the unrealized loss
on securities available for sale (net of tax) since year end 2007, an increase
in the unrealized gain on the cash flow hedge of $110,497, and net income of
$1.4 million.  We also issued 22,127 shares of common stock from stock
options exercised for $220,639 and recorded $55,205 of stock compensation
expense in total for stock option and restricted stock per
FAS123R.  Additionally, we purchased 11,964 shares of Treasury Stock,
which completed the purchase of 65,000 approved by the Board of Directors in May
2007.  The weighted average price of purchases for the first nine
months of 2008 can be found at Item 2.





During
the first nine months of 2008, the Company paid dividends once.  The
dividend declared and paid was $.044 per share in the first quarter totaling
$179,104.  During the second quarter, the Company issued a press
release stating that it elected to forego the declaration of a dividend on its
common stock. 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.





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





September 30, 2008
                              
                              
                              December 31, 2007Actual
                              
                              
                              Well-
                                Capitalized
                              
                              
                              Minimum
                                Required
                              
                              
                              Actual
                              
                              
                              Well-
                                Capitalized
                              
                              
                              Minimum
                                RequiredThe
      CompanyLeverage
      capital
                              
                              
                              9.62
                              %
                              
                              
                              5.00
                              %
                              
                              
                              4.00
                              %
                              
                              
                              9.31
                              %
                              
                              
                              5.00
                              %
                              
                              
                              4.00
                              %Tier
      1 risk-based
                              
                              
                              11.69
                              %
                              
                              
                              6.00
                              %
                              
                              
                              4.00
                              %
                              
                              
                              10.92
                              %
                              
                              
                              6.00
                              %
                              
                              
                              4.00
                              %Total
      risk-based
                              
                              
                              13.04
                              %
                              
                              
                              10.00
                              %
                              
                              
                              8.00
                              %
                              
                              
                              12.08
                              %
                              
                              
                              10.00
                              %
                              
                              
                              8.00
                              %The
      BankLeverage
      capital
                              
                              
                              9.00
                              %
                              
                              
                              5.00
                              %
                              
                              
                              4.00
                              %
                              
                              
                              7.99
                              %
                              
                              
                              5.00
                              %
                              
                              
                              4.00
                              %Tier
      1 risk-based
                              
                              
                              10.89
                              %
                              
                              
                              6.00
                              %
                              
                              
                              4.00
                              %
                              
                              
                              9.40
                              %
                              
                              
                              6.00
                              %
                              
                              
                              4.00
                              %Total
      risk-based
                              
                              
                              12.14
                              %
                              
                              
                              10.00
                              %
                              
                              
                              8.00
                              %
                              
                              
                              10.65
                              %
                              
                              
                              10.00
                              %
                              
                              
                              8.00
                              %




26
 Index





Commitments
and Off-Balance Sheet Risk





The Bank
maintains off-balance-sheet instruments in the normal course of business to meet
the financing needs of its customers.   These financial
instruments include commitments to extend credit and standby letters of
credit.  These instruments involve, to varying degrees, elements of
credit risk in excess of the amount recognized, if any, in the balance
sheet.   The Bank’s maximum exposure to loan loss in the event of
nonperformance by the other party to the financial instruments for commitments
to extend credit and standby letters of credit is represented by the contractual
notional amount of these instruments.   Such financial
instruments are recorded when they are funded.  Fair value of the
Bank’s off-balance-sheet instruments (commitments to extend credit and standby
letters of credit) is based on rates currently charged to enter into similar
agreements, taking into account the remaining terms of the agreements and the
counterparties’ credit standing.   At September 30, 2008, 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, 2007.  There have been no material changes outside the
ordinary course of business in such contractual obligations during the first
nine months of 2008.








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.




27
 Index





PART
II.  OTHER INFORMATION





Item 1.    LEGAL PROCEEDINGS





No
material litigation





Item 1a.   RISK FACTORS





No
material changes from the Risk Factors disclosed in our Annual Report on Form
10-K for the year ended December 31, 2007.





Item 2.   UNREGISTERED SALES OF EQUITY
SECURITIES AND USE OF PROCEEDS





(c)
            Issuer
      Purchase of Equity Securities





Period
                                
                                Total
      Number ofShares
      Repurchased
                                
                                
                                Average
      PricePaid
      Per Share
                                
                                
                                Total
      Number ofShares
      Repurchasedas
      part of PubliclyAnnounced
      Planor
      Program
                                
                                
                                Maximum
      Number ofShares
      (or DollarValue)
      that May Yetbe
      Purchased UnderPlans
      or ProgramsBeginning
      Balance 12/31/07
                                
                                
                                53,036
                                
                                
                                $
                                14.31
                                
                                
                                
                                53,036
                                
                                
                                
                                11,9641/1/2008
      - 1/31/2008
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                -2/1/2008
      - 2/29/2008
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                -3/1/2008
      - 3/31/2008
                                
                                
                                6,000
                                
                                
                                
                                10.94
                                
                                
                                
                                6,000
                                
                                
                                
                                5,9644/1/2008
      - 4/30/2008
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                -5/1/2008
      - 5/31/2008
                                
                                
                                5,964
                                
                                
                                
                                10.05
                                
                                
                                
                                5,964
                                
                                
                                
                                -6/1/2008
      - 6/30/2008
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                -7/1/2008
      - 7/31/20088/1/2008
      - 8/31/20089/1/2008
      - 9/30/2008
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                -65,000
                                
                                
                                $
                                13.61
                                
                                
                                
                                65,000
                                
                                
                                
                                -











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.





28
 Index




SIGNATURES





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





TOWER
      FINANCIAL CORPORATIONDated:  (November
      14), 2008
                  / s /  Michael D.
      CahillMichael
      D. Cahill, President andChief
      Executive OfficerDated:  (November
      14), 2008
                  / s /  Richard R.
      SawyerRichard
      R. SawyerChief
      Financial Officer, and
Secretary






29