UNITED
      STATES


SECURITIES
      AND EXCHANGE COMMISSION


Washington,
      D.C.  20549





**Form
      10-Q**


(Mark
      One)





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





For
      the quarterly period ended
**September 30, 2007**





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





For
      the transition period from
      ____________ to ____________








Commission
      file number 000-25287





**TOWER
        FINANCIAL CORPORATION**


(Exact
      name of Registrant as specified in its charter)








INDIANA
            35-2051170(State
                or other jurisdiction of incorporation or organization)
            (I.R.S.
                Employer Identification No.)







116
      East
      Berry Street, Fort Wayne, Indiana 46802


(Address
      of principal executive offices)








(260)
        427-7000


(Registrant’s
      telephone number)





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


Yes
x  No
o





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 o
            Accelerated
                filer o
            Non-accelerated
                filer x





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


Yes
o   No
      x





Number
      of
      shares of the issuer’s common stock, without par value, outstanding as of
      November 6, 2007: 4,070,569.








**1**





**Forward-Looking
      Statements**





This
      report, including the section on “Management’s Discussion and Analysis of
      Financial Condition and Results of Operations”, includes "forward-looking
      statements." All statements regarding our anticipated results or expectations,
      including our financial position, business plan and strategies, are intended
      to
      be forward-looking statements within the meaning of the safe harbor provisions
      for forward-looking statements contained in the Private Securities Litigation
      Reform Act of 1995. 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




We
      also
      refer you to a discussion of the many other risks and uncertainties described
      under “Risk Factors” in our Annual Report on Form 10-K, in our Quarterly Reports
      on Form 10-Q, or in other reports we file from time to time with the Securities
      and Exchange Commission, which are available on the Commission’s website at
      www.sec.gov.





**2**





**INDEX**





**PART
      I.   FINANCIAL INFORMATION**





Item
                1.
            Financial
                Statements
            page
                no.Consolidated
                  Condensed Balance Sheets atSeptember
                  30, 2007 (unaudited) and December 31, 2006
            4Consolidated
                  Condensed Statements of Operations for the three andnine months
                  ended September 30, 2007 and September 30, 2006
                  (unaudited)Consolidated
                  Condensed Statements of Changes in Stockholders’ Equity for the nine
                  months ended September 30, 2007 and September 30, 2006
                  (unaudited)
            6Consolidated
                  Condensed Statements of Cash Flows for the nine months endedSeptember
                  30, 2007 and September 30, 2006 (unaudited)
            7Notes
                to Consolidated Condensed Financial
                Statements
            8Item
                2.
            Management’s
                Discussion and Analysis of Financial Condition
                and Results of OperationsItem
                3.
            Quantitative
                and Qualitative Disclosures About Market
                Risk
            26Item
                4.
            Controls
                and Procedures
            28**PART
                II.   OTHER INFORMATION**Item
                1.
            Legal
                Proceedings
            29Item
                1a.
            Risk
                Factors
            29Item
                6.
            Exhibits
            29**SIGNATURES**
            29




**3**
 ***Index***





**PART
      I.  FINANCIAL INFORMATION**





**Item
      1.  FINANCIAL STATEMENTS**





**Tower
      Financial Corporation**


**Consolidated
      Condensed Balance Sheets**


At
      September 30, 2007 and December 31, 2006


*(unaudited)***September 30,**
            
            
            **December 31,****2007**
            
            
            **2006****ASSETS**Cash
                and due from banks
            
            $
            12,475,451
            
            
            $
            14,393,790Short-term
                investments and interest-earning deposits
            
            
            7,286,505
            
            
            
            8,863,112Federal
                funds sold
            
            
            6,290,981
            
            
            
            5,608,064Total
                cash and cash equivalents
            
            
            26,052,937
            
            
            
            28,864,966Securities
                available for sale, at fair value
            
            
            69,046,042
            
            
            
            69,491,806FHLB
                and FRB stock
            
            
            3,454,700
            
            
            
            3,078,400Loans
                held for sale
            
            
            4,007,123
            
            
            
            -Loans
            
            
            579,902,194
            
            
            
            550,450,313Allowance
                for loan losses
            
            
            (7,180,424
            )
            
            
            (6,870,442
            )Net
                loans
            
            
            572,721,770
            
            
            
            543,579,871Premises
                and equipment, net
            
            
            8,914,857
            
            
            
            5,870,699Accrued
                interest receivable
            
            
            3,609,815
            
            
            
            3,620,368Bank
                owned life insurance
            
            
            11,153,097
            
            
            
            10,851,519Other
                assets
            
            
            7,953,438
            
            
            
            5,797,183Total
                assets
            
            $
            706,913,779
            
            
            $
            671,154,812**LIABILITIES
                AND STOCKHOLDERS' EQUITY**LIABILITIESDeposits:Noninterest-bearing
            
            $
            74,708,805
            
            
            $
            77,772,481Interest-bearing
            
            
            518,145,021
            
            
            
            508,997,823Total
                deposits
            
            
            592,853,826
            
            
            
            586,770,304Federal
                Home Loan Bank (FHLB) advances
            
            
            43,400,000
            
            
            
            11,200,000Junior
                subordinated debt
            
            
            17,527,000
            
            
            
            17,527,000Accrued
                interest payable
            
            
            1,816,374
            
            
            
            1,716,994Other
                liabilities
            
            
            2,486,349
            
            
            
            2,982,675Total
                liabilities
            
            
            658,083,549
            
            
            
            620,196,973STOCKHOLDERS'
                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;
                4,071,069 shares issued and outstanding at September 30, 2007 and
                4,043,882 at December 31, 2006
            
            
            39,469,478
            
            
            
            38,536,406Treasury
                stock, at cost, 42,736 shares at September 30, 2007
            
            
            (634,119
            )
            
            
            -Retained
                earnings
            
            
            10,172,045
            
            
            
            12,523,750Accumulated
                other comprehensive income (loss), net of tax of ($99,977) at September
                30, 2007 and ($53,785) atDecember
                31, 2006
            
            
            (177,174
            )
            
            
            (102,317
            )Total
                stockholders' equity
            
            
            48,830,230
            
            
            
            50,957,839Total
                liabilities and stockholders' equity
            
            $
            706,913,779
            
            
            $
            671,154,812








*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, 2007 and 2006





*(unaudited)*
            
            
            *(unaudited)***Three Months Ended**
            
            
            **Nine Months Ended****September 30**
            
            
            **September 30****2007**
            
            
            **2006**
            
            
            **2007**
            
            
            **2006****Interest
                income:**Loans,
                including fees
            
            $
            11,085,796
            
            
            $
            10,040,721
            
            
            $
            32,492,233
            
            
            $
            27,264,488Securities
                - taxable
            
            
            660,063
            
            
            
            565,520
            
            
            
            1,991,226
            
            
            
            1,580,679Securities
                - tax exempt
            
            
            202,210
            
            
            
            181,699
            
            
            
            598,151
            
            
            
            498,954Other
                interest income
            
            
            128,032
            
            
            
            117,457
            
            
            
            368,686
            
            
            
            425,374Total
                interest income
            
            
            12,076,101
            
            
            
            10,905,397
            
            
            
            35,450,296
            
            
            
            29,769,495**Interest
                expense:**Deposits
            
            
            5,863,839
            
            
            
            5,142,295
            
            
            
            17,252,182
            
            
            
            13,125,563Short-term
                borrowings
            
            
            15
            
            
            
            -
            
            
            
            532
            
            
            
            -FHLB
                advances
            
            
            436,366
            
            
            
            372,355
            
            
            
            1,025,421
            
            
            
            1,093,602Junior
                subordinated debt
            
            
            287,647
            
            
            
            209,230
            
            
            
            849,253
            
            
            
            627,692Total
                interest expense
            
            
            6,587,867
            
            
            
            5,723,880
            
            
            
            19,127,388
            
            
            
            14,846,857Net
                interest income
            
            
            5,488,234
            
            
            
            5,181,517
            
            
            
            16,322,908
            
            
            
            14,922,638**Provision
                for loan losses**
            
            
            5,246,000
            
            
            
            645,000
            
            
            
            8,171,000
            
            
            
            1,695,000Net
                interest income after provision for loan losses
            
            
            242,234
            
            
            
            4,536,517
            
            
            
            8,151,908
            
            
            
            13,227,638**Noninterest
                income:**Trust
                and brokerage fees
            
            
            790,002
            
            
            
            717,772
            
            
            
            2,354,492
            
            
            
            2,112,270Service
                charges
            
            
            234,657
            
            
            
            174,943
            
            
            
            720,483
            
            
            
            494,806Loan
                broker fees
            
            
            58,310
            
            
            
            25,955
            
            
            
            144,598
            
            
            
            60,983Loss
                on sale of securities
            
            
            (40,804
            )
            
            
            -
            
            
            
            (42,564
            )
            
            
            -Other
                fees
            
            
            366,214
            
            
            
            340,015
            
            
            
            1,150,478
            
            
            
            1,077,690Total
                noninterest income
            
            
            1,408,379
            
            
            
            1,258,685
            
            
            
            4,327,487
            
            
            
            3,745,749**Noninterest
                expense:**Salaries
                and benefits
            
            
            2,627,862
            
            
            
            2,685,003
            
            
            
            8,600,285
            
            
            
            7,752,658Occupancy
                and equipment
            
            
            676,222
            
            
            
            555,323
            
            
            
            2,024,966
            
            
            
            1,547,168Marketing
            
            
            138,499
            
            
            
            146,472
            
            
            
            316,922
            
            
            
            443,108Data
                processing
            
            
            230,508
            
            
            
            177,223
            
            
            
            688,684
            
            
            
            500,834Loan
                and professional costs
            
            
            266,687
            
            
            
            197,917
            
            
            
            992,521
            
            
            
            747,701Office
                supplies and postage
            
            
            96,045
            
            
            
            104,643
            
            
            
            336,888
            
            
            
            333,739Courier
                services
            
            
            97,204
            
            
            
            91,687
            
            
            
            292,975
            
            
            
            271,332Business
                development
            
            
            174,503
            
            
            
            146,947
            
            
            
            516,253
            
            
            
            390,402Other
                expense
            
            
            633,313
            
            
            
            312,001
            
            
            
            1,636,221
            
            
            
            873,635Total
                noninterest expense
            
            
            4,940,843
            
            
            
            4,417,216
            
            
            
            15,405,715
            
            
            
            12,860,577**Income
                before income taxes**
            
            
            (3,290,230
            )
            
            
            1,377,986
            
            
            
            (2,926,320
            )
            
            
            4,112,810Income
                tax expense (benefit)
            
            
            (1,081,984
            )
            
            
            405,020
            
            
            
            (1,111,800
            )
            
            
            1,232,710**Net
                income/(loss)**
            
            $
            (2,208,246
            )
            
            $
            972,966
            
            
            $
            (1,814,520
            )
            
            $
            2,880,100**Other
                comprehensive income net of tax:**Unrealized
                appreciation (depreciation) on available for sale
                securities
            
            
            559,775
            
            
            
            658,162
            
            
            
            (127,169
            )
            
            
            (78,977
            )Unrealized
                gain (loss) on cash flow hedge
            
            
            115,343
            
            
            
            43,560
            
            
            
            52,312
            
            
            
            43,560**Total
                comprehensive income**
            
            $
            (1,533,128
            )
            
            $
            1,674,688
            
            
            $
            (1,889,377
            )
            
            $
            2,844,683**Basic
                earnings (loss) per common share**
            
            $
            (0.54
            )
            
            $
            0.24
            
            
            $
            (0.45
            )
            
            $
            0.72**Diluted
                earnings (loss) per common share**
            
            $
            (0.54
            )
            
            $
            0.24
            
            
            $
            (0.45
            )
            
            $
            0.70Average
                common shares outstanding
            
            
            4,063,750
            
            
            
            4,022,087
            
            
            
            4,068,677
            
            
            
            4,015,867Average
                common shares and dilutive potential common shares
                outstanding
            
            
            4,063,750
            
            
            
            4,123,789
            
            
            
            4,068,677
            
            
            
            4,134,172Dividends
                declared per share
            
            $
            0.044
            
            
            $
            0.040
            
            
            $
            0.132
            
            
            $
            0.120








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





**5**
 ***Index***





**Tower
      Financial Corporation**


**Consolidated
      Condensed Statements of Changes in Stockholders’ Equity**


For
      the
      nine months ended September 30, 2007 and 2006


*(unaudited)*





**Common**
            
            
            
            
            
            **Accumulated****Stock and**
            
            
            
            
            
            **Other****Paid-in**
            
            
            **Retained**
            
            
            **Comprehensive**
            
            
            **Treasury****Capital**
            
            
            **Earnings**
            
            
            **Income (Loss)**
            
            
            **Stock**
            
            
            **Total****Balance,
                January 1, 2006**
            
            $
            38,006,929
            
            
            $
            9,478,812
            
            
            $
            (217,687
            )
            
            $
            -
            
            
            $
            47,268,054Net
                income for 2006
            
            
            
            
            
            
            2,880,100
            
            
            
            
            
            
            
            
            
            
            
            2,880,100Change
                in net unrealized appreciation (depreciation) on securities available
                for
                sale, net of tax of  $(30,377)
            
            
            
            
            
            
            
            
            
            
            (78,977
            )
            
            
            
            
            
            
            (78,977
            )Change
                in net unrealized gain (loss) on cash flow hedge, net of tax of
                $22,440
            
            
            
            
            
            
            
            
            
            
            43,560
            
            
            
            
            
            
            
            43,560Total
                Comprehensive Income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            2,844,683Cash
                dividends paid ($0.12 per share)
            
            
            
            
            
            
            (481,861
            )
            
            
            
            
            
            
            
            
            
            
            (481,861
            )Issuance
                of 17,874 shares of common stock for stock options exercised, including
                tax benefit
            
            
            217,093
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            217,093Stock
                compensation expense
            
            
            84,297
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            84,297**Balance,
                September 30, 2006**
            
            $
            38,308,319
            
            
            $
            11,877,051
            
            
            $
            (253,104
            )
            
            $
            -
            
            
            $
            49,932,266**Balance,
                January 1, 2007**
            
            $
            38,536,406
            
            
            $
            12,523,750
            
            
            $
            (102,317
            )
            
            $
            -
            
            
            $
            50,957,839Net
                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 (Loss)
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (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
            )
            
            $
            48,830,230








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





**6**
 ***Index***





**Tower
      Financial Corporation**


**Consolidated
      Condensed Statements of Cash Flows**


For
      the
      nine months ended September 30, 2007 and 2006





*(unaudited)*
            
            
            *(unaudited)***Nine Months ended**
            
            
            **Nine Months ended****September 30, 2007**
            
            
            **September 30, 2006****Cash
                flows from operating activities:**Net
                income/(loss)
            
            $
            (1,814,520
            )
            
            $
            2,880,100Adjustments
                to reconcile net income/(loss) to net cash from operating
                activities:Depreciation
                and amortization
            
            
            729,747
            
            
            
            403,893Provision
                for loan losses
            
            
            8,171,000
            
            
            
            1,695,000Stock
                compensation expense
            
            
            61,689
            
            
            
            84,297Earnings
                on life insurance
            
            
            (301,578
            )
            
            
            (289,876
            )Loss
                on sale of AFS securities
            
            
            42,564
            
            
            
            -Loss
                on sale of premises and equipment
            
            
            10,520
            
            
            
            -Loans
                originated for sale
            
            
            (817,221
            )
            
            
            -Proceeds
                from the sale of loans
            
            
            5,472,799
            
            
            
            -Tax
                benefit from exercise of stock options
            
            
            (112,264
            )
            
            
            (31,737
            )Change
                in accrued interest receivable
            
            
            10,553
            
            
            
            (539,751
            )Change
                in other assets
            
            
            (1,402,777
            )
            
            
            (2,314,864
            )Change
                in accrued interest payable
            
            
            99,380
            
            
            
            579,605Change
                in other liabilities
            
            
            (496,326
            )
            
            
            312,531Net
                cash from operating activities
            
            
            9,653,566
            
            
            
            2,779,198**Cash
                flows from investing activities:**Net
                change in loans
            
            
            (54,702,229
            )
            
            
            (81,680,146
            )Purchase
                of loans
            
            
            (3,869,618
            )
            
            
            (13,825,907
            )Purchase
                of securities available for sale
            
            
            (6,487,229
            )
            
            
            (12,227,676
            )Proceeds
                from maturities of securities available for sale
            
            
            3,847,191
            
            
            
            -Proceeds
                from sale of securities available for sale
            
            
            2,884,311
            
            
            
            3,136,119Purchase/(redemption)
                of FHLB and FRB stock
            
            
            (376,300
            )
            
            
            187,500Proceeds
                from sale of participation loans
            
            
            12,068,126
            
            
            
            12,102,817Purchase
                of premises, equipment and leasehold expenditures
            
            
            (3,819,672
            )
            
            
            (1,622,189
            )Proceeds
                from sale of premises and equipment
            
            
            6,224
            
            
            
            -Net
                cash used in investing activities
            
            
            (50,449,196
            )
            
            
            (93,929,482
            )**Cash
                flows from financing activities:**Net
                change in deposits
            
            
            6,083,522
            
            
            
            93,384,575Cash
                dividends paid
            
            
            (537,185
            )
            
            
            (481,861
            )Proceeds
                from issuance of common stock from exercise of stock
                options
            
            
            759,119
            
            
            
            185,356Tax
                benefit from exercise of stock options
            
            
            112,264
            
            
            
            31,737Proceeds
                from FHLB advances
            
            
            115,893,000
            
            
            
            72,500,000Repayment
                of FHLB advances
            
            
            (83,693,000
            )
            
            
            (83,500,000
            )Repurchase
                of common stock
            
            
            (634,119
            )
            
            
            -Net
                cash from financing activities
            
            
            37,983,601
            
            
            
            82,119,807**Net
                change in cash and cash equivalents**
            
            
            (2,812,029
            )
            
            
            (9,030,477
            )Cash
                and cash equivalents, beginning of period
            
            
            28,864,966
            
            
            
            37,908,337**Cash
                and cash equivalents, end of period**
            
            $
            26,052,937
            
            
            $
            28,877,860Supplemental
                disclosures of cash flow informationCash
                paid during the year for:Interest
            
            $
            19,028,009
            
            
            $
            14,252,943Income
                taxes
            
            
            -
            
            
            
            2,080,141Non-cash
                Items:Transfer
                of loans to loans held-for-sale
            
            
            8,662,701
            
            
            
            -








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





**7**
 ***Index***





**Tower
      Financial Corporation**


**Notes
      to Consolidated Condensed Financial Statements**








**Note
      1 -- Organization**





Tower
      Financial Corporation, collectively with its subsidiaries, the “Company,” was
      incorporated as an Indiana corporation on July 8, 1998. We are a financial
      services holding company with one bank subsidiary, Tower Bank & Trust (or
      the “Bank”), a trust company subsidiary, Tower Trust Company (or the “Trust
      Company”), and two unconsolidated subsidiary guarantor trusts, Tower Capital
      Trust 2, and Tower Capital Trust 3.





The
      Bank
      is an Indiana chartered bank with depository accounts insured by the Federal
      Deposit Insurance Corporation (“FDIC”) and is a member of the Federal Reserve
      System. The Trust Company is an Indiana Corporation formed on January 1,
      2006.  Tower Capital Trust 2, and Tower Capital Trust 3 are
      unconsolidated, wholly owned Delaware statutory business trusts formed in
      December 2005 and December 2006, respectively, for the exclusive purpose of
      raising Federal Reserve approved capital through the issuance and sale of
      securities known as trust preferred securities.  The Bank has a direct
      wholly owned Nevada investment subsidiary, Tower Capital Investments, Inc.,
      that
      was formed on July 1, 2006 for the purpose of holding long term investments
      and
      an indirect wholly-owned subsidiary, Tower Funding Corporation. Tower Funding
      Corporation is a Maryland real estate investment trust, or “REIT”, formed as
      well on July 1, 2006.  The REIT purchases mortgage-backed real estate
      loans from the Bank.





In
      2006
      we opened a loan production office in Indianapolis, Indiana.  In the
      fourth quarter of 2006, we filed an application with the Indiana Department
      of
      Financial Institutions and the Federal Deposit Insurance Corporation to form
      Tower Bank of Central Indiana (or “TBCI”), to be located in
      Indianapolis.  Once formed and capitalized, the plan was to invest
      capital into the TBCI and own 51% of the common stock of TBCI.  Our
      applications were approved by the Indiana Department of Financial Institutions
      and Federal Deposit Insurance Corporation.  However, we announced in
      June 2007 that we had elected to defer further action on the Indianapolis de
      novo bank project due to management’s perception of current Indianapolis market
      conditions for de novo banks, as well as management’s positive assessment of
      other opportunities available to us closer to Fort Wayne, Indiana.  We
      closed our loan production office in Indianapolis in June 2007.





We
      began
      the year reporting four distinct operating segments.  The segments
      were Banking, Indianapolis operations, Wealth Management, and Corporate and
      Intercompany.  As noted above, in June 2007, we made the decision to
      cease operations in Indianapolis and therefore, to no longer report as a
      separate segment.  An assessment was made during the second quarter
      that the loan production office never met the definition of a reporting segment,
      but was reported as one in anticipation of the formation of TBCI.  The
      remaining three segments are evaluated separately on their individual
      performance, as well, as on their contribution to the Tower Financial
      Corporation as a whole.    Refer to Note 6 for further
      detail on that decision.





The
      Bank
      opened on February 19, 1999 and provides a range of commercial and consumer
      banking services from six locations in its market area comprised of the
      metropolitan area of Fort Wayne and Allen County, Indiana. Those services
      reflect the Bank’s strategy of focusing on small- to medium-sized businesses and
      individual customers. The Bank’s lending strategy is focused on commercial and
      commercial mortgage loans and, to a lesser extent, on consumer and residential
      mortgage loans. The Bank offers a broad array of deposit products, including
      checking, savings, and money market accounts, certificates of deposit and direct
      deposit services. Prior to January 1, 2006, the trust investment and management
      services were offered by the Bank and are now offered by Tower Trust
      Company.





The
      Bank’s and the Trust company’s main offices are located at 116 East Berry Street
      in downtown Fort Wayne, Indiana, which also serves as the Company’s corporate
      headquarters. The Bank also has six branch locations within its market area,
      a
      branch location in Angola, Indiana, and a branch in Warsaw,
      Indiana.








**Note
      2 -- Summary of Significant Accounting Policies**





**Nature
      of Operations, Industry Segments, and Concentrations of Credit Risk:**Tower Financial Corporation was incorporated on July 8, 1998. Our
      wholly-owned banking subsidiary, Tower Bank & Trust Company (the "Bank"),
      commenced operations on February 19, 1999. The Bank has a wholly-owned
      investment subsidiary, Tower Capital Investments, that began operations on
      July
      1, 2006.  Tower Capital Investments owns a real estate investment
      trust (REIT), Tower Funding Corporation, that also began operations on July
      1,
      2006.  Tower Capital Investments and the REIT were formed to provide
      additional flexibility for capital generation and tax
      effectiveness.  The Bank contributed mortgage-backed real estate loans
      to the REIT upon formation.  On January 1, 2006, we formed Tower Trust
      Company (the “Trust”).  The Trust is a wholly-owned subsidiary of the
      Company and provides wealth management services. Prior to the formation of
      the
      Trust company these services were provided by the Bank.  Upon
      formation of the Trust company, certain assets of the Bank were transferred
      to
      the Trust company and the Bank’s wealth management customers became customers of
      the Trust company.  Our wholly-owned, statutory trust subsidiaries,
      Tower Capital Trust 2 (“TCT2”) and Tower Capital Trust 3 (“TCT3”) were formed on
      December 5, 2005 and December 29, 2006, respectively, for the single purpose
      of
      raising Federal Reserve approved capital through the issuance of securities
      known as trust preferred securities.  During 2006, we filed an
      application with the Indiana Department of Financial Institutions and the
      Federal Deposit Insurance Corporation to form Tower Bank of Central Indiana
      (“TBCI”) in Indianapolis.  The application was accepted by both
      parties, but, as previously described, we have elected to defer action on and
      to
      discontinue our TBCI project and have also closed our loan production office
      in
      Indianapolis.





**8**
 ***Index***





While
      our
      management monitors the revenue streams of all of our various products and
      services and financial performance is evaluated on a company-wide basis, our
      operations are considered by management to be aggregated into three reportable
      segments (see Note 6). We accept deposits and grant commercial, real estate,
      and
      installment loans to customers primarily in northeastern Indiana. Substantially
      all loans are secured by specific items of collateral including business assets,
      consumer assets, and real estate. Commercial loans are expected to be repaid
      from cash flow from operations of businesses. Real estate loans are secured
      by
      both residential and commercial real estate. At September 30, 2007, commercial
      and commercial real estate loans totaled approximately 73.1% of total loans,
      residential real estate loans totaled approximately 17.9% and home equity and
      consumer loans totaled approximately 9.0%. Categories by industry of commercial
      loans at September 30, 2007 exceeding 30% of quarter-end stockholders’ equity
      are as follows: real estate (including owner-occupied and investment) - $109.3
      million, or 18.8% of total loans; wholesale and retail trade - $55.8 million,
      or
      9.6% of total loans; building, development and general contracting - $83.1
      million, or 14.3% of total loans; health care and social assistance - $35.8
      million, or 6.2% of total loans; manufacturing - $25.4 million, or 4.4% of
      total
      loans; accommodation and food services - $17.2 million or 3.0% of total loans;
      rental and leasing - $18.0 million or 3.1% of total loans; and finance and
      insurance - $16.4 million or 2.8% of total loans. Other financial instruments
      that potentially represent concentrations of credit risk include deposit
      accounts in other financial institutions and federal funds sold.





**Principles
      of Consolidation:**The accompanying consolidated financial statements
      include the accounts of Tower Financial Corporation, Tower Bank, and Tower
      Trust.





**Use
      of Estimates:**To prepare financial statements in conformity with
      accounting principles generally accepted in the United States of America,
      management makes estimates and assumptions based on available information.
      These
      estimates and assumptions affect the amounts reported in the financial
      statements and the disclosures provided; future results could differ. The
      allowance for loan losses, impaired loan disclosures, and the fair values of
      securities and other financial instruments are particularly subject to
      change.





**Cash
      Flow Reporting:**Cash and cash equivalents include cash on hand, demand
      deposits with other financial institutions, short-term investments and federal
      funds sold. Cash flows are reported net for customer loan and deposit
      transactions, interest-earning deposits and short-term borrowings with
      maturities of 90 days or less.





**Securities:**Securities available for sale consist of those securities which might
      be sold prior to maturity due to changes in interest rates, prepayment risks,
      yield, availability of alternative investments, liquidity needs and other
      factors. Securities classified as available for sale are reported at their
      fair
      value and the related unrealized holding gain or loss is reported as other
      comprehensive income (loss) and stockholders’ equity, net of tax, until
      realized. Other securities, such as Federal Reserve Bank stock and Federal
      Home
      Loan Bank stock, are carried at cost. Premiums and discounts on securities
      are
      recognized as interest income using the interest method over the estimated
      life
      of the security. Gains and losses on the sale of securities available for sale
      are determined based upon amortized cost of the specific security sold.
      Securities are written down to fair value when a decline in fair value is not
      temporary. Declines in fair value of securities below their cost that are other
      than temporary are reflected as realized losses. In estimating
      other-than-temporary losses, management considers: (1) the length of time and
      extent that fair value has been less than cost, (2) the financial condition
      and
      near term prospects of the issuer, and (3) the Company’s ability and intent to
      hold the security for a period sufficient to allow for any anticipated recovery
      in fair value.





**Loans:**
      Loans that management has the intent and ability to hold for the foreseeable
      future or until maturity or payoff are reported at the principal balance
      outstanding, net of unearned interest, deferred loan fees and costs and an
      allowance for loan losses. Loans held for sale are reported at the lower of
      cost
      or market, on an aggregate basis. Interest income is reported on the interest
      method and includes amortization of net deferred loan fees and costs over the
      loan term. Interest income is not reported when full loan repayment is in doubt,
      typically when the loan is impaired or payments are past due over 90 days (180
      days for residential mortgages). In all cases, loans are placed on nonaccrual
      or
      charged-off at an earlier date if collection of principal or interest is
      considered doubtful.





**9**
 ***Index***





All
      interest accrued but not received for loans placed on nonaccrual are reversed
      against income. Interest received on such loans is accounted for on the
      cash-basis or cost recovery method, until qualifying for return to accrual.
      Loans are returned to accrual status when all the principal and interest amounts
      contractually due are brought current and future payments are reasonably
      assured.





**Allowance
      for Loan Losses:** Our allowance for loan losses represents management’s
      estimate of probable incurred 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.





**Foreclosed
      Assets:**Assets acquired through or instead of loan foreclosure are
      initially recorded at fair value when acquired, establishing a new cost basis.
      If fair value declines, a valuation allowance is recorded through expense.
      Costs
      after acquisition are expensed.





**Premises
      and Equipment:**Land is carried at cost.****Premises
      and equipment are stated at cost less accumulated depreciation. Depreciation
      is
      computed using both the straight-line method and accelerated methods over the
      estimated useful lives of the buildings, 39 years; site improvements, 15 years;
      leasehold improvements, 10 years; furniture and equipment, 5 to 8 years; and
      software and computer equipment, 3 years. Maintenance, repairs, and minor
      alterations are charged to current operations as expenditures occur and major
      improvements are capitalized. These assets are reviewed for impairment when
      events indicate the carrying amount may not be recoverable.





**Bank
      Owned Life Insurance:**The Bank has purchased life insurance policies on
      certain officers. Bank owned life insurance is recorded at its cash surrender
      value, or the amount that can be realized. Bank owned life insurance totaled
      $11.2 and $10.9 million at September 30, 2007 and December 31, 2006,
      respectively.





**Benefit
      Plans:** Bonus and 401(k) plan expense is the amount contributed
      determined by formula. Deferred compensation plan expense and supplemental
      employee retirement plan expense is allocated over years of service and any
      related vesting periods.





**Stock
      Based Compensation**:  Effective January 1, 2006, the Company
      adopted Statement of Financial Accounting Standards (“SFAS”) No. 123(R),
*Share-based Payment*, utilizing the modified prospective
      method.  Compensation cost is recorded based on the fair value of the
      awards at grant date, recognized over the employee service
      period.  The applies to awards granted or modified after January 1,
      2006 and to prior option grants that were not vested at that date.





**Income
      Taxes:**Income taxes expense is the sum of 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 temporary
      differences between the 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.





**10**
 ***Index***





**Derivatives:**Statement
      of Financial Accounting Standards No. 133, “Accounting for Derivative
      Instruments and Hedging Activities (“SFAS 133”) which was subsequently amended
      by SFAS 138, requires companies to record derivatives on the balance sheet
      as
      assets and liabilities measured at their fair value.  The accounting
      for increases and decreases in the value of derivatives depends upon the use
      of
      derivatives and whether the derivatives qualify for hedge
      accounting.





In
      accordance with SFAS No 133, the Bank’s interest rate floor is measured at fair
      value and reported as an asset on the consolidated balance sheet at September
      30, 2007.  The portion of the change in fair value of the interest
      rate floor that is deemed effective in hedging the cashflows of the designated
      assets is recorded in accumulated other comprehensive income (loss), net of
      tax
      effects, and reclassified into interest income when such cashflows occur in
      the
      future.  Any ineffectiveness resulting from the interest rate floor is
      recorded as a gain or loss in the consolidated statements of operations as
      a
      part of non-interest income.





**Off-Balance-Sheet
      Financial Instruments:**Financial instruments include off-balance-sheet
      credit instruments, such as commitments to make loans and standby letters of
      credit, issued to meet customer financial needs. The face amount for these
      items
      represents the exposure to loss, before considering customer collateral or
      ability to repay. Such financial instruments are recorded when they are
      funded.





**Fair
      Values of Financial Instruments:**Fair values of financial instruments
      are estimated using relevant market information and other assumptions. Fair
      value estimates involve uncertainties and matters of significant judgment
      regarding interest rates, credit risk, prepayments and other factors, especially
      in the absence of broad markets for particular items. Changes in assumptions
      or
      in market conditions could significantly affect the estimates. 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.





**Dividend
      Restriction:**Banking regulations require maintaining certain capital
      levels and may limit the dividends paid by the Bank to Tower Financial
      Corporation or by us to our shareholders. In January 2006, our Board of
      Directors formally approved the payment of a quarterly dividend of $0.04 per
      share commencing in first quarter 2006. We paid four quarterly dividends of
      $0.04 per share during 2006 totaling $642,974.  In January 2007, our
      Board of Directors approved increasing the quarterly dividend to $0.044 per
      share beginning in the first quarter of 2007, which totaled $537,185 through
      the
      third quarter of 2007.





**Earnings
      Per Common Share:**Basic earnings per common share is net income divided
      by the weighted average number of common shares outstanding during the period.
      Diluted earnings per common share includes the accretion of shares repurchased,
      as well as the dilutive impact of any additional potential common shares
      issuable under the Equity Incentive Plan.





**Comprehensive
      Income (Loss):**Comprehensive income (loss) consists of net income
      (loss) and other comprehensive income (loss). Other comprehensive income (loss)
      includes the net change in net unrealized appreciation (depreciation) on
      securities available for sale and derivatives which qualify for hedge
      accounting, net of reclassification adjustments and tax, which is also
      recognized as a separate component of stockholders’ equity.





**Loss
      Contingencies:**Loss contingencies, including claims and legal actions
      arising in the ordinary course of business, are recorded as liabilities when
      the
      likelihood of loss is probable and an amount or range of loss can be reasonably
      estimated. Management does not believe there now are such matters that will
      have
      a material effect on the consolidated financial statements.





**Restrictions
      on Cash:** Cash on hand or on deposit with the Federal Reserve Bank of
      $877,224 and $808,000 and was sufficient to meet the regulatory reserve and
      clearing requirements at September 30, 2007 and December 31, 2006, respectively.
      These balances do not earn interest.





**Basis
      of Presentation:**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, 2007 and
      its
      consolidated results of operations, comprehensive income, changes in
      stockholders’ equity and cash flows for the three-month and nine-month periods
      ended September 30, 2007 and September 30, 2006.   The results
      for the three month and nine month period ended September 30, 2007 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, 2006, 2005,
      and 2004 and related notes included in the Company’s Annual Report on Form 10-K
      for the year ended December 31, 2006.





**11**
 ***Index***





**Adoption
      of New Accounting Standards:**  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.  The
      adoption had no affect on the Company’s financial statements.





We
      are
      subject to U.S. federal income tax as well as income tax of the state of
      Indiana.  We are no longer subject to examination by taxing
      authorities for years before 2002.  We do not expect the total amount
      of unrecognized tax benefits to significantly increase in the next twelve
      months.  We recognize interest and/or penalties related to income tax
      matters in income tax expense.  We did not have any amounts accrued
      for interest and penalties at January 1, 2007.





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 2002.  We do not expect the total amount
      of unrecognized tax benefits to significantly increase in the next twelve
      months.  We recognize interest and/or penalties related to income tax
      matters in income tax expense.  We did not have any amounts accrued
      for interest and penalties at January 1, 2007.





Effective
      January 1, 2007, we adopted the FASB Emerging Issues Task Force finalized Issue
      No. 06-5, *Accounting for Purchases of Life Insurance - Determining the
      Amount That Could Be Realized in Accordance with FASB Technical Bulletin No.
      85-4 (Accounting for Purchases of Life Insurance).*This issue requires that
      a policyholder consider contractual terms of a life insurance policy in
      determining the amount that could be realized under the insurance
      contract.  It also requires that if the contract provides for a
      greater surrender value if all individual policies in a group are surrendered
      at
      the same time, that the surrender value be determined based on the assumption
      that policies will be surrendered on an individual basis.  Lastly, the
      issue discusses whether the cash surrender value should be discounted when
      the
      policyholder is contractually limited in its ability to surrender a
      policy.  This adoption did not have a material impact on our financial
      statements either.





**Note
      3 – Earnings (Loss) Per Share**





The
      following table reflects the calculation of basic and diluted earnings per
      common share for the three- and six-month periods ended September 30, 2007
      and
      September 30, 2006.  Options not considered in the calculation of
      diluted earnings per common share because they were antidilutive, totaled
      240,802 and 22,910 and  240,802 and 32,410 for the three- and
      nine-month periods ended September 30, 2007 and 2006, respectively.





**Three Months Ended**
            
            
            **Nine Months Ended****September 30**
            
            
            **September 30****2007**
            
            
            **2006**
            
            
            **2007**
            
            
            **2006**Net
                income/(loss)
            
            $
            (2,208,246
            )
            
            $
            972,966
            
            
            $
            (1,814,520
            )
            
            $
            2,880,100Weighted
                average common shares outstanding
            
            
            4,063,750
            
            
            
            4,022,087
            
            
            
            4,068,677
            
            
            
            4,015,867Basic
                earnings (loss) per common share
            
            $
            (0.54
            )
            
            $
            0.24
            
            
            $
            (0.45
            )
            
            $
            0.72**Diluted**Net
                income/(loss)
            
            $
            (2,208,246
            )
            
            $
            972,966
            
            
            $
            (1,814,520
            )
            
            $
            2,880,100Weighted
                average common shares outstanding
            
            
            4,063,750
            
            
            
            4,022,087
            
            
            
            4,068,677
            
            
            
            4,015,867Add:  dilutive
                effect of assumed stock option exercises
            
            
            -
            
            
            
            101,702
            
            
            
            -
            
            
            
            118,305Weighted
                average common shares and dilutive potential common shares
                outstanding
            
            
            4,063,750
            
            
            
            4,123,789
            
            
            
            4,068,677
            
            
            
            4,134,172Diluted
                earnings (loss) per common share
            
            $
            (0.54
            )
            
            $
            0.24
            
            
            $
            (0.45
            )
            
            $
            0.70





**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 240,802 remain outstanding as of September 30, 2007.  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 $61,689 and $84,297 for the nine-months ended
      September 30, 2007 and September 30, 2006, respectively.





**12**
 ***Index***





A
      summary
      of the option activity under the Plans as of September 30, 2007 and changes
      during the nine-month period then ended are presented below:


Weighted-Weighted
            
            
            AverageAverage
            
            
            Remaining
            
            
            AggregateExercise
            
            
            Contractual
            
            
            IntrinsicOptions
            
            Shares
            
            
            Price
            
            
            Term
            
            
            ValueOutstanding
                at 1/1/07
            
            
            315,600
            
            
            $
            11.30Granted
            
            
            0Exercised
            
            
            (71,923
            )
            
            $
            10.55Forfeited
                or expired
            
            
            (2,875
            )
            
            $
            10.77Outstanding
                at 9/30/07
            
            
            240,802
            
            
            $
            11.53
            
            
            
            3.59
            
            
            $
            649,349Exercisable
                at 9/30/07
            
            
            213,582
            
            
            $
            11.07
            
            
            
            3.06
            
            
            $
            646,963








There
      were no stock options granted during the first nine-months ended 2007 or the
      same period in 2006.  The total intrinsic value of options exercised
      during the nine-months ended September 30, 2007 and 2006, was $344,685 and
      $141,562.





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.





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,
      2007, 2,450 restricted shares had been granted under the 2006 Equity Incentive
      Plan.  The fair value of the restricted shares issued was
      $46,383.  Restricted shares become fully vested and not subject to
      forfeiture after five years of service from the date of award and attainment
      of
      certain goals, specified by the compensation committee.  The
      compensation cost of $4,638 that had been charged against income for restricted
      shares awarded under the Plan in accordance with FAS123(R) was reversed in
      the
      quarter ended September 30, 2007, as all shares were forfeited in 2007 and
      no
      more have been issued to date.





A
      summary
      of the status of the Company’s nonvested restricted shares issued as of
      September 30, 2007, and changes during the nine-month period ended September
      30,
      2007, is presented below.  Through September 2007, all shares granted
      were to employees employed at the Indianapolis loan production
      office.  As a result of the closure of that office, all shares issued
      to date were forfeited.


Weighted-AverageGrant-DateNon-vested
                shares
            
            Shares
            
            
            Fair
                ValueNonvested
                at 1/1/07
            
            
            2,000
            
            
            $
            19.22Granted
            
            
            450
            
            
            $
            17.65Vested
            
            
            0Forfeited
                or expired
            
            
            (2,450
            )
            
            $
            18.93Outstanding
                at 9/30/07
            
            
            0Nonvested
                at 9/30/07
            
            
            0





**13**
 ***Index***





**Note
      5 – Derivative Instruments**





Statement
      of Financial Accounting Standards No. 133, “Accounting for Derivative
      Instruments and Hedging Activities (“SFAS 133”) which was subsequently amended
      by SFAS 138, requires companies to record derivatives on the balance sheet
      as
      assets and liabilities measured at their fair value.  The accounting
      for increases and decreases in the value of derivatives depends upon the use
      of
      derivatives and whether the derivatives qualify for hedge
      accounting.





During
      the third quarter of 2006, the Company purchased an interest rate floor for
      $147,000.   The notional amount of the floor is $30 million, with
      a term of three years and a strike price of 7.5%.  The cost of the
      floor is recognized as expense over the term of the floor.  The fair
      value of the floor at September 30, 2007 was $251,867.  The difference
      between the unamortized cost of the floor and its fair value, net of tax, is
      shown in the equity section as a component of Other Comprehensive
      Income.





In
      accordance with SFAS No 133, this interest rate floor is measured at fair value
      and reported as an asset on the consolidated balance sheet at September 30,
      2007.  The portion of the change in fair value of the interest rate
      floor that is deemed effective in hedging the cashflows of the designated assets
      is recorded in accumulated other comprehensive income (loss), net of tax
      effects, and reclassified into interest income when such cashflows occur in
      the
      future.  Any ineffectiveness resulting from the interest rate floor is
      recorded as a gain or loss in the consolidated statements of operations as
      a
      part of non-interest income.





The
      objective of the floor is to protect the overall change in cashflows of the
      designated Prime-rate based loans with a spread of 0% from extreme market
      interest rate changes.  Changes in the fair value of the option are
      expected to be highly effective in offsetting the variability in the expected
      future cashflows attributed to fluctuations in Prime rates below 7.5% (strike
      price of floor as stated above).





**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 Allen County locations, one
      Angola location, and a loan production office 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.





**14**
 ***Index***





Information
      reported internally for performance assessment follows.





**As of and for the three months ended September 30, 2007****Wealth**
            
            
            **Corporate &****Bank**
            
            
            **Management**
            
            
            **Intercompany**
            
            
            **Eliminations**
            
            
            **Total****Income
                Statement Information**Net
                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 Information**Segment
                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, 2007****Wealth**
            
            
            **Corporate &****Bank**
            
            
            **Management**
            
            
            **Intercompany**
            
            
            **Eliminations**
            
            
            **Total****Income
                Statement Information**Net
                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 Information**Segment
                Assets
            
            
            704,782,242
            
            
            
            6,048,246
            
            
            
            69,392,915
            
            
            
            (73,309,624
            )
            
            
            706,913,779




**15**
 ***Index***




**As of and for the three months ended September 30, 2006****Wealth**
            
            
            **Corporate &****Bank**
            
            
            **Management**
            
            
            **Intercompany**
            
            
            **Eliminations**
            
            
            **Total****Income
                Statement Information**Net
                interest income
            
            $
            5,360,762
            
            
            $
            24,290
            
            
            $
            (203,535
            )
            
            $
            -
            
            
            $
            5,181,517Non-interest
                income
            
            
            526,600
            
            
            
            717,901
            
            
            
            1,139,394
            
            
            
            (1,125,210
            )
            
            
            1,258,685Non-interest
                expense
            
            
            3,817,147
            
            
            
            521,689
            
            
            
            78,380
            
            
            
            -
            
            
            
            4,417,216Noncash
                itemsProvision
                for loan losses
            
            
            645,000
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            645,000Depreciation/Amortization
            
            
            395,462
            
            
            
            8,431
            
            
            
            -
            
            
            
            -
            
            
            
            403,893Income
                tax expense (benefit)
            
            
            438,004
            
            
            
            82,470
            
            
            
            (115,454
            )
            
            
            -
            
            
            
            405,020Segment
                Profit/(Loss)
            
            
            987,211
            
            
            
            138,032
            
            
            
            972,933
            
            
            
            (1,125,210
            )
            
            
            972,966**Balance
                Sheet Information**Segment
                Assets
            
            
            642,359,739
            
            
            
            5,541,119
            
            
            
            64,723,975
            
            
            
            (68,863,250
            )
            
            
            643,761,583




**As of and for the nine months ended September 30, 2006****Wealth**
            
            
            **Corporate &****Bank**
            
            
            **Management**
            
            
            **Intercompany**
            
            
            **Eliminations**
            
            
            **Total****Income
                Statement Information**Net
                interest income
            
            $
            15,469,725
            
            
            $
            63,520
            
            
            $
            (610,607
            )
            
            $
            -
            
            
            $
            14,922,638Non-interest
                income
            
            
            4,546,565
            
            
            
            2,112,399
            
            
            
            6,447,290
            
            
            
            (9,360,505
            )
            
            
            3,745,749Non-interest
                expense
            
            
            10,990,470
            
            
            
            1,528,407
            
            
            
            341,700
            
            
            
            -
            
            
            
            12,860,577Noncash
                itemsProvision
                for loan losses
            
            
            1,695,000
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            1,695,000Depreciation/Amortization
            
            
            486,641
            
            
            
            16,103
            
            
            
            -
            
            
            
            -
            
            
            
            502,744Income
                tax expense (benefit)
            
            
            1,350,414
            
            
            
            243,780
            
            
            
            (361,484
            )
            
            
            -
            
            
            
            1,232,710Segment
                Profit/(Loss)
            
            
            5,980,416
            
            
            
            403,732
            
            
            
            5,856,467
            
            
            
            (9,360,505
            )
            
            
            2,880,100**Balance
                Sheet Information**Segment
                Assets
            
            
            642,359,739
            
            
            
            5,541,119
            
            
            
            64,723,975
            
            
            
            (68,863,250
            )
            
            
            643,761,583







**Note
      7 – Allowance for Loan Losses**





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





**September 30, 2007**
            
            
            **December 31, 2006**Loans
                past due over 90 days and still accruing
            
            $
            13,948
            
            
            $
            354,096Nonaccrual
                loans
            
            
            6,470,817
            
            
            
            3,488,417Total
                nonperforming loans
            
            $
            6,484,765
            
            
            $
            3,842,513Other
                real estate owned
            
            
            644,921
            
            
            
            370,000Total
                nonperforming assets
            
            $
            7,129,686
            
            
            $
            4,212,513Nonperforming
                assets to total assets
            
            
            1.01
            %
            
            
            0.63
            %Nonperforming
                loans to total loans
            
            
            1.12
            %
            
            
            0.70
            %




**16**
 ***Index***





Impaired
      loans were as follows:





**September 30, 2007**
            
            
            **December 31, 2006**Loans
                with no allocated allowance for loan losses
            
            $
            8,534,394
            
            
            $
            901,658Loans
                with allocated allowance for loan losses
            
            
            14,178,963
            
            
            
            7,943,308Total
                Impaired Loans
            
            $
            22,713,357
            
            
            $
            8,844,966Amount
                of allowance for loan losses allocated
            
            $
            2,132,000
            
            
            $
            2,756,000Average
                impaired loans during the year
            
            $
            11,316,172
            
            
            $
            7,879,602Interest
                recognized on impaired loans
            
            $
            632,000
            
            
            
            n/a





Information
      regarding interest income recognized during impairment and cash basis interest
      is not considered significant for the year-ended December 31, 2006.








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





**2007**
            
            
            **2006**Beginning
                balance, January 1
            
            $
            6,870,442
            
            
            $
            5,645,301Provision
                charged to operating expense
            
            
            8,171,000
            
            
            
            1,695,000Charge-offs
            
            
            (8,218,524
            )
            
            
            (978,595
            )Recoveries
            
            
            357,506
            
            
            
            219,055Ending
                balance, September 30
            
            $
            7,180,424
            
            
            $
            6,580,761Net
                charge-offs to average loans (annualized)
            
            
            1.82
            %
            
            
            0.21
            %








**Note
      8 – Federal Home Loan Bank Advances**





At
      September 30, 2007 and December 31, 2006 advances form the Federal Home Loan
      Bank (“FHLB”) were:


**2007**
            
            
            **2006**4.88%
                variable rate advance, principal due at maturity March 24,
                2008
            
            $
            2,000,0004.88%
                variable rate advance, principal due at maturity March 25,
                2008
            
            
            7,000,0004.17%
                bullet advance, principal due at maturity June 20, 2007
            
            
            
            
            
            
            2,500,0005.30%
                bullet advance, principal due at maturity October 3, 2007
            
            
            5,750,0005.29%
                bullet advance, principal due at maturity October 26, 2007
            
            
            4,000,0005.29%
                bullet advance, principal due at maturity January 7, 2008
            
            
            3,950,0005.08%
                bullet advance, principal due at maturity March 17, 2008
            
            
            3,500,000
            
            
            
            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
            
            
            2,000,0005.00%
                bullet advance, principal due at maturity April 27, 2009
            
            
            4,000,0005.16%
                bullet advance, principal due at maturity August 18, 2009
            
            
            4,000,000
            
            
            
            4,000,0004.32%
                bullet advance, principal due at maturity June 29, 2010
            
            
            1,200,000
            
            
            
            1,200,000$
            43,400,000
            
            
            $
            11,200,000








Of
      the
      total FHLB borrowings at September 30, 2007 and December 31, 2006 no advances
      had callable options.





At
      September 30, 2007 scheduled principal reductions on these FHLB advances were
      as
      follows:





**Year**
            
            **Advances**2007
            
            $
            9,750,0002008
            
            
            24,450,0002009
            
            
            8,000,0002010
            
            
            1,200,000$
            43,400,000




**17**
 ***Index***





**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, 2007 and December 31,
      2006 and results of operations for the three- and nine-month periods ended
      September 30, 2007 and September 30, 2006.  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,
      2006.





**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,
      2006
      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, 2006.





**Executive
      Overview**





We
      posted
      a net loss of $2.2 million and $1.8 million for the third quarter of 2007 and
      year-to-date through the third quarter of 2007, respectively.  This
      compares unfavorably to the net income of $973,000 and $2.9 million posted
      for
      the third quarter of 2006 and year-to-date through the third quarter of
      2006.  The primary drivers were large provision for loan losses taken
      in the first three quarters of 2007 and expenses related to the Indianapolis
      office, which was closed during the second quarter of 2007.





Net
      interest income increased approximately $1.4 million or 9.4% from the nine-month
      period ended September 30, 2006 to the same period ended September 30,
      2007.  The increase was primarily due to growth in the loan portfolio,
      as average loans during the nine-month period ended September 30, 2007 increased
      over $84 million over the same period of 2006.





Noninterest
      income increased approximately $582,000 from the nine-month period ended
      September 30, 2006 to the same period ended September 30,
      2007.  Significant increases were seen in nearly every area, including
      trust and brokerage fees ($242,000), service charges ($226,000), loan broker
      fees ($84,000), and other fees ($30,000).





Operating
      expenses increased by 11.9% in the third quarter of 2007 compared to the third
      quarter of 2006 and 19.8% year-to-date 2007 compared to the same period in
      2006.  The increases are due to the continued growth of the
      organization, which included opening a sixth branch in Allen County, a loan
      production office in Warsaw, Indiana, a loan production office in Indianapolis,
      Indiana, and the conversion of the Angola loan production office to a full
      service branch all of which were fully-functioning during the first two quarters
      2007, but not during the same period 2006.  The Warsaw loan production
      office is set to convert to a full service branch during the fourth quarter
      of
      2007 and added additional staff during the second and third quarters to prepare
      for the opening.  Additional expenses were incurred in connection with
      the Indianapolis de novo bank project that we decided to defer further action
      on
      in June of 2007.  Also, FDIC insurance premiums increased over
      $300,000 year-to-date through September 2007 due to a change in the assessment
      calculation used by the FDIC, which affected all banks.





Total
      assets grew $35.8 million from December 31, 2006 to September 30,
      2007.  The increase was primarily in the loan portfolio, which grew
      $29.5 million or 7.1% annualized.  An additional $5 million of loans
      related to the Indianapolis office were sold during the third quarter and
      approximately $3 million remain in the held-for-sale account relating to that
      office on the balance sheet at September 30, 2007.





Total
      deposits grew by $6.1 million, or 1.4% annualized, through the third quarter
      of
      2007.  However, Brokered CD’s and out of market deposits decreased by
      $33.3 million from December 31, 2006 to September 30, 2007, reflective in a
      net
      increase of in-market deposits of $39.4 million through the first three quarters
      of 2007.  Additional borrowings of $32.2 million were used to
      supplement deposits to fund loan growth.





**Financial
      Condition**





We
      experienced steady growth in the first nine months of 2007, as total assets
      were
      $707.0 million at September 30, 2007 compared to total assets at December 31,
      2006 of $671.2 million.  The 5.3% increase in assets was primarily due
      to an increase in loans of $29.5 million, a 5.4% increase from December,
      2006.  This growth was supported by $6.1 million of deposit growth and
      $32.2 million of borrowings.





*Cash
      and Investments*.   Cash and cash equivalents, which include
      federal funds sold, were $26.1 million at September 30, 2007, a $2.8 million,
      or
      9.7%, decrease from $28.9 million at December 31, 2006. The decrease in cash
      and
      cash equivalents during the first three quarters of 2007 was reflective of
      our
      cash needs relative to loan growth.  Securities available for sale
      were $69.0 million at the end of the third quarter of 2007, a decrease of
      approximately $446,000 from December 31, 2006.  The decrease was due
      to the maturity and sales of securities of approximately $6.7 million and
      unrealized losses of approximately $200,000.  This was partially
      offset by purchases of approximately $6.5 million in securities during the
      first
      nine months of 2007.





**18**
 ***Index***





*Loans
      Held for Sale*.  Loans held for sale increased $4.0 million during
      the first nine months of 2007.  The majority of these loans 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
      definitive agreement was executed in June with closing to take place in the
      third quarter.  One loan remained at the end of the quarter totaling
      approximately $3.2 million, but is still expected to be sold at par in the
      fourth quarter.  The remaining balance represents mortgage loans held
      for sale that have agreements in place to sell within thirty days of
      closing.





*Loans*.  Total
      loans were $579.9 million at September 30, 2007 reflecting a 5.4% increase
      from
      total loans of $550.5 million at December 31, 2006.  Loan growth
      during the first nine months of 2007 occurred mainly in the residential and
      commercial portfolios, along with the consumer portfolio.   The
      growth of the residential real estate portfolio was due to continued efforts
      to
      neutralize our interest rate risk profile by placing more fixed rate loans
      in
      our portfolio.  Approximately $3.8 million of our residential growth
      came from the purchase of long-term fixed rate mortgages from Countrywide
      Mortgage, all of which carried terms in excess of 20 years.  The
      majority of these loans were jumbo whole loans, none of them were
      sub-prime.  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 73.1% at September 30, 2007 and 75.5% at December
      31,
      2006.





The
      following table summarizes the composition of the loan portfolio at the dates
      indicated:





**September 30, 2007**
              
              
              **December 31, 2006****Balance**
              
              
              **%**
              
              
              **Balance**
              
              
              **%**Commercial
              
              $
              249,053,352
              
              
              
              42.9
              %
              
              $
              236,808,842
              
              
              
              43.0
              %Commercial
                  real estate
              
              
              174,996,741
              
              
              
              30.2
              %
              
              
              178,610,609
              
              
              
              32.5
              %Residential
                  real estate
              
              
              104,054,082
              
              
              
              17.9
              %
              
              
              83,600,521
              
              
              
              15.2
              %Home
                  equity
              
              
              30,326,695
              
              
              
              5.2
              %
              
              
              32,096,950
              
              
              
              5.8
              %Consumer
              
              
              21,568,695
              
              
              
              3.8
              %
              
              
              19,376,393
              
              
              
              3.5
              %Total
                  loans
              
              
              579,999,565
              
              
              
              100.0
              %
              
              
              550,493,315
              
              
              
              100.0
              %Net
                  deferred loan costs
              
              
              (97,371
              )
              
              
              
              
              
              
              (43,002
              )Allowance
                  for loan losses
              
              
              (7,180,424
              )
              
              
              
              
              
              
              (6,870,442
              )Net
                  loans
              
              $
              572,721,770
              
              
              
              
              
              
              $
              543,579,871




*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 and all nonaccrual
      loans.  Nonperforming assets have increased from $4.2 million, or
      0.63% of total assets, at December 31, 2006 to $7.1 million, or 1.01% of total
      assets, at September 30, 2007.  The majority of the increase relates
      to four relationships totaling $4.2 million.  Other smaller
      relationships and property taken to other real-estate owned, netted against
      reductions of approximately $1.1 million on one non-performing borrower and
      a
      total of $1.0 million on several smaller relationships account for the remainder
      of the change.  Total impaired loans at September 30, 2007 were $22.7
      million compared to $8.8 million at December 31, 2006.  The increase
      is primarily due to the downgrade of several loans related to a non-performing
      residential real estate development.  These loans were written down to
      fair value as of September 30, 2007 with $4.8 million recorded as
      charge-offs.  At September 30, 2007, management believes it has
      allocated adequate specific allowances for the remaining risks of $2.1
      million.  The specific reserves for impaired loans at December 31,
      2006 were $2.7 million.





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





**September 30, 2007**
            
            
            **December 31, 2006**Loans
                past due over 90 days and still accruing
            
            $
            13,948
            
            
            $
            354,096Nonaccrual
                loans
            
            
            6,470,817
            
            
            
            3,488,417Total
                nonperforming loans
            
            $
            6,484,765
            
            
            $
            3,842,513Other
                real estate owned
            
            
            644,921
            
            
            
            370,000Total
                nonperforming assets
            
            $
            7,129,686
            
            
            $
            4,212,513Nonperforming
                assets to total assets
            
            
            1.01
            %
            
            
            0.63
            %Nonperforming
                loans to total loans
            
            
            1.12
            %
            
            
            0.70
            %




**19**
 ***Index***





*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.





The
      allowance for loan losses at September 30, 2007 was $7.2 million, or 1.24%
      of
      total loans outstanding, an increase of $310,000, from $6.9 million, or 1.25%,
      allowance at December 31, 2006.   The provision for loan losses
      during the first nine months of 2007 was $8.2 million compared to $1.7 million
      in the first nine months of 2006.  The substantial loan loss provision
      incurred in the first three quarters of 2007 was primarily related to the
      residential development project mentioned above.  The loans are
      secured by the developed land and are personally guaranteed by the
      borrowers.  The lack of sales velocity, a downturn in residential
      sales in general, increases in property taxes on these type properties, and
      issues in the mortgage industry had caused concern as to the ability of the
      borrowers to carry additional future interest costs relating to their
      borrowings.  During the first two quarters the loans were downgraded
      and monitored closely.  During the third quarter new appraisals were
      obtained to value the collateral securing the loans.  The appraisals
      showed a significant shortfall when compared to the original appraisal,
      resulting primarily from slower than expected lot absorption rates.  A
      charge-down of approximately $4.8 million was recorded and the loans are now
      carried on the balance sheet at fair value, the appraised wholesale
      value.  Loans with these borrowers were current with regard to planned
      interest payments at quarter-end, with the exception of one loan.





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





**September 30, 2007**
            
            
            **December 31, 2006**Specific
                allocations
            
            $
            2,132,000
            
            
            $
            2,756,000Loan
                pool percentage allocations
            
            
            5,048,000
            
            
            
            4,110,000Unallocated
            
            
            424
            
            
            
            4,442Total
                allowance for loan losses
            
            $
            7,180,424
            
            
            $
            6,870,442








While
      the
      balance of the allowance increased only $300,000 from December 31, 2006 to
      September 30, 2007, there was substantial activity in the
      account.  Net charge-offs for the first nine months of 2007 were $7.9
      million compared to $760,000 for the first nine months of 2006. Approximately
      $6.0 million of the charge-offs during the nine months ended September 30,
      2007
      were from the commercial real estate class loan class and approximately $1.4
      million were from the commercial loan class.  Nonperforming loans
      increased during the first nine months of 2007 by $2.6 million and were $6.5
      million at September 30, 2007.  Even though nonperforming loans
      increased in the first nine months of 2007, the specific allowance allocations
      decreased by $624,000 from December 31, 2006.  Much of the increase in
      non-performing loans was already identified as impaired and therefore already
      had specific allowance allocations at December 31, 2006.  There were
      several charge-offs and partial charge-offs on non-performing loans due to
      the
      further deterioration of certain borrowers as well.  These charge-offs
      brought the carrying value of the loans down to the net realizable value of
      the
      collateral securing the loans, which caused the specific allowance allocations
      to decrease. The amount of the allowance allocated for loan pools increased
      by
      $938,000 during the first nine months of 2007.  The primary reason for
      the increase was the migration of two lending relationships to the substandard
      classification.  Management considers the allowance for loan losses at
      September 30, 2007 to be adequate; however, there can be no assurance that
      charge-offs in future periods will not exceed the allowance.





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





**2007**
            
            
            **2006**Beginning
                balance, January 1
            
            $
            6,870,442
            
            
            $
            5,645,301Provision
                charged to operating expense
            
            
            8,171,000
            
            
            
            1,695,000Charge-offs
            
            
            (8,218,524
            )
            
            
            (978,595
            )Recoveries
            
            
            357,506
            
            
            
            219,055Ending
                balance, September 30
            
            $
            7,180,424
            
            
            $
            6,580,761Net
                charge-offs to average loans (annualized)
            
            
            1.82
            %
            
            
            0.21
            %








*All
      Other Assets*.  All other assets consist of premises and
      equipment, accrued interest receivable, bank owned life insurance, and other
      assets.     The $2.2 million increase in all other
      assets was attributable to an increase in premises and equipment of $3.0 million
      and an increase of $1.7 million in current and deferred federal tax
      receivables.  This increase in premises and equipment is primarily due
      to our Warsaw, IN office that is currently under construction and land purchased
      in Fort Wayne, Indiana for a future branch location.  The increase in
      the federal tax receivables is primarily from the large loss posted
      year-to-date.





**20**
 ***Index***





*Deposits*.   Total
      deposits were $592.8 million at September 30, 2007 compared to total deposits
      at
      December 31, 2006 of $586.8 million. The growth of $6.1 million, or 1.0%, during
      the first nine months of 2007 was reflected mainly in interest-bearing checking
      and time deposits less than $100,000.  Growth was approximately $8.9
      million in interest-bearing checking and $11.0 million in time deposits less
      than $100,000.  Money market and time deposits greater than $100,000
      decreased by $3.1 million and $9.5 million, respectively. Approximately $6.4
      million of the interest-bearing checking growth was in Health Savings
      Accounts.  Virtually all of the deposit growth during the third
      quarter came from “in-market” deposits.  Brokered CD’s and out of
      market deposits decreased by $32.8 million from $115.5 million at December
      31,
      2006 to $82.7 million at September 30, 2007.  At September 30, 2007,
      brokered CD’s and out of market deposits comprised 13.9% of total deposits,
      compared to 19.4% as of December 31, 2006.





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





**September 30, 2007**
            
            
            **December 31, 2006****Balance**
            
            
            **%**
            
            
            **Balance**
            
            
            **%**Noninterest-bearing
                demand
            
            $
            74,708,805
            
            
            
            12.6
            %
            
            $
            77,772,481
            
            
            
            13.3
            %Interest-bearing
                checking
            
            
            46,432,487
            
            
            
            7.8
            %
            
            
            37,537,496
            
            
            
            6.4
            %Money
                market
            
            
            120,314,304
            
            
            
            20.3
            %
            
            
            123,387,985
            
            
            
            21.0
            %Savings
            
            
            14,273,591
            
            
            
            2.4
            %
            
            
            12,488,159
            
            
            
            2.1
            %Time,
                under $100,000
            
            
            96,217,333
            
            
            
            16.2
            %
            
            
            85,171,413
            
            
            
            14.5
            %Time,
                $100,000 and over
            
            
            240,907,306
            
            
            
            40.7
            %
            
            
            250,412,770
            
            
            
            42.7
            %Total
                deposits
            
            $
            592,853,826
            
            
            
            100.0
            %
            
            $
            586,770,304
            
            
            
            100.0
            %








*Borrowings*.   The
      Company had borrowings in the amount of $43.4 million in Federal Home Loan
      Bank
      (“FHLB”) advances at September 30, 2007 and $11.2 million at December 31,
      2006.  Two of the advances, totaling $9.0 million, are short-term
      daily variable rate advances and the other nine, totaling $34.4 million, are
      bullet advances and mature in a range from October 2007 through June
      2010.





*All
      Other Liabilities.*All other liabilities consists of accrued
      interest payable and other liabilities.  All other liabilities
      decreased $397,000 from year-end 2006.   The decrease in other
      liabilities was primarily related to the payment of the 2006 incentive bonuses
      during the first quarter that were accrued at December 31, 2006.





**Results
      of Operations**





For
      The Three-Month Periods Ended September 30





Results
      of operations for the three-month period ended September 30, 2007 reflected
      a
      net loss of $2.2 million or $(0.54) per diluted share.   This was
      a $3.2 million decrease over 2006’s third quarter net income of $973,000, or
      $0.24 per diluted share.   The operating results for the
      three-month period ended September 30, 2007 were unfavorable compared to the
      same period in 2006 primarily due to the larger loan loss provision incurred
      in
      the third quarter of 2007 and expenses incurred associated with the operation
      of
      and eventual closing of the Indianapolis loan production
      office.  However, strong asset growth provided a higher net interest
      income.  This was offset somewhat by cost of funds increasing at a
      greater rate than yields causing net interest margin to
      compress.  This was due to a more neutral balance sheet in the third
      quarter of 2007 compared to the third quarter of 2006.





Total
      revenue, defined as net interest income plus total noninterest income, increased
      by 7.1% to $6.9 million from $6.4 million from third quarter 2006 to third
      quarter 2007.   For the three-month period ended September 30,
      2007, net interest income increased 5.9%, while total noninterest income
      increased 11.9% from the same period one year ago due to an increase in trust
      and brokerage fees, service charges, and loan broker fees.





**21**
 ***Index***




**Performance
                Ratios**
            
            **September 30****2007**
            
            
            **2006**Return
                on average assets *
            
            
            -1.25
            %
            
            
            0.62
            %Return
                on average equity *
            
            
            -17.52
            %
            
            
            7.94
            %Net
                interest margin (TEY) *
            
            
            3.31
            %
            
            
            3.54
            %Efficiency
                ratio
            
            
            71.64
            %
            
            
            68.59
            %





*
      annualized





*Net
      Interest Income*.   Interest income for the three-month
      periods ended September 30, 2007 and 2006 was $12.1 million and $10.9 million,
      respectively, while interest expense for the third quarter was $6.6 million
      in
      2007 and $5.7 million in 2006, resulting in net interest income
      of  $5.5 million for the third quarter of 2007 and $5.2 million for
      the third quarter of 2006.  The increase in net interest income was
      reflective of the general growth in loans and other earning
      assets.  The tax equivalent net interest margin for the third quarter
      of 2007 was 3.31%, while the tax equivalent net interest margin for the third
      quarter of 2006 was 3.54%.   The decrease in net interest margin
      was mainly due to the Company neutralizing its balance sheet and a flattening
      yield curve.





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 Ended****September 30, 2007**
            
            
            **September 30, 2006****Interest**
            
            
            **Annualized**
            
            
            
            
            
            **Interest**
            
            
            **Annualized****Average**
            
            
            **Earned**
            
            
            **Yield**
            
            
            **Average**
            
            
            **Earned**
            
            
            **Yield**($
                in thousands)
            
            **Balance**
            
            
            **or Paid**
            
            
            **or Cost**
            
            
            **Balance**
            
            
            **or Paid**
            
            
            **or Cost****Assets**Short-term
                investments and interest-earning deposits
            
            $
            6,545
            
            
            $
            77
            
            
            
            4.67
            %
            
            $
            4,022
            
            
            $
            44
            
            
            
            4.34
            %Federal
                funds sold
            
            
            4,469
            
            
            
            51
            
            
            
            4.53
            %
            
            
            5,758
            
            
            
            73
            
            
            
            5.03
            %Securities
                - taxable
            
            
            51,854
            
            
            
            660
            
            
            
            5.05
            %
            
            
            44,532
            
            
            
            566
            
            
            
            5.04
            %Securities
                - tax exempt (1)
            
            
            19,126
            
            
            
            306
            
            
            
            6.35
            %
            
            
            17,060
            
            
            
            280
            
            
            
            6.51
            %Loan
                Held for Sale
            
            
            70
            
            
            
            -
            
            
            
            0.00
            %Loans
            
            
            587,531
            
            
            
            11,086
            
            
            
            7.49
            %
            
            
            520,260
            
            
            
            10,040
            
            
            
            7.66
            %Total
                interest-earning assets
            
            
            669,595
            
            
            
            12,180
            
            
            
            7.22
            %
            
            
            591,632
            
            
            
            11,003
            
            
            
            7.38
            %Allowance
                for loan losses
            
            
            (8,731
            )
            
            
            
            
            
            
            
            
            
            
            (6,323
            )Cash
                and due from banks
            
            
            11,546
            
            
            
            
            
            
            
            
            
            
            
            18,480Other
                assets
            
            
            30,127
            
            
            
            
            
            
            
            
            
            
            
            17,808Total
                assets
            
            $
            702,537
            
            
            
            
            
            
            
            
            
            
            $
            621,597**Liabilities
                and Stockholders' Equity**Interest-bearing
                checking
            
            $
            47,381
            
            
            $
            183
            
            
            
            1.53
            %
            
            $
            30,903
            
            
            $
            88
            
            
            
            1.13
            %Savings
            
            
            14,797
            
            
            
            39
            
            
            
            1.05
            %
            
            
            12,789
            
            
            
            29
            
            
            
            0.90
            %Money
                market
            
            
            120,422
            
            
            
            1,187
            
            
            
            3.91
            %
            
            
            101,984
            
            
            
            916
            
            
            
            3.56
            %Certificates
                of deposit
            
            
            340,321
            
            
            
            4,455
            
            
            
            5.19
            %
            
            
            316,694
            
            
            
            4,110
            
            
            
            5.15
            %FHLB
                advances
            
            
            34,094
            
            
            
            436
            
            
            
            5.07
            %
            
            
            28,330
            
            
            
            372
            
            
            
            5.21
            %Junior
                subordinated debt
            
            
            17,527
            
            
            
            288
            
            
            
            6.52
            %
            
            
            11,856
            
            
            
            209
            
            
            
            6.99
            %Total
                interest-bearing liabilities
            
            
            574,542
            
            
            
            6,588
            
            
            
            4.55
            %
            
            
            502,556
            
            
            
            5,724
            
            
            
            4.52
            %Noninterest-bearing
                checking
            
            
            73,219
            
            
            
            
            
            
            
            
            
            
            
            66,592Other
                liabilities
            
            
            4,762
            
            
            
            
            
            
            
            
            
            
            
            3,719Stockholders'
                equity
            
            
            50,014
            
            
            
            
            
            
            
            
            
            
            
            48,730Total
                liabilities and stockholders' equity
            
            $
            702,537
            
            
            
            
            
            
            
            
            
            
            $
            621,597**Net
                interest income**
            
            
            
            
            
            $
            5,592
            
            
            
            
            
            
            
            
            
            
            $
            5,279**Rate
                spread**
            
            
            
            
            
            
            
            
            
            
            2.67
            %
            
            
            
            
            
            
            
            
            
            
            2.86
            %**Net
                interest income as a percent of average earning
                assets**
            
            
            
            
            
            
            
            
            
            
            3.31
            %
            
            
            
            
            
            
            
            
            
            
            3.54
            %




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





**22**
 ***Index***





*Provision
      for Loan Losses*.   A provision for loan losses was recorded
      in the amount of $5.2 million or 3.57% of average loans (annualized) during
      the
      third quarter of 2007 as compared to $645,000, or 50 basis points on average
      loans (annualized) for the third quarter of 2006.  The increased
      provision recorded for the third quarter of 2007 was driven by charge-offs
      related to the residential development project previously
      mentioned.   The allowance for loan losses at September 30, 2007
      totaled $7.2 million and was 1.24% of total loans outstanding on that
      date.  Total net charge-offs for the three-month period ended
      September 30, 2007 were $5.2 million or 3.54%, annualized, of average loans
      and
      were $238,000, or 18 basis points, annualized, on average loans during the
      same
      period a year ago.





*Noninterest
      Income*.   Noninterest income was $1.4 million during the
      third quarter of 2007.   This was a $150,000, or 11.9%, increase
      compared to the third quarter of 2006.  Trust services fee income,
      service charges, loan broker fees, and other fee revenue all contributed to
      the
      increase. Trust services fees increased $72,000 from the third quarter of 2006
      to $790,000 for the three-month period ended September 30, 2007, reflective
      of
      an increase of $91.2 million, or 17.3%, in assets under
      management.  Service charge revenue increased $60,000, or 34.1%, from
      $175,000 for the three-month period ending September 30, 2006 to $235,000 for
      the same period ended September 30, 2007.  The increase was primarily
      from an increase in over-draft fees and in service charges on HSA deposit
      accounts.  Loan broker fees increased $32,000 from third quarter 2006
      to third quarter 2007.  We saw some growth in residential loan volume
      comparing third quarter 2006 to third quarter 2007 and we sold approximately
      $2
      million more to the secondary market in the third quarter 2007 compared to
      the
      third quarter 2006.  Noninterest income was adversely affected by a
      $15,000 loss on the sale of a security as well.





*Noninterest
      Expense*.   Noninterest expense was $4.9 million for the
      third quarter of 2007 while noninterest expense for the three-month period
      ended
      September 30, 2006 was $4.4 million.  The main components of
      noninterest expense for the third quarter of 2007 were salaries and benefits
      of
      $2.6 million and occupancy and equipment costs of $676,000 and represent mainly
      infrastructure costs for human resource needs to operate the Bank, rent expense,
      and equipment depreciation.  Other expenses were $633,000 in the third
      quarter 2007, a $321,000 increase over the same quarter 2006.  The
      increase was due to an increase in FDIC insurance premiums of $100,000, OREO
      expenses and losses of $100,000, and other smaller items.  Salaries
      and benefits decreased by $57,000 or 2.1% for the quarter even though full-time
      employees decreased by 7.0%, year over year.


While
      noninterest expense increased comparing the third quarter 2007 to the third
      quarter of 2006, it decreased comparing the third quarter 2007 to the second
      quarter 2007.  This is a result of management’s efforts to better
      control costs and improve the efficiency ratio.





*Income
      Taxes.* During the quarters ended September 30, 2007 and
      2006, we recorded $1.1 million and $405,020 in income tax benefit and income
      tax
      expense, respectively.  The effective tax rate recorded was (32.9%)
      for third quarter 2007 as compared to 29.4% for third quarter
      2006.  The tax benefit in 2007 is the result of excess tax-exempt
      income on top of the net loss for the quarter.  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, 2007 reflected
      a net
      loss of $1.8 million, or $(0.45) per diluted share.   This was a
      $4.7 million decrease over 2006’s nine-month period net income of $2.9 million,
      or $0.70 per diluted share.   The operating results for the
      nine-month period ended September 30, 2007 were unfavorable compared to the
      same
      period in 2006 primarily because the large loan loss provisions incurred in
      the
      first three quarters of 2007 and expenses incurred associated with the closing
      of the Indianapolis loan production office.  However, strong asset
      growth provided a higher net interest income.  This was offset
      somewhat by cost of funds increasing at a greater rate than yields causing
      net
      interest margin to compress.  This was due to a more neutral balance
      sheet in the first three quarters of 2007 compared to the same periods of
      2006.





Total
      revenue, defined as net interest income plus total noninterest income, increased
      by 10.6% to $20.7 million from $18.7 million from the first nine-months of
      2006
      to the first nine-months of 2007.  For the nine-month period ended
      September 30, 2007, net interest income increased 9.4%, while total noninterest
      income increased 15.5% from the same period one year ago due to an increase
      in
      trust and brokerage fees, service charge income, and loan broker
      fees.





**Performance
                Ratios**
            
            **September 30****2007**
            
            
            **2006**Return
                on average assets *
            
            
            -0.35
            %
            
            
            0.65
            %Return
                on average equity *
            
            
            -4.78
            %
            
            
            7.98
            %Net
                interest margin (TEY) *
            
            
            3.39
            %
            
            
            3.62
            %Efficiency
                ratio
            
            
            74.60
            %
            
            
            68.89
            %





*
      annualized





*Net
      Interest Income*.   Interest income for the nine-month
      periods ended September 30, 2007 and 2006 was $35.5 million and $29.8 million,
      respectively, while interest expense was $19.1 million through September 30,
      2007 and $14.8 million through September 30, 2006, resulting in net interest
      income of $16.3 million for the first nine months of 2007 and $14.9 million
      for
      the first nine months of 2006.  The increase in net interest income
      was reflective of the general growth in loans and other earning
      assets.  The tax equivalent net interest margin for the first nine
      months of 2007 was 3.39%, while the tax equivalent net interest margin for
      the
      first nine months of 2006 was 3.62%.   The decrease in net
      interest margin was mainly due to the neutralizing of our balance sheet and
      a
      flattening yield curve.





**23**
 ***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 Ended****September 30, 2007**
            
            
            **September 30, 2006****Interest**
            
            
            **Annualized**
            
            
            
            
            
            **Interest**
            
            
            **Annualized****Average**
            
            
            **Earned**
            
            
            **Yield**
            
            
            **Average**
            
            
            **Earned**
            
            
            **Yield**($
                in thousands)
            
            **Balance**
            
            
            **or Paid**
            
            
            **or Cost**
            
            
            **Balance**
            
            
            **or Paid**
            
            
            **or Cost****Assets**Short-term
                investments and interest-earning deposits
            
            $
            4,445
            
            
            $
            194
            
            
            
            5.84
            %
            
            $
            6,624
            
            
            $
            232
            
            
            
            4.68
            %Federal
                funds sold
            
            
            4,931
            
            
            
            175
            
            
            
            4.74
            %
            
            
            5,462
            
            
            
            193
            
            
            
            4.72
            %Securities
                - taxable
            
            
            51,960
            
            
            
            1,991
            
            
            
            5.12
            %
            
            
            42,665
            
            
            
            1,581
            
            
            
            4.95
            %Securities
                - tax exempt (1)
            
            
            19,495
            
            
            
            906
            
            
            
            6.21
            %
            
            
            15,742
            
            
            
            768
            
            
            
            6.52
            %Loans
                held for sale
            
            
            48
            
            
            
            -
            
            
            
            0.00
            %
            
            
            -
            
            
            
            -
            
            
            
            0.00
            %Loans
            
            
            574,670
            
            
            
            32,492
            
            
            
            7.56
            %
            
            
            490,145
            
            
            
            27,264
            
            
            
            7.44
            %Total
                interest-earning assets
            
            
            655,549
            
            
            
            35,758
            
            
            
            7.29
            %
            
            
            560,638
            
            
            
            30,038
            
            
            
            7.16
            %Allowance
                for loan losses
            
            
            (7,803
            )
            
            
            
            
            
            
            
            
            
            
            (6,163
            )Cash
                and due from banks
            
            
            12,117
            
            
            
            
            
            
            
            
            
            
            
            16,117Other
                assets
            
            
            29,764
            
            
            
            
            
            
            
            
            
            
            
            20,864Total
                assets
            
            $
            689,627
            
            
            
            
            
            
            
            
            
            
            $
            591,456**Liabilities
                and Stockholders' Equity**Interest-bearing
                checking
            
            $
            44,335
            
            
            $
            482
            
            
            
            1.45
            %
            
            $
            29,993
            
            
            $
            234
            
            
            
            1.04
            %Savings
            
            
            14,657
            
            
            
            106
            
            
            
            0.97
            %
            
            
            13,808
            
            
            
            81
            
            
            
            0.78
            %Money
                market
            
            
            124,803
            
            
            
            3,443
            
            
            
            3.69
            %
            
            
            94,170
            
            
            
            2,257
            
            
            
            3.20
            %Certificates
                of deposit
            
            
            340,121
            
            
            
            13,221
            
            
            
            5.20
            %
            
            
            290,667
            
            
            
            10,554
            
            
            
            4.85
            %Federal
                funds purchased
            
            
            48
            
            
            
            1
            
            
            
            2.79
            %FHLB
                advances
            
            
            26,817
            
            
            
            1,025
            
            
            
            5.11
            %
            
            
            31,490
            
            
            
            1,093
            
            
            
            4.64
            %Junior
                subordinated debt
            
            
            17,527
            
            
            
            849
            
            
            
            6.48
            %
            
            
            11,856
            
            
            
            628
            
            
            
            7.08
            %Total
                interest-bearing liabilities
            
            
            568,308
            
            
            
            19,127
            
            
            
            4.50
            %
            
            
            471,984
            
            
            
            14,847
            
            
            
            4.21
            %Noninterest-bearing
                checking
            
            
            65,898
            
            
            
            
            
            
            
            
            
            
            
            67,954Other
                liabilities
            
            
            4,641
            
            
            
            
            
            
            
            
            
            
            
            3,248Stockholders'
                equity
            
            
            50,780
            
            
            
            
            
            
            
            
            
            
            
            48,270Total
                liabilities and stockholders' equity
            
            $
            689,627
            
            
            
            
            
            
            
            
            
            
            $
            591,456**Net
                interest income**
            
            
            
            
            
            $
            16,631
            
            
            
            
            
            
            
            
            
            
            $
            15,191**Rate
                spread**
            
            
            
            
            
            
            
            
            
            
            2.79
            %
            
            
            
            
            
            
            
            
            
            
            2.95
            %**Net
                interest income as a percent of average earning
                assets**
            
            
            
            
            
            
            
            
            
            
            3.39
            %
            
            
            
            
            
            
            
            
            
            
            3.62
            %





(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 $8.2 million, or 1.90% (annualized) of average loans during
      the
      first nine months of 2007 as compared to $1.7 million, or 46 basis points
      (annualized) on average loans for the first nine months of 2006.  The
      increased provision recorded during the first three quarters of 2007 was driven
      by charge-offs related to the residential development project previously
      mentioned.  The allowance for loan losses at September 30, 2007
      totaled $7.2 million and was 1.24% of total loans outstanding on that
      date.  Total net charge-offs for the nine-month period ended September
      30, 2007 were $7.9 million, or 1.83%, annualized, of average loans and were
      $760,000, or 14 basis points, annualized, on average loans during the same
      period a year ago.





*Noninterest
      Income*.   Noninterest income was $4.3 million during the
      first nine months of 2007.   This was a $582,000, or 15.5%,
      increase compared to the first nine months of 2006.  The majority of
      the increase relates to trust services fee income and service charge income.
      Trust services fees increased $242,000 from the first nine months of 2006 to
      $2.4 million for the nine-month period ended September 30, 2007, reflective
      of
      an increase of $91.2 million, or 17.3%, in assets under management. Service
      charge income increased by $226,000, or 45.6%, 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.





**24**
 ***Index***





*Noninterest
      Expense*.   Noninterest expense was $15.4 million for the
      first nine months of 2007 while noninterest expense for the first nine months
      of
      2006 was $12.9 million.  The main components of noninterest expense
      for the first nine months of 2007 were salaries and benefits of $8.6 million,
      occupancy and equipment costs of $2.0 million, other expense of $1.6 million,
      and loan and professional costs of $1.0 million.  The salary and
      benefits and occupancy and equipment expense represent mainly infrastructure
      costs for human resource needs to operate the Bank, rent expense and equipment
      depreciation.   The 10.9% increase in salaries and benefits
      reflects a 7.0% growth in full-time employees, year over year, as part of our
      expansion activities throughout the last twelve months, and benefit cost
      increases.  This increased leveled off during the third quarter upon
      closure of the Indianapolis loan production office.  The $763,000
      increase in other expenses is primarily due to an increase in FDIC insurance
      premiums.  Premium expenses in the first nine months of 2007 exceeded
      $350,000, which was an increase of over $300,000 from the same period prior
      year.  An additional $100,000 was incurred in 2007 relating to other
      real estate owned expenses, as well as several smaller increases
      year-over-year.  Loan and professional expenses increased by $245,000,
      or 32.7%, primarily due to Indianapolis start-up costs and legal and consulting
      fees for the 2007 proxy reporting relating to the new compensation disclosure
      requirements.





*Income
      Taxes.* During the nine-month periods ended September 30,
      2007 and 2006, we recorded $1.1 million and $1.2 million in income tax benefit
      and income tax expense, respectively.  The effective tax rate recorded
      was (38.0%) through the first nine-months of 2007 as compared to 30.0% for
      the
      first nine months of 2006.  The tax benefit in 2007 is the result of
      excess tax-exempt income on top of the net loss for the
      year.  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 steady
      deposit growth, as it has been each quarter 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.  In the aggregate these out-of-market deposits and
      borrowings represented $143.1 million, or 21.9% of our total funding, at
      September 30, 2007.   Total deposits at September 30, 2007 were
      $592.9 million and the loan to deposit ratio was 97.8%.   Total
      borrowings at September 30, 2007 were $60.9 million.  We expect to
      continue to experience loan growth and that funding for the loan growth 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 CD’s.  Additionally, we intend to continue to
      develop wholesale, out-of-market deposits, and borrowing capacities and use
      them
      to augment our interest rate sensitivity strategy and liquidity capabilities
      and
      to diversify the funding base of the Bank.





*Capital
      Resources.* Stockholders’ equity is a noninterest-bearing
      source of funds, which provides support for asset
      growth.  Stockholders’ equity was $48.8 million and $51.0 million at
      September 30, 2007 and December 31, 2006, respectively. Affecting the decrease
      in stockholders’ equity during the first nine months of 2007 was the net loss of
      $1.8 million, dividend payments of $537,000, or $0.132 per share, and a $75,000
      increase in the unrealized loss on securities available for sale, net of
      tax.  We also issued 71,923 shares of common stock from stock options
      exercised for $871,000 and recorded $62,000 of stock option compensation expense
      per FAS123R.  Additionally, we purchased 42,736 shares of Treasury
      Stock at a weighted average price of $14.84, including fees, during the first
      nine months of 2007.





During
      the first nine months of 2007, the Company paid three quarterly
      dividends.  The dividend declared and paid was $0.044 per share in
      each quarter and amounted to an annual total of
      $537,000.  Additionally, the board of directors declared a dividend in
      the amount of $0.044 per share on October 17, 2007 payable on November 16,
      2007
      to shareholders of record at the close of business day on October 30,
      2007.  The ability of the Company to pay future cash and stock
      dividends is subject to limitations under various laws and regulations and
      to
      prudent and sound banking practices, however we anticipate continuing to pay
      dividends on a quarterly basis for the foreseeable future.





**25**
 ***Index***





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





**September 30, 2007**
            
            
            **December 31, 2006**Well-
            
            
            Minimum
            
            
            
            
            
            Well-
            
            
            MinimumActual
            
            
            Capitalized
            
            
            Required
            
            
            Actual
            
            
            Capitalized
            
            
            Required**The
                Company**Leverage
                capital
            
            
            9.40
            %
            
            
            5.00
            %
            
            
            4.00
            %
            
            
            10.46
            %
            
            
            5.00
            %
            
            
            4.00
            %Tier
                1 risk-based
            
            
            11.03
            %
            
            
            6.00
            %
            
            
            4.00
            %
            
            
            11.94
            %
            
            
            6.00
            %
            
            
            4.00
            %Total
                risk-based
            
            
            12.15
            %
            
            
            10.00
            %
            
            
            8.00
            %
            
            
            13.06
            %
            
            
            10.00
            %
            
            
            8.00
            %**The
                Bank**Leverage
                capital
            
            
            8.06
            %
            
            
            5.00
            %
            
            
            4.00
            %
            
            
            8.23
            %
            
            
            5.00
            %
            
            
            4.00
            %Tier
                1 risk-based
            
            
            9.44
            %
            
            
            6.00
            %
            
            
            4.00
            %
            
            
            9.37
            %
            
            
            6.00
            %
            
            
            4.00
            %Total
                risk-based
            
            
            10.64
            %
            
            
            10.00
            %
            
            
            8.00
            %
            
            
            10.58
            %
            
            
            10.00
            %
            
            
            8.00
            %








**Subsequent
      Events**





On
      November 2, 2007 Tower Bank and Trust Company, a wholly-owned subsidiary of
      Tower Financial Corporation, announced the closure of its Angola, Indiana branch
      effective February 1, 2008.  This decision was due to management’s
      perception of the current Angola banking environment, required additional
      investment necessary to remain competitive, and more attractive alternatives.
      Management’s assessment showed that the costs associated with closing the branch
      will be minimal and it will contribute to future cost-savings.





**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, 2007, 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, 2006.  There have been no material changes outside the
      ordinary course of business in such contractual obligations during the first
      nine months of 2007.





**Item
      3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
      MARKET RISK**





The
      Company’s primary market risk exposure is interest rate risk and, to a lesser
      extent, liquidity risk. All of the Company’s transactions are denominated in
      U.S. dollars with no specific foreign exchange exposure. The Company has no
      agricultural-related loan assets and therefore has no significant exposure
      to
      changes in commodity prices. Any impact that changes in foreign exchange rates
      and commodity prices would have on interest rates is assumed to be
      insignificant.





Interest
      rate risk is the exposure of the Company’s financial condition to adverse
      movements in interest rates. The Company derives its income primarily from
      the
      excess of interest collected on its interest-earning assets over the interest
      paid on its interest-bearing liabilities. The rates of interest the Company
      earns on its assets and owes on its liabilities generally are established
      contractually for a period of time. Since market interest rates change over
      time, the Company is exposed to lower profitability if it cannot adapt to
      interest rate changes. Accepting interest rate risk can be an important source
      of profitability and stockholder value; however, excessive levels of interest
      rate risk could pose a significant threat to the Company’s earnings and capital
      base. Accordingly, effective risk management that maintains interest rate risk
      at prudent levels is essential to the Company’s safety and
      soundness.





Evaluating
      the exposure to changes in interest rates includes assessing both the adequacy
      of the process used to control interest rate risk and the quantitative level
      of
      exposure. The Company’s interest rate risk management process seeks to ensure
      that appropriate policies, procedures, management information and internal
      controls are in place to maintain interest rate risk at prudent levels with
      consistency and continuity. In evaluating the quantitative level of interest
      rate risk, the Company assesses the existing and potential future effects of
      changes in interest rates on its financial condition, including capital
      adequacy, earnings, liquidity and overall asset quality.





**26**
 ***Index***





There
      are
      two interest rate risk measurement techniques that may be used by the Company.
      The first, which is commonly referred to as GAP analysis, measures the
      difference between the dollar amount of interest-sensitive assets and
      liabilities that will be refinanced or repriced during a given time period.
      A
      significant repricing gap could result in a negative impact to the Company’s net
      interest margin during periods of changing market interest rates.





The
      following table depicts the Company’s GAP position as of  September
      30, 2007:





**Rate
                Sensitivity Analysis****Within**
            
            
            **Three to**
            
            
            **One to**
            
            
            **After****Three**
            
            
            **Twelve**
            
            
            **Five**
            
            
            **Five**($
                in thousands)
            
            **Months**
            
            
            **Months**
            
            
            **Years**
            
            
            **Years**
            
            
            **Total****Assets**Federal
                funds sold, short-term investments and interest-earning
                deposits
            
            $
            13,577
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            13,577Securities
                available for sale
            
            
            3,721
            
            
            
            7,911
            
            
            
            39,941
            
            
            
            17,473
            
            
            
            69,046FHLBI
                and FRB stock
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            3,455
            
            
            
            3,455Fixed
                rate loans
            
            
            23,621
            
            
            
            57,904
            
            
            
            150,406
            
            
            
            51,874
            
            
            
            283,805Variable
                rate loans
            
            
            86,235
            
            
            
            114,445
            
            
            
            89,295
            
            
            
            6,122
            
            
            
            296,097Allowance
                for loan losses
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (7,180
            )Other
                assets
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            48,114Total
                assets
            
            $
            127,154
            
            
            $
            180,260
            
            
            $
            279,642
            
            
            $
            78,924
            
            
            $
            706,914**Liabilities**Interest-bearing
                checking
            
            $
            46,433
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            46,433Savings
                accounts
            
            
            14,274
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            14,274Money
                market accounts
            
            
            120,314
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            120,314Time
                deposits < $100,000
            
            
            11,861
            
            
            
            49,455
            
            
            
            34,871
            
            
            
            30
            
            
            
            96,217Time
                deposits $100,000 and over
            
            
            66,361
            
            
            
            90,329
            
            
            
            84,217
            
            
            
            -
            
            
            
            240,907Short-term
                borrowings
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -FHLB
                advances
            
            
            9,750
            
            
            
            24,450
            
            
            
            9,200
            
            
            
            -
            
            
            
            43,400Junior
                subordinated debt
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            17,527
            
            
            
            17,527Noninterest-bearing
                checking
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            74,709Other
                liabilities
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            4,303Total
                liabilities
            
            
            268,993
            
            
            
            164,234
            
            
            
            128,288
            
            
            
            17,557
            
            
            
            658,084**Stockholders'
                Equity**
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            48,830Total
                sources of funds
            
            $
            268,993
            
            
            $
            164,234
            
            
            $
            128,288
            
            
            $
            17,557
            
            
            $
            706,914Net
                asset (liability) GAP
            
            $
            (141,839
            )
            
            $
            16,026
            
            
            $
            151,354
            
            
            $
            61,367
            
            
            $**Cumulative
                GAP**
            
            $
            (141,839
            )
            
            $
            (125,813
            )
            
            $
            25,541
            
            
            $
            86,908
            
            
            $**Percent
                of cumulative GAP to total assets**
            
            
            -20.1
            %
            
            
            -17.8
            %
            
            
            3.6
            %
            
            
            12.3
            %








A
      second
      interest rate risk measurement used is commonly referred to as net interest
      income simulation analysis. A simulation model assesses the direction and
      magnitude of variations in net interest income resulting from potential changes
      in market interest rates. Key assumptions in the model include prepayment speeds
      on various loan and investment assets; cash flows and maturities of
      interest-sensitive assets and liabilities; and changes in market conditions
      impacting loan and deposit volume and pricing. These assumptions are inherently
      uncertain, subject to fluctuation and revision in a dynamic environment;
      therefore, a model cannot precisely estimate net interest income or exactly
      predict the impact of higher or lower interest rates on net interest income.
      Actual results will differ from simulated results due to timing, magnitude,
      and
      frequency of interest rate changes and changes in market conditions and the
      Company’s strategies, among other factors.





In
      addition to changes in interest rates, the level of future net interest income
      is also dependent on a number of other variables, including the growth,
      composition and absolute levels of loans, deposits, and other earning assets
      and
      interest-bearing liabilities; economic and competitive conditions; potential
      changes in lending, investing, and deposit gathering strategies; client
      preferences; and other factors.





The
      following table provides information about the Company’s financial instruments
      used for purposes other than trading that are rate sensitive to changes in
      interest rates as of September 30, 2007. It does not provide when these items
      may actually reprice.  For loans receivable, securities, and
      liabilities with contractual maturities, the table presents principal cash
      flows
      and related weighted-average interest rates by contractual maturities as well
      as
      the Company’s historical experience of the impact of interest rate fluctuations
      on the prepayment of loans and mortgage backed securities.  For core
      deposits (demand deposits, interest-bearing checking, savings, and money market
      deposits) that have no contractual maturity, the table presents principal cash
      flows and, as applicable, related weighted-average interest rates based upon
      the
      Company’s historical experience and management’s judgment, as applicable,
      concerning their most likely withdrawal behaviors.  The most recent
      historical interest rates for core deposits have been assumed to apply for
      future periods in this table as the actual interest rates that will need to
      be
      paid to maintain these deposits are not currently known.  Weighted
      average variable rates are based upon contractual rates existing at the report
      date.





**27**
 ***Index***




**Principal Amount Maturing in:**($
                in thousands)
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            **Fair Value****09/30/08**
            
            
            **09/30/09**
            
            
            **09/30/10**
            
            
            **09/30/11**
            
            
            **09/30/12**
            
            
            **Thereafter**
            
            
            **Total**
            
            
            **9/30/2007**Rate
                sensitive assets:Fixed
                interest rate loans
            
            $
            81,525
            
            
            $
            45,475
            
            
            $
            38,156
            
            
            $
            31,238
            
            
            $
            25,256
            
            
            $
            62,155
            
            
            $
            283,805
            
            
            $
            283,042Average
                interest rate
            
            
            6.81
            %
            
            
            6.82
            %
            
            
            6.80
            %
            
            
            6.74
            %
            
            
            7.13
            %
            
            
            5.89
            %
            
            
            6.63
            %Variable
                interest rate loans
            
            
            200,680
            
            
            
            43,366
            
            
            
            18,428
            
            
            
            13,212
            
            
            
            11,501
            
            
            
            8,910
            
            
            $
            296,097
            
            
            
            296,097Average
                interest rate
            
            
            7.90
            %
            
            
            7.74
            %
            
            
            7.53
            %
            
            
            7.46
            %
            
            
            7.69
            %
            
            
            7.76
            %
            
            
            7.82
            %Fixed
                interest rate securities
            
            
            11,632
            
            
            
            11,020
            
            
            
            8,995
            
            
            
            7,204
            
            
            
            5,412
            
            
            
            24,783
            
            
            $
            69,046
            
            
            
            69,046Average
                interest rate
            
            
            8.17
            %
            
            
            5.14
            %
            
            
            4.96
            %
            
            
            4.60
            %
            
            
            4.80
            %
            
            
            4.80
            %
            
            
            5.42
            %Other
                interest bearing assets
            
            
            13,577
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            $
            13,577
            
            
            
            13,577Average
                interest rate
            
            
            5.74
            %
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            5.74
            %Rate
                sensitive liabilities:Interest
                bearing checking
            
            
            8,350
            
            
            
            6,787
            
            
            
            5,555
            
            
            
            4,550
            
            
            
            3,731
            
            
            
            17,460
            
            
            $
            46,433
            
            
            
            46,433Average
                interest rate
            
            
            1.50
            %
            
            
            1.51
            %
            
            
            1.52
            %
            
            
            1.52
            %
            
            
            1.53
            %
            
            
            1.54
            %
            
            
            1.53
            %Savings
                accounts
            
            
            3,404
            
            
            
            2,603
            
            
            
            1,966
            
            
            
            1,487
            
            
            
            1,128
            
            
            
            3,686
            
            
            $
            14,274
            
            
            
            14,274Average
                interest rate
            
            
            1.05
            %
            
            
            1.04
            %
            
            
            1.07
            %
            
            
            1.10
            %
            
            
            1.13
            %
            
            
            1.27
            %
            
            
            1.12
            %Money
                market accounts
            
            
            33,475
            
            
            
            24,079
            
            
            
            17,359
            
            
            
            12,529
            
            
            
            9,052
            
            
            
            23,820
            
            
            $
            120,314
            
            
            
            120,314Average
                interest rate
            
            
            3.71
            %
            
            
            3.73
            %
            
            
            3.76
            %
            
            
            3.78
            %
            
            
            3.80
            %
            
            
            3.87
            %
            
            
            3.77
            %Time
                deposits
            
            
            218,006
            
            
            
            96,487
            
            
            
            22,436
            
            
            
            36
            
            
            
            129
            
            
            
            30
            
            
            $
            337,124
            
            
            
            336,456Average
                interest rate
            
            
            5.01
            %
            
            
            5.01
            %
            
            
            4.11
            %
            
            
            4.36
            %
            
            
            4.55
            %
            
            
            4.18
            %
            
            
            4.95
            %Fixed
                interest rate borrowings
            
            
            25,200
            
            
            
            8,000
            
            
            
            1,200
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            $
            34,400
            
            
            
            34,483Average
                interest rate
            
            
            5.11
            %
            
            
            5.08
            %
            
            
            4.32
            %
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            5.08
            %Variable
                interest rate borrowings
            
            
            9,000
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            $
            9,000
            
            
            
            9,000Average
                interest rate
            
            
            4.88
            %
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            4.88
            %





**Item
      4.   CONTROLS AND
      PROCEDURES**





*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 Principal
      Executive Officer and Principal Financial Officer.  Based upon their
      evaluation, our Principal Executive Officer and our Principal 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.





*Changes
      in Internal Control*





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.





**28**
 ***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, 2006.





**Item
      6.   EXHIBITS**





(a)
            Exhibits.





31.1
      Rule 13a-14(a) /15-14(a) Certification of Chief
      Executive Officer.


31.2
      Rule 13a-14(a) /15-14(a) Certification of Chief
      Financial Officer.





32.1
      Certification of Chief Executive Officer pursuant to
      18 U.S.C. Section 1350.


32.2
      Certification of Chief Financial Officer pursuant to
      18 U.S.C. Section 1350.








**SIGNATURES**





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





TOWER
                FINANCIAL CORPORATIONDated:  November
                12, 2007
            /
                s
                /  Donald F. SchenkelDonald
                F. Schenkel, Chairman of the Board,President
                and Chief Executive OfficerDated:  November
                12, 2007
            /
                s
                /  Richard R. SawyerRichard
                R. SawyerChief
                Financial Officer, and Secretary






**29**