UNITED
      STATES


SECURITIES
      AND EXCHANGE COMMISSION


Washington,
      D.C.  20549





**Form
      10-Q**


(Mark
      One)





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





For
      the
      quarterly period ended **March 31, 2007**





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





For
      the
      transition period from ____________ to ____________








Commission
      file number 000-25287





**TOWER
        FINANCIAL CORPORATION**


(Exact
      name of Registrant as specified in its charter)








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








116
      East
      Berry Street, Fort Wayne, Indiana 46802


(Address
      of principal executive offices)








(260)
        427-7000
 (Registrant’s
        telephone number)





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


Yes
S   
      No £





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


Large
                accelerated filer £
            Accelerated
                filer £
            Non-accelerated
                filer S





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


Yes
£   
      No S





Number
      of
      shares of the issuer’s common stock, without par value, outstanding as of May
      10, 2007: 4,076,832.







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





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




2




**INDEX**





**PART
                I.   FINANCIAL INFORMATION**Item
                1.Financial Statements
            page
                no.Consolidated
                Condensed Balance Sheets at March 31, 2007
                (unaudited) and December 31, 2006
            4Consolidated
                Condensed Statements of Operations for the three
                months ended March 31, 2007 and March 31, 2006
                (unaudited)
            5Consolidated
                Condensed Statements of Changes in
                Stockholders’ Equity for the three months ended March 31, 2007 and March
                31, 2006 (unaudited)
            6Consolidated
                Condensed Statements of Cash Flows for the
                three months ended March 31, 2007 and March 31, 2006
                (unaudited)
            7Notes
                to Consolidated Condensed Financial Statements
                (unaudited)
            8Item
                2.  Management’s Discussion and Analysis of
                Financial Condition and Results of Operations
            15Item
                3.  Quantitative and Qualitative Disclosures
                About Market Risk
            22Item
                4.  Controls and
                Procedures
            24**PART
                II.   OTHER INFORMATION**Item
                1.  Legal
                Proceedings
            25Item
                6.  Exhibits
            25**SIGNATURES**
            25




3
 *Index*




**PART
      I.  FINANCIAL INFORMATION**





**Item
      1.  FINANCIAL STATEMENTS**





**Tower
      Financial Corporation**


**Consolidated
      Condensed Balance Sheets**


At
      March
      31, 2007 and December 31, 2006





*(unaudited)*
              **March
                31,**
              **2007**
            
            
            **December
                31,**
              **2006****ASSETS**Cash
                and due from banks
            
            $
            12,314,115
            
            
            $
            14,393,790Short-term
                investments and interest-earning deposits
            
            
            6,039,916
            
            
            
            8,863,112Federal
                funds sold
            
            
            5,581,358
            
            
            
            5,608,064Total
                cash and cash equivalents
            
            
            23,935,389
            
            
            
            28,864,966Securities
                available for sale, at fair value
            
            
            67,896,768
            
            
            
            69,491,806FHLB
                and FRB stock
            
            
            3,078,400
            
            
            
            3,078,400Loans
            
            
            568,480,656
            
            
            
            550,450,313Allowance
                for loan losses
            
            
            (7,662,831
            )
            
            
            (6,870,442
            )Net
                loans
            
            
            560,817,825
            
            
            
            543,579,871Premises
                and equipment, net
            
            
            6,339,101
            
            
            
            5,870,699Accrued
                interest receivable
            
            
            3,610,898
            
            
            
            3,620,368Bank
                owned life insurance
            
            
            10,948,708
            
            
            
            10,851,519Other
                assets
            
            
            6,404,918
            
            
            
            5,797,183Total
                assets
            
            $
            683,032,007
            
            
            $
            671,154,812**LIABILITIES
                AND STOCKHOLDERS' EQUITY**LIABILITIESDeposits:Noninterest-bearing
            
            $
            71,218,960
            
            
            $
            77,772,481Interest-bearing
            
            
            518,582,786
            
            
            
            508,997,823Total
                deposits
            
            
            589,801,746
            
            
            
            586,770,304Federal
                Home Loan Bank (FHLB) advances
            
            
            20,200,000
            
            
            
            11,200,000Junior
                subordinated debt
            
            
            17,527,000
            
            
            
            17,527,000Accrued
                interest payable
            
            
            1,741,542
            
            
            
            1,716,994Other
                liabilities
            
            
            2,375,541
            
            
            
            2,982,675Total
                liabilities
            
            
            631,645,829
            
            
            
            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;
                4,072,332 shares issued and outstanding at March 31, 2007 and 4,043,882
                at
                December 31, 2006
            
            
            38,939,159
            
            
            
            38,536,406Retained
                earnings
            
            
            12,521,268
            
            
            
            12,523,750Accumulated
                other comprehensive income(loss), net of tax of $(34,183) at March
                31,
                2007 and $(53,785) at December 31, 2006
            
            
            (74,249
            )
            
            
            (102,317
            )Total
                stockholders' equity
            
            
            51,386,178
            
            
            
            50,957,839Total
                liabilities and stockholders' equity
            
            $
            683,032,007
            
            
            $
            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 months ended March 31, 2007 and 2006





*(unaudited)*
              **Three
                Months ended**
              **March
                31****2007**
            
            
            **2006****Interest
                income:**Loans,
                including fees
            
            $
            10,317,566
            
            
            $
            8,145,444Securities
                - taxable
            
            
            653,945
            
            
            
            490,564Securities
                - tax exempt
            
            
            200,775
            
            
            
            147,392Other
                interest income
            
            
            219,080
            
            
            
            145,002Total
                interest income
            
            
            11,391,366
            
            
            
            8,928,402**Interest
                expense:**Deposits
            
            
            5,675,885
            
            
            
            3,593,755FHLB
                advances
            
            
            191,744
            
            
            
            352,179Junior
                subordinated debt
            
            
            281,649
            
            
            
            209,230Total
                interest expense
            
            
            6,149,278
            
            
            
            4,155,164Net
                interest income
            
            
            5,242,088
            
            
            
            4,773,238**Provision
                for loan losses**
            
            
            1,425,000
            
            
            
            575,000Net
                  interest income after provisionfor loan losses
            
            
            3,817,088
            
            
            
            4,198,238**Noninterest
                income:**Trust
                and brokerage fees
            
            
            845,893
            
            
            
            790,956Service
                charges
            
            
            265,853
            
            
            
            178,681Loan
                broker fees
            
            
            29,195
            
            
            
            30,620Other
                fees
            
            
            357,129
            
            
            
            391,045Total
                noninterest income
            
            
            1,498,070
            
            
            
            1,391,302**Noninterest
                expense:**Salaries
                and benefits
            
            
            2,995,501
            
            
            
            2,502,982Occupancy
                and equipment
            
            
            688,194
            
            
            
            480,177Marketing
            
            
            79,043
            
            
            
            172,346Data
                processing
            
            
            227,949
            
            
            
            145,968Loan
                and professional costs
            
            
            358,813
            
            
            
            220,786Office
                supplies and postage
            
            
            123,385
            
            
            
            106,639Courier
                services
            
            
            100,810
            
            
            
            92,706Business
                development
            
            
            157,753
            
            
            
            104,944Other
                expense
            
            
            430,847
            
            
            
            273,338Total
                noninterest expense
            
            
            5,162,295
            
            
            
            4,099,886**Income
                before income taxes**
            
            
            152,863
            
            
            
            1,489,654Income
                taxes expense (benefit)
            
            
            (23,750
            )
            
            
            496,700**Net
                income**
            
            $
            176,613
            
            
            $
            992,954**Basic
                earnings per common share**
            
            $
            0.04
            
            
            $
            0.25**Diluted
                earnings per common share**
            
            $
            0.04
            
            
            $
            0.24Average
                common shares outstanding
            
            
            4,068,657
            
            
            
            4,008,000Average
                common shares and dilutive potential common shares
                outstanding
            
            
            4,163,169
            
            
            
            4,105,496Dividends
                declared per share
            
            $
            0.044
            
            
            
            0.04




*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
      three months ended March 31, 2007 and 2006


*(unaudited)*





**Common**
              **Stock
                and**
              **Paid-in**
              **Capital**
            
            
            **Retained**
              **Earnings**
            
            
            **Accumulated**
              **Other**
              **Comprehensive**
              **Income
                (Loss)**
            
            
            **Total****Balance,
                January 1, 2006**
            
            $
            38,006,929
            
            
            $
            9,478,812
            
            
            $
            (217,687
            )
            
            $
            47,268,054Net
                income for 2006
            
            
            
            
            
            
            992,954
            
            
            
            
            
            
            
            992,954Change
                in net unrealized appreciation (depreciation) on securities available
                for
                sale, net of tax of $102,611
            
            
            
            
            
            
            
            
            
            
            (182,419
            )
            
            
            (182,419
            )Total
                Comprehensive Income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            810,535Cash
                dividends paid ($0.04 per share)
            
            
            
            
            
            
            (160,317
            )
            
            
            
            
            
            
            (160,317
            )Issuance
                of 156 shares of common stock for stock options exercised including
                tax
                benefit
            
            
            2,013
            
            
            
            
            
            
            
            
            
            
            
            2,013Stock
                based compensation expense
            
            
            30,501
            
            
            
            
            
            
            
            
            
            
            
            30,501**Balance,
                March 31, 2006**
            
            $
            38,039,443
            
            
            $
            10,311,449
            
            
            $
            (400,106
            )
            
            $
            47,950,786**Balance,
                January 1, 2007**
            
            $
            38,536,406
            
            
            $
            12,523,750
            
            
            $
            (102,317
            )
            
            $
            50,957,839Net
                income for 2007
            
            
            
            
            
            
            176,613
            
            
            
            
            
            
            
            176,613Change
                in net unrealized appreciation (depreciation) on securities available,
                for
                sale, net of tax of $17,397
            
            
            
            
            
            
            
            
            
            
            30,273
            
            
            
            30,273Change
                in net unrealized gain (loss) on cash flow hedge, net of tax of
                $(1,136)
            
            
            
            
            
            
            
            
            
            
            (2,205
            )
            
            
            (2,205
            )Total
                Comprehensive Income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            204,681Cash
                dividends paid ($0.044 per share)
            
            
            
            
            
            
            (179,095
            )
            
            
            
            
            
            
            (179,095
            )Issuance
                of 28,000 shares of common stock for stock options exercised, including
                tax benefit
            
            
            380,823
            
            
            
            
            
            
            
            
            
            
            
            380,823Stock
                based compensation expense
            
            
            21,930
            
            
            
            
            
            
            
            
            
            
            
            21,930**Balance,
                March 31, 2007**
            
            $
            38,939,159
            
            
            $
            12,521,268
            
            
            $
            (74,249
            )
            
            $
            51,386,178




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





6
 *Index*





**Tower
      Financial Corporation**


**Consolidated
      Condensed Statements of Cash Flows**


For
      the
      three months ended March 31, 2007 and 2006





*(unaudited)*
              **Three
                Months ended**
              **March
                31, 2007**
            
            
            *(unaudited)*
              **Three
                Months ended**
              **March
                31, 2006****Cash
                flows from operating activities:**Net
                income
            
            $
            176,613
            
            
            $
            992,954Adjustments
                to reconcile net income to net cash from operating
                activities:Depreciation
                and amortization
            
            
            236,327
            
            
            
            192,665Provision
                for loan losses
            
            
            1,425,000
            
            
            
            575,000Stock
                option compensation expense
            
            
            21,930
            
            
            
            30,501Earnings
                on life insurance
            
            
            (97,189
            )
            
            
            (95,298
            )Change
                in accrued interest receivable
            
            
            9,470
            
            
            
            56,841Change
                in other assets
            
            
            (627,337
            )
            
            
            (835,548
            )Change
                in accrued interest payable
            
            
            24,548
            
            
            
            162,953Change
                in other liabilities
            
            
            (607,134
            )
            
            
            (261,167
            )Net
                cash from operating activities
            
            
            562,228
            
            
            
            818,901**Cash
                flows from investing activities:**Net
                change in loans
            
            
            (21,397,312
            )
            
            
            (18,314,352
            )Purchase
                of loans
            
            
            (3,103,568
            )
            
            
            (9,207,992
            )Purchase
                of securities available for sale
            
            
            -
            
            
            
            (4,456,890
            )Proceeds
                from maturities of securities available for sale
            
            
            1,658,020
            
            
            
            974,254Proceeds
                from sale of participation loans
            
            
            5,837,926
            
            
            
            3,757,269Purchase
                of premises and equipment
            
            
            (720,041
            )
            
            
            (867,331
            )Net
                cash from investing activities
            
            
            (17,724,975
            )
            
            
            (28,115,042
            )**Cash
                flows from financing activities:**Net
                change in deposits
            
            
            3,031,442
            
            
            
            11,227,235Cash
                dividends paid
            
            
            (179,095
            )
            
            
            (160,317
            )Proceeds
                from issuance of common stock from exercise of stock
                options
            
            
            321,314
            
            
            
            2,013Tax
                benefit from issuance of common stock
            
            
            59,509Proceeds
                from FHLB advances
            
            
            23,200,000
            
            
            
            23,000,000Repayment
                of FHLB advances
            
            
            (14,200,000
            )
            
            
            (20,000,000
            )Net
                cash from financing activities
            
            
            12,233,170
            
            
            
            14,068,931**Net
                change in cash and cash equivalents**
            
            
            (4,929,577
            )
            
            
            (13,227,210
            )Cash
                and cash equivalents, beginning of period
            
            
            28,864,966
            
            
            
            37,908,337**Cash
                and cash equivalents, end of period**
            
            $
            23,935,389
            
            
            $
            24,681,127Supplemental
                disclosures of cash flow informationCash
                paid during the year for:Interest
            
            $
            6,124,730
            
            
            $
            3,992,211Income
                taxes
            
            
            -




*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.





We
      have
      four distinct operating segments, which are further detailed in Note 6 of the
      Financial Statements.  The segments are Banking, Indianapolis
      operations, Wealth Management, and Corporate and Intercompany.  The
      segments are evaluated separately on their individual performance, as well,
      as
      on their contribution to the Tower Financial Corporation as a
      whole.





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, a loan production office in Warsaw, Indiana,
      and a loan production office in Indianapolis, Indiana.





During
      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,
      Indiana.  Once formed and capitalized, we plan to invest between $6.75
      and $7.65 million and will own 51% of the common stock of TBCI.  In
      the first quarter of 2007 the Indiana Department of Financial Institutions
      approved our application for the formation of TBCI and we are awaiting final
      approval from the Federal Deposit Insurance Corporation.  Upon
      formation of TBCI, the Indianapolis loan production office will be converted
      into the corporate office for TBCI and the employees, loans, and deposits will
      be transferred from the Bank to TBCI.  We expect to be reimbursed for
      a portion of start-up costs incurred to date at that time.  Total
      costs through the first quarter of 2007 were approximately
      $528,000.





**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 has been accepted and has been
      approved by the Indiana Department of Financial Institutions.  We
      anticipate approval by the Federal Deposit Insurance Corporation during the
      second quarter of 2007, with an opening in the summer of 2007.  Upon
      formation, we will own 51% of the common stock of TBCI.  During 2006
      the Indianapolis office operated as a loan production office of the
      Bank.





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 four 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 March 31, 2007, commercial
      and
      commercial real estate loans totaled approximately 74.8% of total loans,
      residential real estate loans totaled approximately 16.0% and home equity and
      consumer loans totaled approximately 9.2%. Categories by industry of commercial
      loans at March 31, 2007 exceeding 30% of quarter-end stockholders’ equity are as
      follows: real estate (including owner-occupied and investment) - $106.9 million,
      or 18.8% of total loans; wholesale and retail trade - $47.1 million, or 8.3%
      of
      total loans; building, development and general contracting - $81.2 million,
      or
      14.3% of total loans; health care and social assistance - $35.2 million, or
      6.2%
      of total loans; manufacturing - $24.7 million, or 4.3% of total loans;
      accommodation and food services - $22.9 million or 4.0% of total loans; rental
      and leasing - $16.4 million or 2.9% of total loans; and finance and insurance
      -
      $19.6 million or 3.4% 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
      $10.9 million at March 31, 2007 and December 31, 2006.





**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 March 31,
      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 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 dividend to $0.044 per share beginning in
      the
      first quarter of 2007, which totaled $179,095.





**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 dilutive impact of any additional
      potential common shares issuable under the Equity Incentive Plan.





**Comprehensive
      Income:**Comprehensive income consists of net income 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
      $38,735 and $1,050,288 and was sufficient to meet the regulatory reserve and
      clearing requirements at March 31, 2007 and 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 March 31, 2007 and its
      consolidated results of operations, comprehensive income, changes in
      stockholders’ equity and cash flows for the three-month periods ended March 31,
      2007 and March 31, 2006.   The results for the period ended March
      31, 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:**  Effective January 1, 2007, we
      adopted FASB Interpretation No. 48, *Accounting for Uncertainty in Income
      Taxes – an interpretation of FASB Statement No. 109* (FIN 48), which
      prescribes a recognition threshold and measurement attribute for a tax position
      taken or expected to be taken in a tax return.  FIN 48 also provides
      guidance on derecognition, classification, interest and penalties, accounting
      in
      interim periods, disclosure and transition.  That adoption of FIN 48
      did not have a material effect on our financial statements.





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.





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 Per Share**





The
      following table reflects the calculation of basic and diluted earnings per
      common share for the three-month periods ended March 31, 2007 and March 31,
      2006.  Options not considered in the calculation of diluted earnings
      per common share because they were antidilutive, totaled 22,910 and 20,750
      for
      the three-month period ended March 31, 2007 and 2006, respectively.





**Three
                Months Ended**
              **March
                31****2007**
            
            
            **2006****Basic**Net
                income
            
            $
            176,613
            
            
            $
            992,954Weighted
                average common shares outstanding
            
            
            4,068,657
            
            
            
            4,008,000Basic
                earnings per common share
            
            $
            0.04
            
            
            $
            0.25**Diluted**Net
                income
            
            $
            176,613
            
            
            $
            992,954Weighted
                average common shares outstanding
            
            
            4,068,657
            
            
            
            4,008,000Add:  dilutive
                effect of assumed stock option exercises
            
            
            94,512
            
            
            
            97,496Weighted
                average common shares and dilutive potential common shares
                outstanding
            
            
            4,163,169
            
            
            
            4,105,496Diluted
                earnings per common share
            
            $
            0.04
            
            
            $
            0.24




**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 287,600 remain outstanding as of March 31, 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 $19,611 and $30,501 for the three months ended
      March 31, 2007 and March 31, 2006, respectively.  No income tax
      benefit was recognized in the income statement for the share-based compensation
      arrangements.





12
 *Index*




A
      summary
      of the option activity under the Plans as of March 31, 2007 and changes during
      the three-month period then ended are presented below:





Options
            
            Shares
            
            
            Weighted
              Average
              Exercise
              Price
            
            
            Weighted-
              Average
              Remaining
              Contractual
              Term
            
            
            Aggregate
              Intrinsic
              ValueOutstanding
                at 1/1/07
            
            
            315,600
            
            
            $
            11.30Granted
            
            
            0Exercised
            
            
            28,000
            
            
            $
            11.48Forfeited
                or expired
            
            
            0Outstanding
                at 3/31/07
            
            
            287,600
            
            
            $
            11.29
            
            
            
            3.74
            
            
            $
            1,596,180Exercisable
                at 3/31/07
            
            
            253,718
            
            
            $
            10.81
            
            
            
            3.74
            
            
            $
            1,529,920




The
      weighted-average grant-date fair value of options granted during the three
      months ended 2007 and 2006 was $0 and $0.  The total intrinsic value
      of options exercised during the three months ended March 31, 2007 and 2006,
      was
      $175,028 and $560.





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 March 31,
      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 that has been charged against income for restricted shares
      awarded under the Plan in accordance with FAS123(R) was $2,319 for the three
      months ended March 31, 2007.  No income tax benefit was recognized in
      the income statement for the share-based compensation arrangements.





A
      summary
      of the status of the Company’s nonvested shares as of March 31, 2007, and
      changes during the three-month period ended March 31, 2007, is presented
      below:





Non-vested
                shares
            
            Shares
            
            
            Weighted-Average
              Grant-Date
              Fair
                ValueNonvested
                at 1/1/07
            
            
            2,000
            
            
            $
            19.22Granted
            
            
            450
            
            
            $
            17.65Vested
            
            
            0Nonvested
                at 3/31/07
            
            
            2,450
            
            
            $
            18.93




**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.





13
 *Index*




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 fair value of
      the floor at March 31, 2007 was $168,880.  The difference between the
      purchase price and the fair value, net of tax, is shown in the equity section
      as
      an 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 March 31,
      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 four distinct businesses for
      reporting purposes.  The four segments are Banking, Indianapolis
      operations, 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
      Indianapolis segment currently operates as a loan production office of the
      Bank
      and was opened in July 2006.   In October 2006, the Company filed
      an application with the Indiana Department of Financial Institutions (DFI)
      and
      the Federal Deposit Insurance Corporation (FDIC) to form a de novo bank, Tower
      Bank of Central Indiana (TBCI).  In the first quarter of 2007 the
      Indiana Department of Financial Institutions approved our application for the
      formation of TBCI and we are awaiting final approval from the Federal Deposit
      Insurance Corporation.  Upon formation of TBCI, the Indianapolis loan
      production office will be converted into the corporate office for TBCI and
      the
      employees, loans, and deposits will be transferred from the Bank to
      TBCI.  We will be reimbursed for start-up costs incurred to date at
      that time.





The
      Wealth Management segment is made up of Tower Trust
      Company.    On January 1, 2006, the Trust Company was formed
      as a wholly-owned subsidiary of the Company.   Prior to January
      1, 2006, the Trust Company operated as a division of the
      Bank.   The Trust Company provides estate planning, investment
      management, and retirement planning, as well as investment brokerage
      services.





The
      Corporate and Intercompany segment includes the holding company and subordinated
      debentures.  We incur general corporate expenses, as well as interest
      expense on the subordinated debentures.





Information
      reported internally for performance assessment follows.





14
 *Index*




**As
                of and for the three months ended March 31, 2007****Bank**
            
            
            **Indianapolis**
            
            
            **Wealth**
              **Management**
            
            
            **Corporate
                &**
              **Intercompany**
            
            
            **Eliminations**
            
            
            **Total****Income
                Statement Information**Net
                interest income
            
            $
            5,448,940
            
            
            $
            43,394
            
            
            $
            31,403
            
            
            $
            (281,649
            )
            
            $
            -
            
            
            $
            5,242,088Non-interest
                income
            
            
            645,634
            
            
            
            -
            
            
            
            845,892
            
            
            
            451,613
            
            
            
            (445,069
            )
            
            
            1,498,070Non-interest
                expense
            
            
            4,187,245
            
            
            
            210,320
            
            
            
            605,670
            
            
            
            159,060
            
            
            
            -
            
            
            
            5,162,295Noncash
                itemsProvision
                for loan losses
            
            
            1,417,407
            
            
            
            7,593
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            1,425,000Depreciation/Amortization
            
            
            223,976
            
            
            
            3,195
            
            
            
            9,156
            
            
            
            
            
            
            
            
            
            
            
            236,327Income
                tax expense (benefit)
            
            
            23,090
            
            
            
            -
            
            
            
            118,870
            
            
            
            (165,710
            )
            
            
            -
            
            
            
            (23,750
            )Segment
                Profit/(Loss)
            
            
            466,832
            
            
            
            (174,519
            )
            
            
            152,755
            
            
            
            176,614
            
            
            
            (445,069
            )
            
            
            176,613**Balance
                Sheet Information**Segment
                Assets
            
            
            677,716,216
            
            
            
            3,595,684
            
            
            
            5,754,192
            
            
            
            71,946,599
            
            
            
            (75,980,684
            )
            
            
            683,032,007








**As
                and for the three months ending March 31, 2006****Bank**
            
            
            **Indianapolis**
            
            
            **Wealth**
              **Management**
            
            
            **Corporate
                &**
              **Intercompany**
            
            
            **Eliminations**
            
            
            **Total****Income
                Statement Information**Net
                interest income
            
            $
            4,964,098
            
            
            $
            -
            
            
            $
            18,370
            
            
            $
            (209,230
            )
            
            $
            -
            
            
            $
            4,773,238Non-interest
                income
            
            
            3,559,611
            
            
            
            -
            
            
            
            790,955
            
            
            
            4,198,640
            
            
            
            (7,157,904
            )
            
            
            1,391,302Non-interest
                expense
            
            
            3,447,469
            
            
            
            -
            
            
            
            499,046
            
            
            
            153,371
            
            
            
            -
            
            
            
            4,099,886Noncash
                itemsProvision
                for loan losses
            
            
            575,000
            
            
            
            -
            
            
            
            
            
            
            
            -
            
            
            
            -
            
            
            
            575,000Depreciation/Amortization
            
            
            192,665
            
            
            
            -
            
            
            
            
            
            
            
            -
            
            
            
            -
            
            
            
            192,665Income
                tax expense
            
            
            507,700
            
            
            
            -
            
            
            
            124,370
            
            
            
            (135,370
            )
            
            
            -
            
            
            
            496,700Segment
                Profit
            
            
            3,993,540
            
            
            
            -
            
            
            
            185,909
            
            
            
            3,971,409
            
            
            
            (7,157,904
            )
            
            
            992,954**Balance
                Sheet Information**Segment
                Assets
            
            
            571,439,355
            
            
            
            -
            
            
            
            5,243,412
            
            
            
            62,828,043
            
            
            
            (66,878,397
            )
            
            
            572,632,413





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




15
 *Index*





**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**





Net
      Income for the first quarter 2007 was $176,613, an 82.2% decrease from first
      quarter 2006.  The decrease was primarily due to a large provision for
      loan losses taken in the first quarter 2007.





Operating
      expenses increased by 25.9% in first quarter 2007 compared to first quarter
      2006
      due to the continued growth of the organization, which included opening a sixth
      branch in Allen County, a loan production office in Warsaw, Indiana, and a
      loan
      production office in Indianapolis, Indiana.  All of which were
      fully-functioning in first quarter 2007, but not in first quarter
      2006.





Total
      Assets grew $11.9 million from December 31, 2006 to March 31,
      2007.  The increase was primarily in the loan portfolio, which grew
      $18.0 million or 13.1% annualized.  This was offset somewhat by the
      decrease in cash and short-term investments of $5 million, which was used to
      fund some of the growth in the loan portfolio.





Total
      Deposits grew by only $3 million, or 2.1% annualized, in the first quarter
      2007.  However, Brokered CD’s and out of market deposits decreased by
      $20.5 million from December 31, 2006 to March 31, 2007, reflective of a net
      increase of in-market deposits of $23.5 million in the first
      quarter.





**Financial
      Condition**





We
      experienced modest growth in the first three months of 2007, as total assets
      of
      the Company were $683.0 million at March 31, 2007 compared to total assets
      at
      December 31, 2006 of $671.2 million.  The 1.8% increase in assets was
      primarily due to an increase in loans of $18.0 million, or 3.3%.  This
      growth was supported by $9.0 million in borrowings and $3.0 million of deposit
      growth.  The remainder of the growth was supported through the use of
      cash and cash equivalents, which decreased by $4.9 million, or 17.1% during
      the
      first three months of 2007 due to our continued efforts to lower our excess
      liquidity from December 31, 2006 versus borrowing additional funds.





*Cash
      and Investments*.   Cash and cash equivalents, which include
      federal funds sold, were $23.9 million at March 31, 2007, a decrease of $4.9
      million, or 17.1%.  Securities available for sale were $67.9 million
      at the end of the first quarter of 2007, a decrease of $1.6 million from
      December 31, 2006 due to maturities and pay downs.  The net decrease
      in cash and cash equivalents during the first quarter of 2007 was reflective
      of
      our cash needs relative to loan growth.





*Loans*.  Total
      loans were $568.5 million at March 31, 2007 reflecting an 3.3% increase from
      total loans of $550.5 million at December 31, 2006.   Loan growth
      during the first three months of 2007 occurred mainly in the residential and
      commercial portfolios, with some growth in the commercial real estate
      portfolio.   The growth of the residential real estate portfolio
      was due to a continued effort to neutralize our interest rate risk profile
      by
      placing more fixed rate loans in our portfolio.  Approximately $3.1
      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 overall mix of the loan portfolio has changed slightly
      since year-end as we have increased our residential real estate portfolio.
      The
      total of commercial and commercial real estate loans in the portfolio was 74.8%
      at March 31, 2007 and 75.5% at December 31, 2006.





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





**March
                31, 2007**
            
            
            **December
                31, 2006****Balance**
            
            
            **%**
            
            
            **Balance**
            
            
            **%**Commercial
            
            $
            243,334,105
            
            
            
            42.8%
            
            
            $
            236,808,842
            
            
            
            43.0%Commercial
                real estate
            
            
            181,657,086
            
            
            
            32.0%
            
            
            
            178,610,609
            
            
            
            32.5%Residential
                real estate
            
            
            91,156,096
            
            
            
            16.0%
            
            
            
            83,600,521
            
            
            
            15.2%Home
                equity
            
            
            32,024,893
            
            
            
            5.6%
            
            
            
            32,096,950
            
            
            
            5.8%Consumer
            
            
            20,341,313
            
            
            
            3.6%
            
            
            
            19,376,393
            
            
            
            3.5%Total
                loans
            
            
            568,513,493
            
            
            
            100.0%
            
            
            
            550,493,315
            
            
            
            100.0%Net
                deferred loan costs/(fees)
            
            
            (32,837
            )
            
            
            
            
            
            
            (43,002
            )Allowance
                for loan losses
            
            
            (7,662,831
            )
            
            
            
            
            
            
            (6,870,442
            )Net
                loans
            
            $
            560,817,825
            
            
            
            
            
            
            $
            543,579,871




16
 *Index*





*Nonperforming
      Assets.*  Nonperforming assets include nonperforming loans and
      other real estate owned (OREO).  Nonperforming loans include loans
      past due over 90 days and still accruing interest and all nonaccrual
      loans.  Nonperforming assets have increased from $4.2 million, or
      0.63% of total assets, at December 31, 2006 to $6.1 million, or 0.89% of total
      assets, at March 31, 2007. The increase is primarily attributed to several
      loans, two of which individually exceed $500,000.  We have guarantees
      that support both of these loans.  Total impaired loans at March 31,
      2007 were $8.1 million, compared to $8.8 million at December 31,
      2006.  The decrease was due to a combination of pay-offs and
      charge-offs in the 1st quarter
      of
      2007.  At March 31, 2007, management believes it has allocated
      adequate specific reserves of $2.6 million for these risks.  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:





**March
                31, 2007**
            
            
            **December
                31, 2006**Loans
                past due over 90 days and still accruing
            
            $
            564,073
            
            
            $
            354,096Nonaccrual
                loans
            
            
            4,749,046
            
            
            
            3,488,417Total
                nonperforming loans
            
            $
            5,313,119
            
            
            $
            3,842,513Other
                real estate owned
            
            
            743,921
            
            
            
            370,000Total
                nonperforming assets
            
            $
            6,057,040
            
            
            $
            4,212,513Nonperforming
                assets to total assets
            
            
            0.89
            %
            
            
            0.63
            %Nonperforming
                loans to total loans
            
            
            0.93
            %
            
            
            0.70
            %





*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 March 31, 2007 was $7.7 million, or 1.35% of total
      loans outstanding, an increase of $792,000 from $6.9 million, or 1.25%, at
      December 31, 2006.   The provision for loan losses during the
      first three months of 2007 was $1,425,000 compared to $575,000 in the first
      three months of 2006.  The substantial loan loss provision incurred in
      the first quarter of 2007 was primarily related to a risk-rating downgrade
      of
      two borrowers.  The loans outstanding to these borrowers are in the
      commercial real estate class.  The loans are secured by land and are
      primarily for the purpose of residential development, with some commercial
      development.  The deterioration in financial condition has caused
      concern as to the ability of the borrowers to carry future interest costs
      relating to their borrowings, and the potential of lower realized value on
      the
      sale of the real estate if the borrower elects to accelerate sales to help
      with
      cash flow.  Loans with these borrowers were current at quarter-end,
      were not deemed impaired, as management has not concluded it is probable that
      we
      will not be paid in full accordance with the loan terms; therefore, no specific
      reserve was allocated to these loans.  However, due to the migration
      of these loans into the special mention loan pool, a larger reserve percentage
      was allocated to these loans in the first quarter of 2007 versus the fourth
      quarter of 2006.





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





March
                31, 2007
            
            
            December
                31, 2006Specific
                allocations
            
            $
            2,559,000
            
            
            $
            2,756,000Loan
                pool percentage allocations
            
            
            5,094,000
            
            
            
            4,110,000Unallocated
            
            
            9,831
            
            
            
            4,442Total
                allowance for loan losses
            
            $
            7,662,831
            
            
            $
            6,870,442





The
      addition to the allowance during the first three months of 2007 was directly
      attributable to the deterioration of two lending relationships, as well as
      net
      charge-off activity during the period.  Net charge-offs for the first
      three months of 2007 were $632,611 compared to $158,045 for the first three
      months of 2006. The charge-offs during the three months ended March 31, 2007
      were primarily attributable to two commercial and two commercial real estate
      loans, and offset by a $100,000 recovery of a commercial loan
      charge-off.  Nonperforming loans increased during the first three
      months of 2007 by $1.5 million and were $5.3 million at March 31,
      2007.  Even though nonperforming loans increased in the first three
      months of 2007, the specific allowance allocations decreased by $197,000 from
      December 31, 2006.  The majority of the increase in non-performing
      loans were loans already identified as impaired and therefore already had
      specific allowance allocations.  There were some partial charge-offs
      on non-performing loans to bring 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 $984,000 during the first three months of
      2007.  As noted above, the primary reason for the increase was the
      migration of two lending relationships to the special mention loan
      classification.





17
 *Index*





Management
      considers the allowance for loan losses at March 31, 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
            
            
            1,425,000
            
            
            
            575,000Charge-offs
            
            
            (782,435
            )
            
            
            (335,057
            )Recoveries
            
            
            149,824
            
            
            
            177,012Ending
                balance, March 31
            
            $
            7,662,831
            
            
            $
            6,062,256Net
                charge-offs to average loans (annualized)
            
            
            0.46
            %
            
            
            0.14
            %





*Other
      Assets*.   The $607,735 increase in other assets was
      attributable to the addition of $400,000 in OREO properties, net of $100,000
      sale of OREO properties.  Other increases in prepaid expenses account
      for the remainder of the increase.





*Deposits*.   Total
      deposits were $589.8 million at March 31, 2007 compared to total deposits at
      December 31, 2006 of $586.7 million. The growth of $3.0 million, or 0.5%, during
      the first three months of 2007 was reflected primarily in money market accounts,
      time deposits less than $100,000, and interest-bearing
      checking.  Growth was approximately $5.1 million in money market
      deposits, $4.2 million in time deposits less than $100,000, and $3.0 million
      in
      interest-bearing checking accounts.   The majority all of the
      deposit growth during the first three months of 2007 came from “in-market”
deposits.  Brokered CD’s and out-of-market deposits decreased by $20.5
      million from $115.5 million at December 31, 2006 to $95.0 million at March
      31,
      2007.  At March 31, 2007, brokered CD’s and out-of-market deposits
      comprised 16.1% 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:





**March
                31, 2007**
            
            
            **December
                31, 2006****Balance**
            
            
            **%**
            
            
            **Balance**
            
            
            **%**Noninterest-bearing
                demand
            
            $
            71,218,960
            
            
            
            12.1
            %
            
            $
            77,772,481
            
            
            
            13.3
            %Interest-bearing
                checking
            
            
            40,475,605
            
            
            
            6.9
            %
            
            
            37,537,496
            
            
            
            6.4
            %Money
                market
            
            
            128,487,901
            
            
            
            21.8
            %
            
            
            123,387,985
            
            
            
            21.0
            %Savings
            
            
            12,937,511
            
            
            
            2.2
            %
            
            
            12,488,159
            
            
            
            2.1
            %Time,
                under $100,000
            
            
            89,372,761
            
            
            
            15.2
            %
            
            
            85,171,413
            
            
            
            14.5
            %Time,
                $100,000 and over
            
            
            247,309,008
            
            
            
            41.8
            %
            
            
            250,412,770
            
            
            
            42.7
            %Total
                deposits
            
            $
            589,801,746
            
            
            
            100.0
            %
            
            $
            586,770,304
            
            
            
            100.0
            %





*Borrowings*.   The
      Company had borrowings in the amount of $20.2 million in Federal Home Loan
      Bank
      (“FHLB”) advances at March 31, 2007 and $11.2 million at December 31,
      2006.  Three advances, totaling $9.0 million, were short-term daily
      variable rate advances and the other four, totaling $11.2 million, are bullet
      advances and mature in a range from June 2007 through June 2010.





*Other
      Liabilities.*Other liabilities decreased $607,000 from year-end
      2006.   The decrease was primarily due to the pay-out of accrued
      bonuses for the 2006 Officer Plan.





**Results
      of Operations**





For
      The Three-Month Periods Ended March 31





Results
      of operations for the three-month period ended March 31, 2007 reflected net
      income of $176,613, or $0.04 per diluted share.   This was an
      $816,000, or 82.2%, decrease from 2006’s first quarter net income of $992,954,
      or $0.24 per diluted share.   The operating results for the
      three-month period ended March 31, 2007 were unfavorable compared to the same
      period in 2006 primarily because the large loan loss provision incurred in
      the
      first quarter of 2007.  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
      quarter 2007 compared to the first quarter of 2006.





18
 *Index*





Total
      revenue, defined as net interest
      income plus total noninterest income, increased by 9.3% to $6.7 million from
      $6.2 million from first quarter 2006 to first quarter 2007.   For
      the three-month period ended March 31, 2007, net interest income increased
      9.8%,
      while total noninterest income increased 7.7% from the same period one year
      ago
      primarily due to an increase in Trust and Brokerage fees and Service
      Charges.





**Performance
                Ratios**
            
            **March
                31****2007**
            
            
            **2006**Return
                on average assets *
            
            
            0.11
            %
            
            
            0.72
            %Return
                on average equity *
            
            
            1.40
            %
            
            
            8.42
            %Net
                interest margin (TEY) *
            
            
            3.42
            %
            
            
            3.74
            %Efficiency
                ratio
            
            
            76.24
            %
            
            
            66.52
            %*
                annualized





*Net
      Interest Income*.   Interest income for the three-month
      periods ended March 31, 2007 and 2006 was $11.4 million and $8.9 million,
      respectively, while interest expense for the first quarter was $6.2 million
      in
      2007 and $4.1 million in 2006, resulting in net interest income
      of  $5.2 million for the first quarter of 2007 and $4.8 million for
      the first 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 first quarter
      of 2007 was 3.42%, while the tax equivalent net interest margin for the first
      quarter of 2006 was 3.74%.   The decrease in net interest margin
      was mainly due to the Company neutralizing its balance sheet and a flattening
      yield curve. The yield on earning assets increased 42 basis points during the
      period while cost of funds increased 44 basis points, decreasing our rate spread
      on earning assets.





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:





19
 *Index*




**As
                of and For The Three Month Period Ended****March
                31, 2007**
            
            
            **March
                31, 2006**($
                in thousands)
            
            **Average**
              **Balance**
            
            
            **Interest**
              **Earned**
              **or
                Paid**
            
            
            **Annualized**
              **Yield**
              **or
                Cost**
            
            
            **Average**
              **Balance**
            
            
            **Interest**
              **Earned**
              **or
                Paid**
            
            
            **Annualized**
              **Yield**
              **or
                Cost****Assets**Short-term
                investments and interest-earning deposits
            
            $
            5,367
            
            
            $
            132
            
            
            
            9.97
            %
            
            $
            6,951
            
            
            $
            82
            
            
            
            4.78
            %Federal
                funds sold
            
            
            5,468
            
            
            
            87
            
            
            
            6.45
            %
            
            
            5,944
            
            
            
            63
            
            
            
            4.30
            %Securities
                - taxable
            
            
            52,329
            
            
            
            654
            
            
            
            5.07
            %
            
            
            40,842
            
            
            
            491
            
            
            
            4.88
            %Securities
                - tax exempt (1)
            
            
            19,405
            
            
            
            304
            
            
            
            6.35
            %
            
            
            14,044
            
            
            
            223
            
            
            
            6.44
            %Loans
            
            
            551,000
            
            
            
            10,318
            
            
            
            7.59
            %
            
            
            458,642
            
            
            
            8,145
            
            
            
            7.20
            %Total
                interest-earning assets
            
            
            633,569
            
            
            
            11,495
            
            
            
            7.36
            %
            
            
            526,423
            
            
            
            9,004
            
            
            
            6.94
            %Allowance
                for loan losses
            
            
            (6,953
            )
            
            
            
            
            
            
            
            
            
            
            (5,915
            )Cash
                and due from banks
            
            
            11,546
            
            
            
            
            
            
            
            
            
            
            
            14,628Other
                assets
            
            
            25,831
            
            
            
            
            
            
            
            
            
            
            
            21,343Total
                assets
            
            $
            663,993
            
            
            
            
            
            
            
            
            
            
            $
            556,479**Liabilities
                and Stockholders' Equity**Interest-bearing
                checking
            
            $
            38,579
            
            
            $
            124
            
            
            
            1.30
            %
            
            $
            28,749
            
            
            $
            68
            
            
            
            0.96
            %Savings
            
            
            12,756
            
            
            
            32
            
            
            
            1.02
            %
            
            
            14,692
            
            
            
            25
            
            
            
            0.69
            %Money
                market
            
            
            125,609
            
            
            
            1,186
            
            
            
            3.83
            %
            
            
            77,215
            
            
            
            491
            
            
            
            2.58
            %Certificates
                of deposit
            
            
            370,501
            
            
            
            4,334
            
            
            
            4.74
            %
            
            
            271,382
            
            
            
            3,010
            
            
            
            4.50
            %FHLB
                advances
            
            
            15,746
            
            
            
            192
            
            
            
            4.95
            %
            
            
            34,120
            
            
            
            352
            
            
            
            4.18
            %Junior
                subordinated debt
            
            
            17,527
            
            
            
            281
            
            
            
            6.50
            %
            
            
            11,856
            
            
            
            209
            
            
            
            7.15
            %Total
                interest-bearing liabilities
            
            
            580,718
            
            
            
            6,149
            
            
            
            4.29
            %
            
            
            438,014
            
            
            
            4,155
            
            
            
            3.85
            %Noninterest-bearing
                checking
            
            
            61,436
            
            
            
            
            
            
            
            
            
            
            
            67,764Other
                liabilities
            
            
            4,586
            
            
            
            
            
            
            
            
            
            
            
            2,854Stockholders'
                equity
            
            
            50,779
            
            
            
            
            
            
            
            
            
            
            
            47,846Total
                liabilities and stockholders' equity
            
            $
            697,519
            
            
            
            
            
            
            
            
            
            
            $
            556,478**Net
                interest income**
            
            
            
            
            
            $
            5,346
            
            
            
            
            
            
            
            
            
            
            $
            4,849**Rate
                spread**
            
            
            
            
            
            
            
            
            
            
            3.07
            %
            
            
            
            
            
            
            
            
            
            
            3.09
            %**Net
                interest income as a percent of average earning
                assets**
            
            
            
            
            
            
            
            
            
            
            3.42
            %
            
            
            
            
            
            
            
            
            
            
            3.74
            %





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





*Provision
      for Loan Losses*.   A provision for loan losses was recorded
      in the amount of $1,425,000, or 103 basis points, annualized, on average loans
      during the first quarter of 2007 as compared to $575,000, or 51 basis points,
      annualized, on average loans for the first quarter of 2006.  The
      increased provision recorded for the first quarter of 2007 was driven by the
      migration of two lending relationships to the special mention loan category
      and
      by higher net charge-offs.   The allowance for loan losses at
      March 31, 2007 totaled $7,662,831 and was 1.35% of total loans outstanding
      on
      that date.  Total net charge-offs for the three-month period ended
      March 31, 2007 were $632,611, or 46 basis points, annualized, on average loans
      and were $158,045, or 14 basis points, annualized, on average loans during
      the
      same period a year ago.





*Noninterest
      Income*.   Noninterest income was $1.5 million during the
      first quarter of 2007.   This was a $106,768, or 7.7%, increase
      compared to the first quarter of 2006.  The majority of the increase
      relates to Service Charge income and Trust services fee
      income.  Service Charge income increased $87,172 from the first
      quarter of 2006 to $265,853 for the three-month period ended March 31,
      2007.  Trust services fees increased $54,937 from the first quarter of
      2006 to $845,893 for the three-month period ended March 31, 2007, reflective
      of
      an increase of $70.1 million, or 13.9%, in assets under management.





*Noninterest
      Expense*.   Noninterest expense was $5.2 million for the
      first quarter of 2007 while noninterest expense for the three-month period
      ended
      March 31, 2006 was $4.1 million.  The main components of noninterest
      expense for the first quarter of 2007 were salaries and benefits of $3.0
      million, occupancy and equipment costs of $688,194, and loan and professional
      costs in the amount of $358,813 and represent mainly infrastructure costs for
      human resource needs to operate the Bank, rent expense and equipment
      depreciation.   The 19.7% increase in salaries and benefits
      reflects a 23.0% growth in full-time employees, year over year, as part of
      our
      expansion activities throughout the last twelve months, significant benefit
      cost
      increases, and the recognition of $21,930 in stock compensation expense per
      FAS123(R).  The majority of our expansion was due to the opening of
      our Southwest Fort Wayne financial center, the Warsaw, Indiana loan production
      office, the transformation of our Angola loan production office into a full
      service financial center, and the opening of the loan production office in
      Indianapolis.  Loan and professional expenses increased by $138,027,
      or 62.5%, primarily due to Indianapolis start-up costs, and legal and consulting
      fees for the 2007 proxy reporting relating to the new compensation
      rules.  Other expenses increased $157,509, or 57.6%, due primarily
      from approximately $75,000 of extra-ordinary expenses associated with a refund
      of unearned loan fees on recourse loans sent back to the originator, a debit
      card printing error, and  a robbery at one of our
      branches.





20
 *Index*





*Income
      Taxes.* During the quarters ended March 31, 2007 and 2006,
      the Company recorded $23,750 and $496,700, in income taxes benefit and income
      tax expense, respectively. The effective tax rate recorded was 0% for 2007
      as
      compared to 33.4% for 2006.  The tax benefit in 2007 is the result of
      excess tax-exempt income over net income.  Tax-exempt income includes
      earnings on bank-owned life insurance and municipal securities.





**Liquidity
      and Capital Resources**





*Liquidity*.   Our
      general liquidity strategy is to fund growth with deposits and to maintain
      an
      adequate level of short- and medium-term investments to meet typical daily
      loan
      and deposit activity needs.   The first 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 $133.2 million, or 21.2% of our total funding, at March
      31, 2007.   Total deposits at March 31, 2007 were $589.8 million
      and the loan to deposit ratio was 96.4%.   Total borrowings at
      March 31, 2007 were $37.7 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 $51.4 million and $51.0 million at
      March 31, 2007 and December 31, 2006, respectively. Affecting the increase
      in
      stockholders’ equity during the first three months of 2007 was $176,613 in net
      income, reduced by a dividend payment of $179,095, or $0.044 per share, and
      a
      $28,068 increase in the unrealized appreciation of securities available for
      sale, net of tax.  Additionally, the Company issued 28,000 shares of
      common stock from stock options exercised for $380,823 and recorded $21,930
      of
      stock option compensation expense per FAS123R.





During
      the first three months of 2007, we made one dividend payment.  The
      dividend declared and paid was $0.044 per share, which was a 10% increase over
      the 2006 quarterly dividends.  The dividend payment amounted to
      $179,095.  In April of 2007, the Board declared a $0.044/share
      dividend for shareholders of record as of May 1, 2007.  Our ability to
      pay future cash and stock dividends is subject to limitations under various
      laws
      and regulations and to prudent and sound banking practices, however we
      anticipate to continuing paying dividends on a quarterly basis at the increased
      level for the foreseeable future.








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





**March
                31, 2007**
            
            
            **December
                31, 2006**Actual
            
            
            Well-
              Capitalized
            
            
            Minimum
              Required
            
            
            Actual
            
            
            Well-
              Capitalized
            
            
            Minimum
              Required**The
                Company**Leverage
                capital
            
            
            10.31
            %
            
            
            5.00
            %
            
            
            4.00
            %
            
            
            10.46
            %
            
            
            5.00
            %
            
            
            4.00
            %Tier
                1 risk-based
            
            
            11.76
            %
            
            
            6.00
            %
            
            
            4.00
            %
            
            
            11.94
            %
            
            
            6.00
            %
            
            
            4.00
            %Total
                risk-based
            
            
            12.92
            %
            
            
            10.00
            %
            
            
            8.00
            %
            
            
            13.06
            %
            
            
            10.00
            %
            
            
            8.00
            %**The
                Bank**Leverage
                capital
            
            
            8.03
            %
            
            
            5.00
            %
            
            
            4.00
            %
            
            
            8.23
            %
            
            
            5.00
            %
            
            
            4.00
            %Tier
                1 risk-based
            
            
            9.19
            %
            
            
            6.00
            %
            
            
            4.00
            %
            
            
            9.37
            %
            
            
            6.00
            %
            
            
            4.00
            %Total
                risk-based
            
            
            10.44
            %
            
            
            10.00
            %
            
            
            8.00
            %
            
            
            10.58
            %
            
            
            10.00
            %
            
            
            8.00
            %




**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 March 31, 2007, the rates
      on existing off-balance-sheet instruments were equivalent to current market
      rates, considering the underlying credit standing of the
      counterparties.





21
 *Index*





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
      three 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.





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 March 31,
      2007:





22
 *Index*





**Rate
      Sensitivity Analysis**


($
                in thousands)
            
            **Within**
              **Three**
              **Months**
            
            
            **Three
                to**
              **Twelve**
              **Months**
            
            
            **One
                to**
              **Five**
              **Years**
            
            
            **After**
              **Five**
              **Years**
            
            
            **Total****Assets**Federal
                funds sold, short-term investments and interest-earning
                deposits
            
            
            11,621
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            $
            11,621Securities
                available for sale
            
            
            1,797
            
            
            
            8,121
            
            
            
            36,468
            
            
            
            21,511
            
            
            
            67,897FHLBI
                and FRB stock
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            3,078
            
            
            
            3,078Fixed
                rate loans
            
            
            19,072
            
            
            
            48,005
            
            
            
            143,259
            
            
            
            41,235
            
            
            
            251,571Variable
                rate loans
            
            
            98,657
            
            
            
            120,131
            
            
            
            96,686
            
            
            
            1,436
            
            
            
            316,910Allowance
                for loan losses
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (7,663
            )Other
                assets
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            39,618Total
                assets
            
            $
            131,147
            
            
            $
            176,257
            
            
            $
            276,414
            
            
            $
            67,260
            
            
            $
            683,032**Liabilities**Interest-bearing
                checking
            
            
            40,476
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            $
            40,476Savings
                accounts
            
            
            12,938
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            12,938Money
                market accounts
            
            
            128,488
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            128,488Time
                deposits < $100,000
            
            
            12,682
            
            
            
            36,262
            
            
            
            40,292
            
            
            
            137
            
            
            
            89,373Time
                deposits $100,000 and over
            
            
            68,315
            
            
            
            86,584
            
            
            
            92,410
            
            
            
            -
            
            
            
            247,309Short-term
                borrowings
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -FHLB
                advances
            
            
            2,500
            
            
            
            12,500
            
            
            
            5,200
            
            
            
            -
            
            
            
            20,200Junior
                subordinated debt
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            17,527
            
            
            
            17,527Noninterest-bearing
                checking
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            71,219Other
                liabilities
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            4,117Total
                liabilities
            
            
            265,398
            
            
            
            135,347
            
            
            
            137,901
            
            
            
            17,664
            
            
            
            631,646**Stockholders'
                Equity**
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            51,386Total
                sources of funds
            
            $
            265,398
            
            
            $
            135,347
            
            
            $
            137,901
            
            
            $
            17,664
            
            
            $
            683,032Net
                asset (liability) GAP
            
            $
            (134,251
            )
            
            $
            40,910
            
            
            $
            138,512
            
            
            $
            49,595
            
            
            $**Cumulative
                GAP**
            
            $
            (134,251
            )
            
            $
            (93,341
            )
            
            $
            45,171
            
            
            $
            94,767
            
            
            $**Percent
                of cumulative GAP to total assets**
            
            
            -19.7
            %
            
            
            -13.7
            %
            
            
            6.6
            %
            
            
            13.9
            %




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 March 31, 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.





23
 *Index*




**Principal
                Amount Maturing in:**($
                in thousands)
            
            **03/31/08**
            
            
            **03/31/09**
            
            
            **03/31/10**
            
            
            **03/31/11**
            
            
            **03/31/12**
            
            
            **Thereafter**
            
            
            **Total**
            
            
            **Fair
                Value**
              **3/31/2007**Rate
                sensitive assets:Fixed
                interest rate loans
            
            $
            67,076
            
            
            $
            49,473
            
            
            $
            33,537
            
            
            $
            29,773
            
            
            $
            21,693
            
            
            $
            50,019
            
            
            $
            251,571
            
            
            $
            249,500Average
                interest rate
            
            
            7.10
            %
            
            
            6.80
            %
            
            
            6.68
            %
            
            
            6.76
            %
            
            
            6.85
            %
            
            
            5.47
            %
            
            
            6.60
            %Variable
                interest rate loans
            
            
            218,788
            
            
            
            55,316
            
            
            
            18,283
            
            
            
            11,610
            
            
            
            8,835
            
            
            
            4,077
            
            
            
            316,910
            
            
            
            316,910Average
                interest rate
            
            
            8.31
            %
            
            
            8.22
            %
            
            
            8.27
            %
            
            
            8.16
            %
            
            
            7.85
            %
            
            
            8.18
            %
            
            
            8.27
            %Fixed
                interest rate securities
            
            
            9,918
            
            
            
            4,600
            
            
            
            12,679
            
            
            
            9,525
            
            
            
            4,212
            
            
            
            26,963
            
            
            
            67,897
            
            
            
            67,977Average
                interest rate
            
            
            5.08
            %
            
            
            4.80
            %
            
            
            4.86
            %
            
            
            4.57
            %
            
            
            4.92
            %
            
            
            4.62
            %
            
            
            4.76
            %Other
                interest bearing assets
            
            
            11,621
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            11,621
            
            
            
            11,621Average
                interest rate
            
            
            5.07
            %
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            5.07
            %Rate
                sensitive liabilities:Interest
                bearing checking
            
            
            7,447
            
            
            
            6,074
            
            
            
            4,910
            
            
            
            3,980
            
            
            
            3,233
            
            
            
            14,832
            
            
            
            40,476
            
            
            
            40,476Average
                interest rate
            
            
            1.31
            %
            
            
            1.32
            %
            
            
            1.32
            %
            
            
            1.33
            %
            
            
            1.34
            %
            
            
            1.35
            %
            
            
            1.33
            %Savings
                accounts
            
            
            3,521
            
            
            
            2,565
            
            
            
            1,866
            
            
            
            1,358
            
            
            
            988
            
            
            
            2,640
            
            
            
            12,938
            
            
            
            12,938Average
                interest rate
            
            
            1.07
            %
            
            
            1.06
            %
            
            
            1.06
            %
            
            
            1.06
            %
            
            
            1.06
            %
            
            
            1.06
            %
            
            
            1.07
            %Money
                market accounts
            
            
            35,390
            
            
            
            25,782
            
            
            
            18,614
            
            
            
            13,448
            
            
            
            9,722
            
            
            
            25,532
            
            
            
            128,488
            
            
            
            128,488Average
                interest rate
            
            
            2.00
            %
            
            
            2.00
            %
            
            
            1.99
            %
            
            
            1.98
            %
            
            
            1.98
            %
            
            
            1.95
            %
            
            
            1.99
            %Time
                deposits
            
            
            203,843
            
            
            
            108,710
            
            
            
            23,830
            
            
            
            41
            
            
            
            120
            
            
            
            137
            
            
            
            336,681
            
            
            
            335,194Average
                interest rate
            
            
            5.07
            %
            
            
            5.48
            %
            
            
            4.09
            %
            
            
            4.25
            %
            
            
            4.55
            %
            
            
            4.95
            %
            
            
            5.14
            %Fixed
                interest rate borrowings
            
            
            6,000
            
            
            
            -
            
            
            
            4,000
            
            
            
            1,200
            
            
            
            -
            
            
            
            17,527
            
            
            
            28,727
            
            
            
            27,513Average
                interest rate
            
            
            4.70
            %
            
            
            0.00
            %
            
            
            5.16
            %
            
            
            4.32
            %
            
            
            0.00
            %
            
            
            6.61
            %
            
            
            5.91
            %Variable
                interest rate borrowings
            
            
            9,000
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            9,000
            
            
            
            9,000Average
                interest rate
            
            
            5.47
            %
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            5.47
            %





**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.




24
 *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:  May
                10, 2007
            /
                s
                /  Donald F. SchenkelDonald
                F. Schenkel, Chairman of the Board,President
                and Chief Executive OfficerDated:  May
                10, 2007
            /
                s
                /  Richard R. SawyerRichard
                R. SawyerChief
                Financial Officer






25