**UNITE
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C.  20549**





**Form
      10-Q**


(Mark
      One)





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





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





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





For
      the
      transition period from ____________ to ____________








Commission
      file number 000-25287





**TOWER
        FINANCIAL CORPORATION**





(Exact
      name of Registrant as specified in its charter)








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








116
      East
      Berry Street, Fort Wayne, Indiana 46802


(Address
      of principal executive offices)








(260)
        427-7000


(Registrant’s
      telephone number)





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


Yes  x       No  o





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


Large
                accelerated filer o
            Accelerated
                filer o
            Non-accelerated
                filer x





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


Yes  o        No  x





Number
      of
      shares of the issuer’s common stock, without par value, outstanding as of August
      7, 2007: 4,062,199.







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 June 30, 2007
                (unaudited) and December 31, 2006
            4Consolidated
                Condensed Statements of Operations for the three
                and six months ended June 30, 2007 and June 30, 2006
                (unaudited)
            5Consolidated
                Condensed Statements of Changes in Stockholders’
                Equity for the six months ended June 30, 2007 and June 30, 2006
                (unaudited)
            6Consolidated
                Condensed Statements of Cash Flows for the six
                months ended June 30, 2007 and June 30, 2006
                (unaudited)
            7Notes
                to Consolidated Condensed Financial
                Statements
            8Item
                2.  Management’s Discussion and Analysis of
                Financial Condition and Results of Operations
            16Item
                3.  Quantitative and Qualitative Disclosures
                About Market Risk
            25Item
                4.  Controls and Procedures
            27**PART
                II.   OTHER
                INFORMATION**Item
                1.   Legal Proceedings
            28Item
                1a.  Risk Factors
            28Item
                4.   Submission of Matters to a Vote of
                Security Holders
            28Item
                6.   Exhibits
            28**SIGNATURES**
            29




3
 *Index*





**PART
      I.  FINANCIAL INFORMATION**





**Item
      1.  FINANCIAL STATEMENTS**





**Tower
      Financial Corporation**


**Consolidated
      Condensed Balance Sheets**


At
      June
      30, 2007 and December 31, 2006




*(unaudited)***June
                30,**
            
            
            **December
                31,****2007**
            
            
            **2006****ASSETS**Cash
                and due from banks
            
            $
            6,977,240
            
            
            $
            14,393,790Short-term
                investments and interest-earning deposits
            
            
            154,569
            
            
            
            8,863,112Federal
                funds sold
            
            
            10,631,456
            
            
            
            5,608,064Total
                cash and cash equivalents
            
            
            17,763,265
            
            
            
            28,864,966Securities
                available for sale, at fair value
            
            
            67,895,093
            
            
            
            69,491,806FHLB
                and FRB stock
            
            
            3,112,500
            
            
            
            3,078,400Loans
                held for sale
            
            
            9,455,115
            
            
            
            -Loans
            
            
            581,782,504
            
            
            
            550,450,313Allowance
                for loan losses
            
            
            (7,175,809
            )
            
            
            (6,870,442
            )Net
                loans
            
            
            574,606,695
            
            
            
            543,579,871Premises
                and equipment, net
            
            
            6,782,316
            
            
            
            5,870,699Accrued
                interest receivable
            
            
            3,779,111
            
            
            
            3,620,368Bank
                owned life insurance
            
            
            11,047,397
            
            
            
            10,851,519Other
                assets
            
            
            7,199,385
            
            
            
            5,797,183Total
                assets
            
            $
            701,640,877
            
            
            $
            671,154,812**LIABILITIES
                AND STOCKHOLDERS' EQUITY**LIABILITIESDeposits:Noninterest-bearing
            
            $
            76,035,017
            
            
            $
            77,772,481Interest-bearing
            
            
            519,523,019
            
            
            
            508,997,823Total
                deposits
            
            
            595,558,036
            
            
            
            586,770,304Federal
                Home Loan Bank (FHLB) advances
            
            
            33,850,000
            
            
            
            11,200,000Junior
                subordinated debt
            
            
            17,527,000
            
            
            
            17,527,000Accrued
                interest payable
            
            
            1,623,428
            
            
            
            1,716,994Other
                liabilities
            
            
            2,546,390
            
            
            
            2,982,675Total
                liabilities
            
            
            651,104,854
            
            
            
            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;
                4,063,647 shares issued and outstanding at June 30, 2007 and 4,043,882
                at
                December 31, 2006
            
            
            39,053,685
            
            
            
            38,536,406Treasury
                stock, at cost, 14,735 shares at June 30, 2007
            
            
            (224,655
            )
            
            
            -Retained
                earnings
            
            
            12,559,285
            
            
            
            12,523,750Accumulated
                other comprehensive income (loss), net of tax of  ($439,059) at
                June 30, 2007 and ($53,785) at December 31, 2006
            
            
            (852,292
            )
            
            
            (102,317
            )Total
                stockholders' equity
            
            
            50,536,023
            
            
            
            50,957,839Total
                liabilities and stockholders' equity
            
            $
            701,640,877
            
            
            $
            671,154,812





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





4
 *Index*





**Tower
      Financial Corporation**


**Consolidated
      Condensed Statements of Operations**


For
      the
      three and six months ended June 30, 2007 and 2006





*(unaudited)***Three
                Months ended**
            
            
            **Six
                Months Ended****June
                30**
            
            
            **June
                30****2007**
            
            
            **2006**
            
            
            **2007**
            
            
            **2006****Interest
                income:**Loans,
                including fees
            
            $
            11,088,346
            
            
            $
            9,076,121
            
            
            $
            21,406,436
            
            
            $
            17,221,565Securities
                - taxable
            
            
            668,747
            
            
            
            524,597
            
            
            
            1,331,162
            
            
            
            1,015,161Securities
                - tax exempt
            
            
            195,166
            
            
            
            169,863
            
            
            
            395,941
            
            
            
            317,255Other
                interest income
            
            
            21,574
            
            
            
            162,912
            
            
            
            240,653
            
            
            
            307,915Total
                interest income
            
            
            11,973,833
            
            
            
            9,933,493
            
            
            
            23,374,192
            
            
            
            18,861,896**Interest
                expense:**Deposits
            
            
            5,712,457
            
            
            
            4,389,514
            
            
            
            11,388,342
            
            
            
            7,983,268Short-term
                borrowings
            
            
            516
            
            
            
            
            
            
            
            516FHLB
                advances
            
            
            397,313
            
            
            
            369,069
            
            
            
            589,057
            
            
            
            721,249Junior
                subordinated debt
            
            
            279,957
            
            
            
            209,230
            
            
            
            561,606
            
            
            
            418,461Total
                interest expense
            
            
            6,390,243
            
            
            
            4,967,813
            
            
            
            12,539,521
            
            
            
            9,122,978Net
                interest income
            
            
            5,583,590
            
            
            
            4,965,680
            
            
            
            10,834,671
            
            
            
            9,738,918**Provision
                for loan losses**
            
            
            1,500,000
            
            
            
            475,000
            
            
            
            2,925,000
            
            
            
            1,050,000Net
                interest income after provision for loan losses
            
            
            4,083,590
            
            
            
            4,490,680
            
            
            
            7,909,671
            
            
            
            8,688,918**Noninterest
                income:**Trust
                and brokerage fees
            
            
            718,607
            
            
            
            603,542
            
            
            
            1,564,490
            
            
            
            1,394,498Service
                charges
            
            
            220,494
            
            
            
            141,182
            
            
            
            489,525
            
            
            
            319,864Loan
                broker fees
            
            
            57,093
            
            
            
            4,409
            
            
            
            82,590
            
            
            
            35,028Loss
                on sale of securities
            
            
            (1,760
            )
            
            
            -
            
            
            
            (1,760
            )
            
            
            -Other
                fees
            
            
            435,599
            
            
            
            346,630
            
            
            
            784,265
            
            
            
            737,674Total
                noninterest income
            
            
            1,430,033
            
            
            
            1,095,763
            
            
            
            2,919,110
            
            
            
            2,487,064**Noninterest
                expense:**Salaries
                and benefits
            
            
            2,976,922
            
            
            
            2,564,673
            
            
            
            5,972,423
            
            
            
            5,067,656Occupancy
                and equipment
            
            
            660,552
            
            
            
            511,668
            
            
            
            1,348,745
            
            
            
            991,845Marketing
            
            
            99,380
            
            
            
            124,290
            
            
            
            178,422
            
            
            
            296,636Data
                processing
            
            
            230,228
            
            
            
            177,644
            
            
            
            458,177
            
            
            
            323,611Loan
                and professional costs
            
            
            367,022
            
            
            
            328,998
            
            
            
            725,835
            
            
            
            549,784Office
                supplies and postage
            
            
            117,458
            
            
            
            122,457
            
            
            
            240,842
            
            
            
            229,096Courier
                services
            
            
            94,962
            
            
            
            86,939
            
            
            
            195,771
            
            
            
            179,645Business
                development
            
            
            183,996
            
            
            
            138,511
            
            
            
            341,748
            
            
            
            243,455Other
                expense
            
            
            572,056
            
            
            
            288,294
            
            
            
            1,002,908
            
            
            
            561,483Total
                noninterest expense
            
            
            5,302,576
            
            
            
            4,343,474
            
            
            
            10,464,871
            
            
            
            8,443,211**Income
                before income taxes**
            
            
            211,047
            
            
            
            1,242,969
            
            
            
            363,910
            
            
            
            2,732,771Income
                tax expense (benefit)
            
            
            (6,065
            )
            
            
            330,990
            
            
            
            (29,815
            )
            
            
            827,690**Net
                income**
            
            $
            217,112
            
            
            $
            911,979
            
            
            $
            393,725
            
            
            $
            1,905,081**Basic
                earnings per common share**
            
            $
            0.05
            
            
            $
            0.23
            
            
            $
            0.10
            
            
            $
            0.47**Diluted
                earnings per common share**
            
            $
            0.05
            
            
            $
            0.22
            
            
            $
            0.09
            
            
            $
            0.46Average
                common shares outstanding
            
            
            4,073,678
            
            
            
            4,017,254
            
            
            
            4,071,181
            
            
            
            4,012,652Average
                common shares and dilutive  potential common shares
                outstanding
            
            
            4,146,386
            
            
            
            4,119,906
            
            
            
            4,152,975
            
            
            
            4,128,173Dividends
                declared per share
            
            $
            0.044
            
            
            
            n/a
            
            
            $
            0.088
            
            
            
            n/a





*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
      six months ended June 30, 2007 and 2006


*(unaudited)*




**Common**
            
            
            
            
            
            **Accumulated****Stock
                and**
            
            
            
            
            
            **Other****Paid-in**
            
            
            **Retained**
            
            
            **Comprehensive**
            
            
            **Treasury****Capital**
            
            
            **Earnings**
            
            
            **Income
                (Loss)**
            
            
            **Stock**
            
            
            **Total****Balance,
                January 1, 2006**
            
            $
            38,006,929
            
            
            $
            9,478,812
            
            
            $
            (217,687
            )
            
            $
            -
            
            
            $
            47,268,054Net
                income for 2006
            
            
            
            
            
            
            1,905,081
            
            
            
            
            
            
            
            
            
            
            
            1,905,081Change
                in net unrealized appreciation  (depreciation) on securities
                available for sale, net of tax of $414,641
            
            
            
            
            
            
            
            
            
            
            (737,139
            )
            
            
            
            
            
            
            (737,139
            )Total
                Comprehensive Income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1,167,942Cash
                dividends paid ($0.04 per share)
            
            
            
            
            
            
            (321,009
            )
            
            
            
            
            
            
            
            
            
            
            (321,009
            )Issuance
                of 11,374 shares of common  stock for stock options
                exercised,  including tax benefit
            
            
            146,308
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            146,308Stock
                compensation expense
            
            
            57,666
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            57,666**Balance,
                June 30, 2006**
            
            $
            38,210,903
            
            
            $
            11,062,884
            
            
            $
            (954,826
            )
            
            $
            -
            
            
            $
            48,318,961**Balance,
                January 1, 2007**
            
            $
            38,536,406
            
            
            $
            12,523,750
            
            
            $
            (102,317
            )
            
            $
            -
            
            
            $
            50,957,839Net
                income for 2007
            
            
            
            
            
            
            393,725
            
            
            
            
            
            
            
            
            
            
            
            393,725Change
                in net unrealized appreciation  (depreciation) on securities
                available for sale, net of tax of ($352,804)
            
            
            
            
            
            
            
            
            
            
            (686,944
            )Change
                in net unrealized gain (loss)  on cash flow hedge, net of tax of
                ($32,470)
            
            
            
            
            
            
            
            
            
            
            (63,031
            )
            
            
            
            
            
            
            (63,031
            )Total
                Comprehensive Income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            330,694Cash
                dividends paid ($0.088 per share)
            
            
            
            
            
            
            (358,190
            )
            
            
            
            
            
            
            
            
            
            
            (358,190
            )Issuance
                of 36,500 shares of common  stock for stock options exercised,
                including tax benefit
            
            
            473,418
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            473,418Stock
                compensation expense
            
            
            43,861
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            43,861Repurchase
                14,735 shares of common stock
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (224,655
            )**Balance,
                June 30, 2007**
            
            $
            39,053,685
            
            
            $
            12,559,285
            
            
            $
            (852,292
            )
            
            $
            (224,655
            )
            
            $
            50,536,023




6
 *Index*





**Tower
      Financial Corporation**


**Consolidated
      Condensed Statements of Cash Flows**


For
      the
      six months ended June 30, 2007 and 2006




*(unaudited)*
            
            
            *(unaudited)***Six
                Months ended**
            
            
            **Six
                Months ended****June
                30, 2007**
            
            
            **June
                30, 2006****Cash
                flows from operating activities:**Net
                income
            
            $
            393,725
            
            
            $
            1,905,081Adjustments
                to reconcile net income to net cash from operating
                activities:Depreciation
                and amortization
            
            
            500,908
            
            
            
            403,893Provision
                for loan losses
            
            
            2,925,000
            
            
            
            1,050,000Stock
                compensation expense
            
            
            43,861
            
            
            
            57,666Earnings
                on life insurance
            
            
            (195,878
            )
            
            
            (192,504
            )Loss
                on sale of AFS securities
            
            
            (1,760
            )
            
            
            -Change
                in accrued interest receivable
            
            
            (158,743
            )
            
            
            (293,890
            )Change
                in other assets
            
            
            (1,107,063
            )
            
            
            (1,602,290
            )Change
                in accrued interest payable
            
            
            (93,566
            )
            
            
            297,025Change
                in other liabilities
            
            
            (436,285
            )
            
            
            (171,480
            )Net
                cash from operating activities
            
            
            1,870,199
            
            
            
            1,453,501**Cash
                flows from investing activities:**Net
                change in loans
            
            
            (51,605,447
            )
            
            
            (55,233,583
            )Purchase
                of loans
            
            
            (3,869,618
            )
            
            
            (9,136,078
            )Purchase
                of securities available for sale
            
            
            (3,685,633
            )
            
            
            (8,735,350
            )Proceeds
                from maturities of securities available for sale
            
            
            2,751,037
            
            
            
            1,849,222Proceeds
                from sale of securities available for sale
            
            
            1,490,040
            
            
            
            -Purchase
                of FHLB and FRB stock
            
            
            (34,100
            )
            
            
            -Proceeds
                from sale of participation loans
            
            
            12,068,126
            
            
            
            8,161,735Purchase
                of premises, equipment and leasehold expenditures
            
            
            (1,414,610
            )
            
            
            (1,570,603
            )Net
                cash from investing activities
            
            
            (44,300,205
            )
            
            
            (64,664,657
            )**Cash
                flows from financing activities:**Net
                change in deposits
            
            
            8,787,732
            
            
            
            49,283,996Net
                change in short-term borrowingsCash
                dividends paid
            
            
            (358,190
            )
            
            
            (321,009
            )Proceeds
                from issuance of common stock from exercise of stock
                options
            
            
            403,913
            
            
            
            114,571Tax
                benefit from exercise of stock options
            
            
            69,505
            
            
            
            31,737Proceeds
                from FHLB advances
            
            
            71,100,000
            
            
            
            53,000,000Repayment
                of FHLB advances
            
            
            (48,450,000
            )
            
            
            (51,500,000
            )Repurchase
                of common stock
            
            
            (224,655
            )
            
            
            -Net
                cash from financing activities
            
            
            31,328,305
            
            
            
            50,609,295**Net
                change in cash and cash equivalents**
            
            
            (11,101,701
            )
            
            
            (12,601,861
            )Cash
                and cash equivalents, beginning of period
            
            
            28,864,966
            
            
            
            37,908,337**Cash
                and cash equivalents, end of period**
            
            $
            17,763,265
            
            
            $
            25,306,476Supplemental
                disclosures of cash flow informationCash
                paid during the year for:Interest
            
            $
            12,633,087
            
            
            $
            8,825,953Income
                taxes
            
            
            540,000
            
            
            
            1,455,141




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





7
 *Index*





**Tower
      Financial Corporation**


**Notes
      to Consolidated Condensed Financial Statements**




**Note
      1 -- Organization**





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





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





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





We
      began
      the year with four distinct operating segments, which are further detailed
      in
      Note 6 of the Financial Statements.  The segments were 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.  In June 2007, we made the decision to cease
      operations in Indianapolis and therefore, to no longer report as a separate
      segment.  Refer to Note 6 for further detail on that
      decision.





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





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




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





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





8
 *Index*





While
      our
      management monitors the revenue streams of all of our various products and
      services and financial performance is evaluated on a company-wide basis, our
      operations are considered by management to be aggregated into three reportable
      segments (see Note 6). We accept deposits and grant commercial, real estate,
      and
      installment loans to customers primarily in northeastern Indiana. Substantially
      all loans are secured by specific items of collateral including business assets,
      consumer assets, and real estate. Commercial loans are expected to be repaid
      from cash flow from operations of businesses. Real estate loans are secured
      by
      both residential and commercial real estate. At June 30, 2007, commercial and
      commercial real estate loans totaled approximately 74.0% of total loans,
      residential real estate loans totaled approximately 17.3% and home equity and
      consumer loans totaled approximately 8.7%. Categories by industry of commercial
      loans at June 30, 2007 exceeding 30% of quarter-end stockholders’ equity are as
      follows: real estate (including owner-occupied and investment) - $112.5 million,
      or 19.3% of total loans; wholesale and retail trade - $51.0 million, or 8.8%
      of
      total loans; building, development and general contracting - $81.0 million,
      or
      13.9% of total loans; health care and social assistance - $33.6 million, or
      5.8%
      of total loans; manufacturing - $27.4 million, or 4.7% of total loans;
      accommodation and food services - $22.7 million or 3.9% of total loans; rental
      and leasing - $18.0 million or 3.1% of total loans; and finance and insurance
      -
      $19.2 million or 3.3% 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.





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.





9
 *Index*





**Allowance
      for Loan Losses:** Our allowance for loan losses represents management’s
      estimate of probable incurred losses in the loan portfolio at the balance sheet
      date. Additions to the allowance may result from recording provision for loan
      losses and recoveries, while charge-offs are deducted from the allowance.
      Allocation of the allowance is made for analytical purposes only, and the entire
      allowance is available to absorb probable and estimated credit losses inherent
      in the loan portfolio.





We
      have
      an established process for determining the adequacy of the allowance for loan
      losses that relies on various procedures and pieces of information to arrive
      at
      a range of probable outcomes. First, management allocates specific portions
      of
      the allowance for loan losses to identified problem loans. Problem loans are
      identified through a loan risk rating system and monitored through watchlist
      reporting. Specific reserves are determined for each identified credit based
      on
      delinquency rates, collateral and other risk factors identified for that credit.
      Second, management’s evaluation of the allowance for different loan groups is
      based on consideration of actual loss experience, the present and prospective
      financial condition of borrowers, industry concentrations within the loan
      portfolio and general economic conditions, and absent the ability of some of
      those factors, as well as peer industry data of comparable banks.





The
      determination of the level of allowance and, correspondingly, the provision
      for
      loan losses, rests upon estimates and assumptions, including past loan loss
      experience, the nature and volume of the portfolio, information about specific
      borrower situations and estimated collateral values, economic conditions and
      other factors. Loan losses are charged against the allowance when management
      believes the uncollectibility of a loan is confirmed.





A
      loan is
      impaired when full payment under the loan terms is not expected. Large groups
      of
      smaller balance homogeneous loans, such as consumer and residential real estate
      loans, are collectively evaluated for impairment, and accordingly, they are
      not
      identified for impairment disclosures. Commercial loans and mortgage loans
      secured by other properties are evaluated individually for impairment. When
      analysis of a borrower's operating results and financial condition indicates
      that underlying cash flows of the borrower's business are not adequate to meet
      its debt service requirements, the loan is evaluated for impairment. If a loan
      is impaired, a portion of the allowance is allocated so that the loan is
      reported, net, at the present value of estimated future cash flows using the
      loan's existing interest rate or at the fair value of collateral if repayment
      is
      expected solely from the collateral.





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





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





**Bank
      Owned Life Insurance:**The Bank has purchased life insurance policies on
      certain officers. Bank owned life insurance is recorded at its cash surrender
      value, or the amount that can be realized. Bank owned life insurance totaled
      $11.0 and $10.9 million at June 30, 2007 and December 31, 2006,
      respectively.





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





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





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





10
 *Index*





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





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





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





**Fair
      Values of Financial Instruments:**Fair values of financial instruments
      are estimated using relevant market information and other assumptions. Fair
      value estimates involve uncertainties and matters of significant judgment
      regarding interest rates, credit risk, prepayments and other factors, especially
      in the absence of broad markets for particular items. Changes in assumptions
      or
      in market conditions could significantly affect the estimates. The fair value
      estimates of existing on- and off-balance-sheet financial instruments do not
      include the value of anticipated future business or the value of assets and
      liabilities not considered financial instruments.





**Dividend
      Restriction:**Banking regulations require maintaining certain capital
      levels and may limit the dividends paid by the Bank to Tower Financial
      Corporation or by us to our shareholders. In January 2006, our Board of
      Directors formally approved the payment of a quarterly dividend of $0.04 per
      share commencing in first quarter 2006. We paid four quarterly dividends of
      $0.04 per share during 2006 totaling $642,974.  In January 2007, our
      Board of Directors approved increasing the quarterly dividend to $0.044 per
      share beginning in the first quarter of 2007, which totaled $358,190 through
      the
      second quarter of 2007.





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





**Comprehensive
      Income:**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
      $129,114 and $808,000 and was sufficient to meet the regulatory reserve and
      clearing requirements at June 30, 2007 and December 31, 2006, respectively.
      These balances do not earn interest.





**Basis
      of Presentation:**The accompanying unaudited consolidated
      condensed financial statements were prepared in accordance with generally
      accepted accounting principles for interim periods and with instructions for
      Form 10-Q and, therefore, do not include all disclosures required by generally
      accepted accounting principles for complete presentation of the Company’s
      financial statements.  In the opinion of management, the unaudited
      consolidated condensed financial statements contain all adjustments necessary
      to
      present fairly its consolidated financial position at June 30, 2007 and its
      consolidated results of operations, comprehensive income, changes in
      stockholders’ equity and cash flows for the three-month and six-month periods
      ended June 30, 2007 and June 30, 2006.   The results for the
      three month and six month period ended June 30, 2007 should not be considered
      as
      indicative of results for a full year.   These consolidated
      condensed financial statements should be read in conjunction with the audited
      financial statements for the years ended December 31, 2006, 2005, and 2004
      and
      related notes included in the Company’s Annual Report on Form 10-K for the year
      ended December 31, 2006.





11
 *Index*





**Adoption
      of New Accounting Standards:**  We adopted FASB Interpretation
      48, Accounting for Uncertainty in Income Taxes (“FIN 48”), as of January 1,
      2007.  A tax position is recognized as a benefit only if it is "more
      likely than not" that the tax position would be sustained in a tax examination,
      with a tax examination being presumed to occur.  The amount recognized
      is the largest amount of tax benefit that is greater than 50% likely of being
      realized on examination.  For tax positions not meeting the "more
      likely than  not" test, no tax benefit is recorded.  The
      adoption had no affect on the Company’s financial statements.





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





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





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





**Note
      3 - Earnings Per Share**





The
      following table reflects the calculation of basic and diluted earnings per
      common share for the three- and six-month periods ended June 30, 2007 and June
      30, 2006.  Options not considered in the calculation of diluted
      earnings per common share because they were antidilutive, totaled 45,660 and
      33,160 and 22,910 and 6,250 for the three- and six-month periods ended June
      30,
      2007 and 2006, respectively.





**Three
                Months Ended**
            
            
            **Six
                Months Ended****June
                30**
            
            
            **June
                30****2007**
            
            
            **2006**
            
            
            **2007**
            
            
            **2006****Basic**Net
                income
            
            $
            217,112
            
            
            $
            911,979
            
            
            $
            393,725
            
            
            $
            1,905,081Weighted
                average common shares outstanding
            
            
            4,073,678
            
            
            
            4,017,254
            
            
            
            4,071,181
            
            
            
            4,012,652Basic
                earnings per common share
            
            $
            0.05
            
            
            $
            0.23
            
            
            $
            0.10
            
            
            $
            0.47**Diluted**Net
                income
            
            $
            217,112
            
            
            $
            911,979
            
            
            $
            393,725
            
            
            $
            1,905,081Weighted
                average common shares outstanding
            
            
            4,073,678
            
            
            
            4,017,254
            
            
            
            4,071,181
            
            
            
            4,012,652Add:  dilutive
                effect of assumed stock option exercises
            
            
            72,708
            
            
            
            102,652
            
            
            
            81,794
            
            
            
            115,521Weighted
                average common shares and dilutive potential common shares
                outstanding
            
            
            4,146,386
            
            
            
            4,119,906
            
            
            
            4,152,975
            
            
            
            4,128,173Diluted
                earnings per common share
            
            $
            0.05
            
            
            $
            0.22
            
            
            $
            0.09
            
            
            $
            0.46




**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 279,100 remain outstanding as of June 30, 2007.  Option
      awards were granted with an exercise price equal to the market price of the
      Company’s stock at the date of each grant, vesting over a four-year period, and
      issued with a ten-year contractual term.  The compensation cost that
      has been charged against income for options granted under the Plans in
      accordance with FAS123(R) was $39,223 and $57,666 for the six-months ended
      June
      30, 2007 and June 30, 2006, respectively.





12
 *Index*





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





Weighted-Weighted
            
            
            AverageAverage
            
            
            Remaining
            
            
            AggregateExercise
            
            
            Contractual
            
            
            IntrinsicOptions
            
            Shares
            
            
            Price
            
            
            Term
            
            
            ValueOutstanding
                at 1/1/07
            
            
            315,600
            
            
            $
            11.30Granted
            
            
            
            
            
            
            0Exercised
            
            
            36,500
            
            
            $
            11.07Forfeited
                or expired
            
            
            0Outstanding
                at 6/30/07
            
            
            279,100
            
            
            $
            11.33
            
            
            
            3.54
            
            
            $
            1,032,108Exercisable
                at 6/30/07
            
            
            250,468
            
            
            $
            10.91
            
            
            
            3.04
            
            
            $
            1,017,848








There
      were no stock options granted during the first six-months ended 2007 or the
      same
      period 2006.  The total intrinsic value of options exercised during
      the six-months ended June 30, 2007 and 2006, was $218,928 and
      $80,123.





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 June 30,
      2007, 2,450 restricted shares had been granted under the 2006 Equity Incentive
      Plan.  The fair value of the restricted shares issued was
      $46,383.  Restricted shares become fully vested and not subject to
      forfeiture after five years of service from the date of award and attainment
      of
      certain goals, specified by the compensation committee.  The
      compensation cost that has been charged against income for restricted shares
      awarded under the Plan in accordance with FAS123(R) was $4,638 for the
      six-months ended June 30, 2007.





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





Weighted-AverageGrant-DateNon-vested
                shares
            
            Shares
            
            
            Fair
                ValueNonvested
                at 1/1/07
            
            
            2,000
            
            
            $
            19.22Granted
            
            
            450
            
            
            $
            17.65Vested
            
            
            0Forfeited
                or expired
            
            
            (2,450
            )
            
            $
            18.93Outstanding
                at 6/30/07
            
            
            0Nonvested
                at 6/30/07
            
            
            0




13
 *Index*





**Note
      5 – Derivative Instruments**





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





During
      the third quarter of 2006, the Company purchased an interest rate floor for
      $147,000.   The notional amount of the floor is $30 million, with
      a term of three years and a strike price of 7.5%.  The cost of the
      floor is recognized as expense over the term of the floor.  The
      unamortized cost of the floor and its fair value at June 30, 2007 was
      $73,765.  The difference between the unamortized cost of the floor and
      its 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 June 30,
      2007.  The portion of the change in fair value of the interest rate
      floor that is deemed effective in hedging the cashflows of the designated assets
      is recorded in accumulated other comprehensive income (loss), net of tax
      effects, and reclassified into interest income when such cashflows occur in
      the
      future.  Any ineffectiveness resulting from the interest rate floor is
      recorded as a gain or loss in the consolidated statements of operations as
      a
      part of non-interest income.





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





**Note
      6 –  Business Segments**





Management
      separates Tower Financial Corporation into three distinct businesses for
      reporting purposes.  The three segments are Banking, Wealth
      Management, and Corporate and Intercompany.  The segments are
      evaluated separately on their individual performance, as well as their
      contribution as a whole.





In
      the
      two previous quarters, we reported a fourth segment, Indianapolis
      operations.  It operated as a loan production office of the Bank
      during the last quarter of 2006 and the first two quarters of 2007 in
      Indianapolis, IN.  While the loan production office did not meet the
      definition of a reportable segment during that time, we chose to report it
      as
      such in anticipation of the formation of a de novo bank to be created in 2007,
      called Tower Bank of Central Indiana (TBCI), at which time we planned that
      the
      loan production office would be acquired by the new entity.  We
      received approval by the Indiana Department of Financial Institutions (DFI)
      and
      the Federal Deposit Insurance Corporation (FDIC) to form the
      TBCI.  However, as noted in Note 1 above, in June 2007 we elected to
      cease operations in Indianapolis.  We also determined that the loan
      production office alone did not constitute a separate reportable segment and
      therefore we will no longer report it as such.  Through six-months
      ended June 30, 2007 the Indianapolis operations generated approximately $123,000
      of income and incurred expenses of approximately $549,000.





The
      majority of assets and income result from the Banking segment.  The
      Bank is a full-service commercial bank with six Allen County locations, one
      Angola location, and a loan production office in Warsaw.





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





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





Information
      reported internally for performance assessment follows.





14
 *Index*








**As
                of and for the three months ended June 30, 2007****Wealth**
            
            
            **Corporate
                &****Bank**
            
            
            **Management**
            
            
            **Intercompany**
            
            
            **Eliminations**
            
            
            **Total****Income
                Statement Information**Net
                interest income
            
            $
            5,839,686
            
            
            $
            32,854
            
            
            $
            (288,950
            )
            
            $
            -
            
            
            $
            5,583,590Non-interest
                income
            
            
            717,026
            
            
            
            718,708
            
            
            
            304,906
            
            
            
            (310,607
            )
            
            
            1,430,033Non-interest
                expense
            
            
            4,558,122
            
            
            
            575,550
            
            
            
            168,904
            
            
            
            -
            
            
            
            5,302,576Noncash
                itemsProvision
                for loan losses
            
            
            1,500,000
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            1,500,000Depreciation/Amortization
            
            
            254,942
            
            
            
            9,639
            
            
            
            -
            
            
            
            -
            
            
            
            264,581Income
                tax expense (benefit)
            
            
            86,834
            
            
            
            84,660
            
            
            
            (177,559
            )
            
            
            -
            
            
            
            (6,065
            )Segment
                Profit/(Loss)
            
            
            411,756
            
            
            
            91,352
            
            
            
            24,611
            
            
            
            (310,607
            )
            
            
            217,112**Balance
                Sheet Information**Segment
                Assets
            
            
            699,797,435
            
            
            
            5,879,983
            
            
            
            71,226,752
            
            
            
            (75,263,293
            )
            
            
            701,640,877








**As
                of and for the six months ended June 30, 2007****Wealth**
            
            
            **Corporate
                &****Bank**
            
            
            **Management**
            
            
            **Intercompany**
            
            
            **Eliminations**
            
            
            **Total****Income
                Statement Information**Net
                interest income
            
            $
            11,332,020
            
            
            $
            64,257
            
            
            $
            (561,606
            )
            
            $
            -
            
            
            $
            10,834,671Non-interest
                income
            
            
            1,362,660
            
            
            
            1,564,600
            
            
            
            747,526
            
            
            
            (755,676
            )
            
            
            2,919,110Non-interest
                expense
            
            
            8,955,687
            
            
            
            1,181,220
            
            
            
            327,964
            
            
            
            -
            
            
            
            10,464,871Noncash
                itemsProvision
                for loan losses
            
            
            2,925,000
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            2,925,000Depreciation/Amortization
            
            
            482,113
            
            
            
            18,795
            
            
            
            -
            
            
            
            -
            
            
            
            500,908Income
                tax expense (benefit)
            
            
            109,924
            
            
            
            203,530
            
            
            
            (343,269
            )
            
            
            -
            
            
            
            (29,815
            )Segment
                Profit/(Loss)
            
            
            704,069
            
            
            
            244,107
            
            
            
            201,225
            
            
            
            (755,676
            )
            
            
            393,725**Balance
                Sheet Information**Segment
                Assets
            
            
            699,797,435
            
            
            
            5,879,983
            
            
            
            71,226,752
            
            
            
            (75,263,293
            )
            
            
            701,640,877




15
 *Index*




**As
                of and for the three months ended June 30, 2006****Wealth**
            
            
            **Corporate
                &****Bank**
            
            
            **Management**
            
            
            **Intercompany**
            
            
            **Eliminations**
            
            
            **Total****Income
                Statement Information**Net
                interest income
            
            $
            5,148,355
            
            
            $
            20,860
            
            
            $
            (203,535
            )
            
            $
            -
            
            
            $
            4,965,680Non-interest
                income
            
            
            454,663
            
            
            
            603,542
            
            
            
            1,114,949
            
            
            
            (1,077,391
            )
            
            
            1,095,763Non-interest
                expense
            
            
            3,725,854
            
            
            
            507,672
            
            
            
            109,948
            
            
            
            -
            
            
            
            4,343,474Noncash
                itemsProvision
                for loan losses
            
            
            475,000
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            475,000Depreciation/Amortization
            
            
            198,477
            
            
            
            7,673
            
            
            
            -
            
            
            
            -
            
            
            
            206,150Income
                tax expense (benefit)
            
            
            404,710
            
            
            
            36,940
            
            
            
            (110,660
            )
            
            
            -
            
            
            
            330,990Segment
                Profit/(Loss)
            
            
            997,454
            
            
            
            79,790
            
            
            
            912,126
            
            
            
            (1,077,391
            )
            
            
            911,979**Balance
                Sheet Information**Segment
                Assets
            
            
            608,548,047
            
            
            
            5,345,735
            
            
            
            63,150,572
            
            
            
            (67,263,246
            )
            
            
            609,781,108








**As
                of and for the six months ended June 30, 2006****Wealth**
            
            
            **Corporate
                &****Bank**
            
            
            **Management**
            
            
            **Intercompany**
            
            
            **Eliminations**
            
            
            **Total****Income
                Statement Information**Net
                interest income
            
            $
            10,106,760
            
            
            $
            39,230
            
            
            $
            (407,072
            )
            
            $
            -
            
            
            $
            9,738,918Non-interest
                income
            
            
            4,019,966
            
            
            
            1,394,497
            
            
            
            5,307,896
            
            
            
            (8,235,295
            )
            
            
            2,487,064Non-interest
                expense
            
            
            7,173,174
            
            
            
            1,006,718
            
            
            
            263,319
            
            
            
            -
            
            
            
            8,443,211Noncash
                itemsProvision
                for loan losses
            
            
            1,050,000
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            1,050,000Depreciation/Amortization
            
            
            396,220
            
            
            
            7,673
            
            
            
            -
            
            
            
            -
            
            
            
            403,893Income
                tax expense (benefit)
            
            
            912,410
            
            
            
            161,310
            
            
            
            (246,030
            )
            
            
            -
            
            
            
            827,690Segment
                Profit/(Loss)
            
            
            4,991,142
            
            
            
            265,699
            
            
            
            4,883,535
            
            
            
            (8,235,295
            )
            
            
            1,905,081**Balance
                Sheet Information**Segment
                Assets
            
            
            608,548,047
            
            
            
            5,345,735
            
            
            
            63,150,572
            
            
            
            (67,263,246
            )
            
            
            609,781,108








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





The
      following presents management’s discussion and analysis of the consolidated
      financial condition of the Company as of June 30, 2007 and December 31, 2006
      and
      results of operations for the three- and six-month periods ended June 30, 2007
      and June 30, 2006.  This discussion should be read in conjunction with
      the Company’s consolidated condensed financial statements and the related notes
      appearing elsewhere in this report and the Company’s Annual Report on Form 10-K
      for the year ended December 31, 2006.





**Critical
      Accounting Policies**





A
      comprehensive discussion of the Company’s critical accounting policies is
      disclosed in our Annual Report on Form 10-K for the year ended December 31,
      2006
      and included by reference in Note 2 above.   There have been no
      material changes in the information regarding our critical accounting policies
      since December 31, 2006.





16
 *Index*





**Executive
      Overview**





Net
      Income was $217,112 and $393,725 for the second quarter 2007 and year-to-date
      through the second quarter of 2007, respectively.  This is a decrease
      of 76.2% and 79.3% compared to the same two periods of 2006.  The
      decrease was primarily due to a large provision for loan losses taken in the
      first two quarters 2007 and expenses related to the Indianapolis office, which
      was closed during the second quarter of 2007.





Net
      interest income increased approximately $2.0 million or 20.5% from the six-month
      period ended June 30, 2006 to the same period ended June 30,
      2007.  The increase was primarily due to growth in the loan portfolio,
      average loans during the six-month period ended June 30, 2007 increased over
      $75
      million over the same period of 2006.





Noninterest
      income increase approximately $334,000 from the six-month period ended June
      30,
      2006 to the same period ended June 30, 2007.  Significant increases
      were seen in nearly every area, including trust and brokerage fees ($115,000),
      service charges ($79,000), loan broker fees ($53,000), and other fees
      ($87,000).





Operating
      expenses increased by 22.1% in second quarter 2007 compared to second quarter
      2006 and 23.9% year-to-date 2007 compared to the same period in
      2006.  The increases are due to the continued growth of the
      organization, which included opening a sixth branch in Allen County, a loan
      production office in Warsaw, Indiana, and a loan production office in
      Indianapolis, Indiana,  all of which were fully-functioning during the
      first two quarters 2007, but not during the same period
      2006.  Additional expenses were incurred in connection with the
      Indianapolis de novo bank project that we decided to defer further action on
      in
      June of 2007.  Also, FDIC insurance premiums increased over $200,000
      year-to-date through June 2007 due to a change in the assessment calculation
      used by the FDIC, which affected all banks.





Total
      assets grew $30.5 million from December 31, 2006 to June 30,
      2007.  The increase was primarily in the loan portfolio, which grew
      $31 million or 11.4% annualized.  Loans related to the Indianapolis
      office were moved to ‘Held for Sale’ in the amount of $9.5 million as a result
      of an agreement reached with an Indianapolis financial institution to purchase
      the loans at par.  These increases were offset somewhat by the
      decrease in cash and short-term investments of $11.1 million, which was used
      to
      fund some of the growth in the loan portfolio.





Total
      deposits grew by $8.8 million, or 3.0% annualized, through the second quarter
      of
      2007.  However, Brokered CD’s and out of market deposits decreased by
      $21.9 million from December 31, 2006 to June 30, 2007, reflective in a net
      increase of in-market deposits of $30.7 million through the first two quarters
      of 2007.  Additional borrowings of $22.7 million were used to
      supplement deposits to fund loan growth.





**Financial
      Condition**





We
      experienced steady growth in the first six months of 2007, as total assets
      were
      $702.0 million at June 30, 2007 compared to total assets at December 31, 2006
      of
      $671.2 million.  The 4.5% increase in assets was primarily due to an
      increase in loans of $31.3 million and loans held for sale of $9.5
      million.  When combined, this is a 7.4% increase over loans from
      December, 2006.  This growth was supported by $8.7 million of deposit
      growth and $22.7 million of borrowings.  The remainder of the growth
      was supported through the use of cash and cash equivalents, which decreased
      by
      $11.1 million, or 38.5%, during the first six 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 $17.8 million at June 30, 2007, a $11.1 million, or
      38.5%, decrease from $28.9 million at December 31, 2006. The decrease in cash
      and cash equivalents during the second quarter of 2007 was reflective of our
      cash needs relative to loan growth.  Securities available for sale
      were $67.9 million at the end of the second quarter of 2007, an decrease of
      $1.6
      million from December 31, 2006.  The decrease was due to the maturity
      of securities of approximately $4.2 million and unrealized losses of
      approximately $1.1 million.  This was partially offset by purchases of
      approximately $3.7 million in securities during the first six months of
      2007.





*Loans
      Held for Sale*.  Loans held for sale increased $9.5 million during
      the first six months of 2007.  These loans were originated by the
      Indianapolis loan production office.  In June of 2007, when the
      decision was made to defer further action on the creation of the Indianapolis
      de
      novo bank an agreement was reached with a financial institution in the
      Indianapolis market to sell theses loans at par.  The definitive
      agreement was executed in June with closing to take place in the third
      quarter.





*Loans*.  Total
      loans were $581.8 million at June 30, 2007 reflecting a 5.7% increase from
      total
      loans of $550.5 million at December 31, 2006.  Loan growth during the
      first six months of 2007 occurred mainly in the residential and commercial
      portfolios, along with the consumer portfolio.   The growth of
      the residential real estate portfolio was due to continued efforts to neutralize
      our interest rate risk profile by placing more fixed rate loans in our
      portfolio.  Approximately $3.8 million of our residential growth came
      from the purchase of long-term fixed rate mortgages from Countrywide Mortgage,
      all of which carried terms in excess of 20 years.  The overall mix of
      the loan portfolio has not materially changed since year-end as the total of
      commercial and commercial real estate loans of the portfolio was 74.0% at June
      30, 2007 and 75.5% at December 31, 2006.





17
 *Index*





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





**June
                30, 2007**
            
            
            **December 31,
                2006****Balance**
            
            
            **%**
            
            
            **Balance**
            
            
            **%**Commercial
            
            $
            250,890,814
            
            
            
            43.1%
            
            
            $
            236,808,842
            
            
            
            43.0%Commercial
                real estate
            
            
            179,518,482
            
            
            
            30.9%
            
            
            
            178,610,609
            
            
            
            32.5%Residential
                real estate
            
            
            100,549,674
            
            
            
            17.3%
            
            
            
            83,600,521
            
            
            
            15.2%Home
                equity
            
            
            30,168,261
            
            
            
            5.2%
            
            
            
            32,096,950
            
            
            
            5.8%Consumer
            
            
            20,748,115
            
            
            
            3.5%
            
            
            
            19,376,393
            
            
            
            3.5%Total
                loans
            
            
            581,875,346
            
            
            
            100.0%
            
            
            
            550,493,315
            
            
            
            100.0%Net
                deferred loan costs
            
            
            (92,842
            )
            
            
            
            
            
            
            (43,002
            )Allowance
                for loan losses
            
            
            (7,175,809
            )
            
            
            
            
            
            
            (6,870,442
            )Net
                loans
            
            $
            574,606,695
            
            
            
            
            
            
            $
            543,579,871




*Nonperforming
      Assets.*  Nonperforming assets include nonperforming loans and
      other real estate owned (OREO).  Nonperforming loans include loans
      past due over 90 days and still accruing interest and all nonaccrual
      loans.  Nonperforming assets have increased from $4.2 million, or
      0.63% of total assets, at December 31, 2006 to $5.2 million, or 0.74% of total
      assets, at June 30, 2007.  The majority of the increase relates to two
      relationships totaling $1.3 million.  Other smaller relationships and
      property taken to other real-estate owned, netted against an approximate
      $500,000 reduction on one non-performing borrower account for the remainder
      of
      the change.  Total impaired loans at June 30, 2007 were $5.6 million
      compared to $8.8 million at December 31, 2006.  The decrease was due
      to a combination of pay-offs and charge-offs during the first two quarters
      of
      2007. At June 30, 2007, management believes it has allocated adequate specific
      allowances for these risks of $1.3 million.  The specific reserves for
      impaired loans at December 31, 2006 were $2.7 million.





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




**June
                30, 2007**
            
            
            **December 31,
                2006**Loans
                past due over 90 days and still accruing
            
            $
            80,737
            
            
            $
            354,096Nonaccrual
                loans
            
            
            4,358,022
            
            
            
            3,488,417Total
                nonperforming loans
            
            $
            4,438,759
            
            
            $
            3,842,513Other
                real estate owned
            
            
            743,921
            
            
            
            370,000Total
                nonperforming assets
            
            $
            5,182,680
            
            
            $
            4,212,513Nonperforming
                assets to total assets
            
            
            0.74
            %
            
            
            0.63
            %Nonperforming
                loans to total loans
            
            
            0.76
            %
            
            
            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 June 30, 2007 was $7.2 million, or 1.23% of total
      loans outstanding, an increase of $305,000 from $6.9 million, or 1.25%, at
      December 31, 2006.   The provision for loan losses during the
      first six months of 2007 was $2,925,000 compared to $1,050,000 in the first
      six
      months of 2006.  The substantial loan loss provision incurred in the
      first two quarters 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 and
      were not deemed impaired, as management has concluded it is still probable
      that
      we will 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 and second quarters of 2007 versus
      the
      fourth quarter of 2006.





18
 *Index*





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





**June 30,
                2007**
            
            
            **December 31,
                2006**Specific
                allocations
            
            $
            1,299,000
            
            
            $
            2,756,000Loan
                pool percentage allocations
            
            
            5,788,000
            
            
            
            4,110,000Unallocated
            
            
            88,809
            
            
            
            4,442Total
                allowance for loan losses
            
            $
            7,175,809
            
            
            $
            6,870,442




The
      addition to the allowance during the first six months of 2007 was directly
      attributable to net charge-off activity during the period, as well as the
      downgrade of two lending relationships.  Net charge-offs for the first
      six months of 2007 were $2.6 million compared to $521,742 for the six months
      of
      2006. Over half of the charge-offs during the six months ended June 30, 2007
      were from the commercial loan class.  The majority of these loans
      already had a portion of the balance specifically reserved.  The
      remaining charge-offs were primarily commercial real estate, with some coming
      from the consumer class.  Nonperforming loans increased during the
      first six months of 2007 by $596,000 and were $4.4 million at June 30,
      2007.  Even though nonperforming loans increased in the first six
      months of 2007, the specific allowance allocations decreased by $1.5 million
      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 several
      charge-offs and partial charge-offs on non-performing loans due to the further
      deterioration of certain borrowers.  These charge-offs brought the
      carrying value of the loans down to the net realizable value of the collateral
      securing the loans, which caused the specific allowance allocations to decrease.
      The amount of the allowance allocated for loan pools increased by $1.7 million
      during the first six months of 2007.  As noted above, the primary
      reason for the increase was the migration of two lending relationships to the
      special loan classification.  Management considers the allowance for
      loan losses at June 30, 2007 to be adequate; however, there can be no assurance
      that charge-offs in future periods will not exceed the allowance.





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





**2007**
            
            
            **2006**Beginning
                balance, January 1
            
            $
            6,870,442
            
            
            $
            5,645,301Provision
                charged to operating expense
            
            
            2,925,000
            
            
            
            1,050,000Charge-offs
            
            
            (2,786,440
            )
            
            
            (738,977
            )Recoveries
            
            
            166,807
            
            
            
            217,235Ending
                balance, June 30
            
            $
            7,175,809
            
            
            $
            6,173,559Net
                charge-offs to average loans (annualized)
            
            
            0.92
            %
            
            
            0.22
            %




*Other
      Assets*.   The $1.4 million increase in other assets was
      attributable to an increase in premises and equipment of
      $912,000.  This increase in premises and equipment is primarily due to
      our Warsaw, IN office that is currently under construction.





*Deposits*.   Total
      deposits were $595.6 million at June 30, 2007 compared to total deposits at
      December 31, 2006 of $586.8 million. The growth of $8.8 million, or 1.5%, during
      the first half of 2007 was reflected mainly in interest-bearing checking and
      time deposits less than $100,000.  Growth was approximately $10.9
      million in interest-bearing checking and $9.6 million in time deposits less
      than
      $100,000.  Money market and time deposits greater than $100,000
      decreased by $7.0 million and $3.7 million, respectively. Approximately $5
      million of the interest-bearing checking growth was in Health Savings
      Accounts.  Virtually all of the deposit growth during the second
      quarter came from “in-market” deposits.  Brokered CD’s and out of
      market deposits decreased by $21.9 million from $115.5 million at December
      31,
      2006 to $93.6 million at June 30, 2007.  At June 30, 2007, brokered
      CD’s and out of market deposits comprised 15.7% of total deposits, compared to
      19.4% as of December 31, 2006.





19
 *Index*





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





**June 30,
                2007**
            
            
            **December 31,
                2006****Balance**
            
            
            **%**
            
            
            **Balance**
            
            
            **%**Noninterest-bearing
                demand
            
            $
            76,035,017
            
            
            
            12.8%
            
            
            $
            77,772,481
            
            
            
            13.3%Interest-bearing
                checking
            
            
            48,405,589
            
            
            
            8.1%
            
            
            
            37,537,496
            
            
            
            6.4%Money
                market
            
            
            116,435,681
            
            
            
            19.6%
            
            
            
            123,387,985
            
            
            
            21.0%Savings
            
            
            13,209,968
            
            
            
            2.2%
            
            
            
            12,488,159
            
            
            
            2.1%Time,
                under $100,000
            
            
            94,772,075
            
            
            
            15.9%
            
            
            
            85,171,413
            
            
            
            14.5%Time,
                $100,000 and over
            
            
            246,699,706
            
            
            
            41.4%
            
            
            
            250,412,770
            
            
            
            42.7%Total
                deposits
            
            $
            595,558,036
            
            
            
            100.0%
            
            
            $
            586,770,304
            
            
            
            100.0%








*Borrowings*.   The
      Company had borrowings in the amount of $33.9 million in Federal Home Loan
      Bank
      (“FHLB”) advances at June 30, 2007 and $11.2 million at December 31,
      2006.  Seven of the advances, totaling $15.15 million, are short-term
      daily variable rate advances and the other six, totaling $18.7 million, are
      bullet advances and mature in a range from October 2007 through June
      2010.





*Other
      Liabilities.*Other liabilities decreased $436,000 from year-end
      2006.   The decrease in other liabilities was primarily related
      to the payment of the 2006 incentive bonuses during the first quarter that
      were
      accrued at December 31, 2006.





**Results
      of Operations**





For
      The Three-Month Periods Ended June 30





Results
      of operations for the three-month period ended June 30, 2007 reflected net
      income of $217,112 or $0.05 per diluted share.   This was a
      $694,867, or 76.2%, decrease over 2006’s second quarter net income of $911,979,
      or $0.22 per diluted share.   The operating results for the
      three-month period ended June 30, 2007 were unfavorable compared to the same
      period in 2006 primarily due to the larger loan loss provision incurred in
      the
      second quarter of 2007 and expenses incurred associated with the operation
      of
      and eventual closing of the Indianapolis loan production
      office.  However, strong asset growth provided a higher net interest
      income.  This was offset somewhat by cost of funds increasing at a
      greater rate than yields causing net interest margin to
      compress.  This was due to a more neutral balance sheet in the second
      quarter 2007 compared to the second quarter of 2006.





Total
      revenue, defined as net interest income plus total noninterest income, increased
      by 15.7% to $7.0 million from $6.1 million from second quarter 2006 to second
      quarter 2007.   For the three-month period ended June 30, 2007,
      net interest income increased 12.4%, while total noninterest income increased
      30.5% from the same period one year ago primarily due to an increase in trust
      and brokerage fees, service charges, and loan broker fees.




**Performance
                  Ratios**
              
              **June
                  30****2007**
              
              
              **2006**Return
                  on average assets *
              
              
              0.12
              %
              
              
              0.61
              %Return
                  on average equity *
              
              
              1.68
              %
              
              
              7.58
              %Net
                  interest margin (TEY) *
              
              
              3.44
              %
              
              
              3.60
              %Efficiency
                  ratio
              
              
              75.60
              %
              
              
              71.62
              %*
                annualized


*Net
      Interest Income*.   Interest income for the three-month
      periods ended June 30, 2007 and 2006 was $12.0 million and $9.9 million,
      respectively, while interest expense for the second quarter was $6.4 million
      in
      2007 and $5.0 million in 2006, resulting in net interest income
      of  $5.6 million for the second quarter of 2007 and $5.0 million for
      the second 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 second quarter
      of 2007 was 3.44%, while the tax equivalent net interest margin for the second
      quarter of 2006 was 3.60%.   The decrease in net interest margin
      was mainly due to the Company neutralizing its balance sheet and a flattening
      yield curve.





20
 *Index*





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





**At
                and For The Three Month Period Ended****June
                30, 2007**
            
            
            **June
                30, 2006****Interest**
            
            
            **Annualized**
            
            
            
            
            
            **Interest**
            
            
            **Annualized****Average**
            
            
            **Earned**
            
            
            **Yield**
            
            
            **Average**
            
            
            **Earned**
            
            
            **Yield**($
                in thousands)
            
            **Balance**
            
            
            **or
                Paid**
            
            
            **or
                Cost**
            
            
            **Balance**
            
            
            **or
                Paid**
            
            
            **or
                Cost****Assets**Short-term
                investments and interest-earning deposits (1)
            
            $
            1,423
            
            
            $
            (19
            )
            
            
            -5.36
            %
            
            $
            8,899
            
            
            $
            107
            
            
            
            4.82
            %Federal
                funds sold
            
            
            4,856
            
            
            
            41
            
            
            
            3.39
            %
            
            
            4,684
            
            
            
            56
            
            
            
            4.80
            %Securities
                - taxable
            
            
            51,696
            
            
            
            668
            
            
            
            5.18
            %
            
            
            42,622
            
            
            
            525
            
            
            
            4.94
            %Securities
                - tax exempt (2)
            
            
            19,956
            
            
            
            296
            
            
            
            5.95
            %
            
            
            16,120
            
            
            
            261
            
            
            
            6.49
            %Loan
                Held for Sale
            
            
            72
            
            
            
            -
            
            
            
            0.00
            %Loans
            
            
            585,407
            
            
            
            11,088
            
            
            
            7.60
            %
            
            
            491,533
            
            
            
            9,076
            
            
            
            7.41
            %Total
                interest-earning assets
            
            
            663,410
            
            
            
            12,074
            
            
            
            7.30
            %
            
            
            563,858
            
            
            
            10,025
            
            
            
            7.13
            %Allowance
                for loan losses
            
            
            (7,724
            )
            
            
            
            
            
            
            
            
            
            
            (6,251
            )Cash
                and due from banks
            
            
            13,262
            
            
            
            
            
            
            
            
            
            
            
            15,245Other
                assets
            
            
            33,225
            
            
            
            
            
            
            
            
            
            
            
            23,441Total
                assets
            
            $
            702,173
            
            
            
            
            
            
            
            
            
            
            $
            596,293**Liabilities
                and Stockholders' Equity**Interest-bearing
                checking
            
            $
            47,043
            
            
            $
            175
            
            
            
            1.49
            %
            
            $
            30,326
            
            
            $
            78
            
            
            
            1.03
            %Savings
            
            
            16,419
            
            
            
            34
            
            
            
            0.83
            %
            
            
            13,942
            
            
            
            27
            
            
            
            0.78
            %Money
                market
            
            
            128,377
            
            
            
            1,070
            
            
            
            3.34
            %
            
            
            103,313
            
            
            
            850
            
            
            
            3.30
            %Certificates
                of deposit
            
            
            343,033
            
            
            
            4,433
            
            
            
            5.18
            %
            
            
            283,924
            
            
            
            3,434
            
            
            
            4.85
            %Short-term
                borrowings
            
            
            -
            
            
            
            1
            
            
            
            0.00
            %
            
            
            -
            
            
            
            
            
            
            
            -FHLB
                advances
            
            
            30,610
            
            
            
            397
            
            
            
            5.20
            %
            
            
            31,952
            
            
            
            369
            
            
            
            4.63
            %Junior
                subordinated debt
            
            
            17,527
            
            
            
            280
            
            
            
            6.41
            %
            
            
            11,856
            
            
            
            209
            
            
            
            7.07
            %Total
                interest-bearing liabilities
            
            
            583,009
            
            
            
            6,390
            
            
            
            4.40
            %
            
            
            475,313
            
            
            
            4,967
            
            
            
            4.19
            %Noninterest-bearing
                checking
            
            
            63,039
            
            
            
            
            
            
            
            
            
            
            
            69,507Other
                liabilities
            
            
            4,576
            
            
            
            
            
            
            
            
            
            
            
            3,241Stockholders'
                equity
            
            
            51,549
            
            
            
            
            
            
            
            
            
            
            
            48,232Total
                liabilities and stockholders' equity
            
            $
            702,173
            
            
            
            
            
            
            
            
            
            
            $
            596,293**Net
                interest income**
            
            
            
            
            
            $
            5,684
            
            
            
            
            
            
            
            
            
            
            $
            5,058**Rate
                spread**
            
            
            
            
            
            
            
            
            
            
            2.90
            %
            
            
            
            
            
            
            
            
            
            
            2.94
            %**Net
                interest income as a percent of average earning
                assets**
            
            
            
            
            
            
            
            
            
            
            3.44
            %
            
            
            
            
            
            
            
            
            
            
            3.60
            %





(1)
            An
                elimination adjustment relating to the first quarter of 2006 was
                made in
                the second quarter of 2006, which created a deficit balance in this
                account for the three-months ended June 30, 2007.  The
                adjustment is not considered material to the financial
                statements.


(2)
            Computed
                on a tax equivalent basis for tax exempt securities using a 35% statutory
                tax rate.




*Provision
      for Loan Losses*.   A provision for loan losses was recorded
      in the amount of $1.5 million or 1.02% basis points on average loans
      (annualized) during the second quarter of 2007 as compared to $475,000, or
      39
      basis points on average loans (annualized) for the second quarter of
      2006.  The increased provision recorded for the second quarter of 2007
      was driven by a combination of increased charge-off activity and the increase
      in
      reserves for two lending relationships.   The allowance for loan
      losses at June 30, 2007 totaled $7,175,809 and was 1.23% of total loans
      outstanding on that date.  Total net charge-offs for the three-month
      period ended June 30, 2007 were $1,987,022, or 136 basis points, annualized,
      on
      average loans and were $363,697, or 30 basis points, annualized, on average
      loans during the same period a year ago.





*Noninterest
      Income*.   Noninterest income was $1.4 million during the
      second quarter of 2007.   This was a $334,270, or 30.5%, increase
      compared to the second quarter of 2006.  Trust services fee income,
      service charges, loan broker fees, and other fee revenue all contributed to
      the
      increase. Trust services fees increased $115,065 from the second quarter of
      2006
      to $718,607 for the three-month period ended June 30, 2007, reflective of an
      increase of $95.9 million, or 19.0%, in assets under
      management.  Service charge revenue increased $79,312, or 56.2%, from
      $141,182 for the three-month period ending June 30, 2006 to $220,494 for the
      same period ended June 30, 2007.  The increase was primarily from an
      increase in over-draft fees and in service charges on HSA deposit
      accounts.  Loan broker fees increased $52,684 from second quarter 2006
      to second quarter 2007.  Residential loan volume was constant from
      second quarter 2006 to second quarter 2007.  However, we sold
      approximately $4 million more to the secondary market in the second quarter
      2007
      compared to the second quarter 2006.  Other Fee revenue increased by
      $87,209, or 25.2%, due several smaller increases, including lock box fees,
      letter of credit fees, and debit card interchange income.





21
 *Index*





*Noninterest
      Expense*.   Noninterest expense was $5.3 million for the
      second quarter of 2007 while noninterest expense for the three-month period
      ended June 30, 2006 was $4.3 million.  The main components of
      noninterest expense for the second quarter of 2007 were salaries and benefits
      of
      $3.0 million and occupancy and equipment costs of $660,552 and represent mainly
      infrastructure costs for human resource needs to operate the Bank, rent expense,
      and equipment depreciation.  Other expenses were $572,056 in the
      second quarter 2007, a $283,762 increase over the same quarter
      2006.  The increase was due primarily to an increase in FDIC insurance
      premiums.  Premiums expenses in the second quarter 2007 exceeded
      $215,000, which was an increase of over $200,000 from the same quarter prior
      year.   The 16.1% increase in salaries and benefits reflects a
      12.4% growth in full-time employees, year over year, as part of our expansion
      activities throughout the last twelve months, and significant benefit cost
      increases.





*Income
      Taxes.* During the quarters ended June 30, 2007 and 2006,
      we recorded $6,065 and $330,990 in income tax benefit and income tax expense,
      respectively.  The effective tax rate recorded was 0% for second
      quarter 2007 as compared to 26.6% for second quarter 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.





For
      The Six-Month Periods Ended June 30





Results
      of operations for the six-month period ended June 30, 2007 reflected net income
      of $393,725, or $0.09 per diluted share.   This was a $1.5
      million, or 79.3%, decrease over 2006’s six-month period net income of
      $1,905,081, or $0.46 per diluted share.   The operating results
      for the six-month period ended June 30, 2007 were unfavorable compared to the
      same period in 2006 primarily because the large loan loss provisions incurred
      in
      the first two quarters of 2007 and expenses incurred associate with the closing
      of the Indianapolis loan production office.  However, strong asset
      growth provided a higher net interest income.  This was offset
      somewhat by cost of funds increasing at a greater rate than yields causing
      net
      interest margin to compress.  This was due to a more neutral balance
      sheet in the first two quarters of 2007 compared to the same periods of
      2006.





Total
      revenue, defined as net interest income plus total noninterest income, increased
      by 12.5% to $13.8 million from $12.2 million from the first six-months of 2006
      to the first six-months of 2007.  For the six-month period ended June
      30, 2007, net interest income increased 11.3%, while total noninterest income
      increased 17.4% from the same period one year ago primarily due to an increase
      in trust and brokerage fees and service charge income.


**Performance
                    Ratios**
                
                **June
                    30****2007**
                
                
                **2006**Return
                    on average assets *
                
                
                0.12
                %
                
                
                0.67
                %Return
                    on average equity *
                
                
                1.54
                %
                
                
                8.00
                %Net
                    interest margin (TEY) *
                
                
                3.43
                %
                
                
                3.67
                %Efficiency
                    ratio
                
                
                76.10
                %
                
                
                69.05
                %*
                  annualized




*Net
      Interest Income*.   Interest income for the six-month periods
      ended June 30, 2007 and 2006 was $23.4 million and $18.9 million, respectively,
      while interest expense was $12.5 million through June 30, 2007 and $9.1 million
      through June 30, 2006, resulting in net interest income of $10.8 million for
      the
      first six months of 2007 and $9.7 million for the first six months of
      2006.  The increase in net interest income was reflective of the
      general growth in loans and other earning assets.  The tax equivalent
      net interest margin for the first six months of 2007 was 3.43%, while the tax
      equivalent net interest margin for the first six months of 2006 was
      3.67%.   The decrease in net interest margin was mainly due to
      the neutralizing of our balance sheet and a flattening yield curve.





22
 *Index*





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




**At
                  and For The Six Month Periods Ended****June
                  30, 2007**
              
              
              **June
                  30, 2006****Interest**
              
              
              **Annualized**
              
              
              
              
              
              **Interest**
              
              
              **Annualized****Average**
              
              
              **Earned**
              
              
              **Yield**
              
              
              **Average**
              
              
              **Earned**
              
              
              **Yield**($
                  in thousands)
              
              **Balance**
              
              
              **or
                  Paid**
              
              
              **or
                  Cost**
              
              
              **Balance**
              
              
              **or
                  Paid**
              
              
              **or
                  Cost****Assets**Short-term
                  investments and interest-earning deposits
              
              $
              3,395
              
              
              $
              117
              
              
              
              6.95
              %
              
              $
              7,925
              
              
              $
              189
              
              
              
              4.81
              %Federal
                  funds sold
              
              
              5,162
              
              
              
              124
              
              
              
              4.84
              %
              
              
              5,314
              
              
              
              119
              
              
              
              4.52
              %Securities
                  - taxable
              
              
              52,013
              
              
              
              1,331
              
              
              
              5.16
              %
              
              
              41,732
              
              
              
              1,015
              
              
              
              4.90
              %Securities
                  - tax exempt (1)
              
              
              19,680
              
              
              
              600
              
              
              
              6.15
              %
              
              
              15,082
              
              
              
              488
              
              
              
              6.52
              %Loans
                  held for sale
              
              
              36
              
              
              
              -
              
              
              
              0.00
              %Loans
              
              
              568,204
              
              
              
              21,406
              
              
              
              7.60
              %
              
              
              475,088
              
              
              
              17,222
              
              
              
              7.31
              %Total
                  interest-earning assets
              
              
              648,490
              
              
              
              23,578
              
              
              
              7.33
              %
              
              
              545,141
              
              
              
              19,033
              
              
              
              7.04
              %Allowance
                  for loan losses
              
              
              (7,339
              )
              
              
              
              
              
              
              
              
              
              
              (6,083
              )Cash
                  and due from banks
              
              
              12,402
              
              
              
              
              
              
              
              
              
              
              
              14,936Other
                  assets
              
              
              29,546
              
              
              
              
              
              
              
              
              
              
              
              22,392Total
                  assets
              
              $
              683,099
              
              
              
              
              
              
              
              
              
              
              $
              576,386**Liabilities
                  and Stockholders' Equity**Interest-bearing
                  checking
              
              $
              42,811
              
              
              $
              300
              
              
              
              1.41
              %
              
              $
              29,538
              
              
              $
              146
              
              
              
              1.00
              %Savings
              
              
              14,587
              
              
              
              67
              
              
              
              0.93
              %
              
              
              14,317
              
              
              
              53
              
              
              
              0.75
              %Money
                  market
              
              
              126,993
              
              
              
              2,256
              
              
              
              3.58
              %
              
              
              90,264
              
              
              
              1,340
              
              
              
              2.99
              %Certificates
                  of deposit
              
              
              340,021
              
              
              
              8,765
              
              
              
              5.20
              %
              
              
              277,653
              
              
              
              6,445
              
              
              
              4.68
              %FHLB
                  advances
              
              
              23,178
              
              
              
              589
              
              
              
              5.12
              %
              
              
              33,036
              
              
              
              721
              
              
              
              4.40
              %Junior
                  subordinated debt
              
              
              17,527
              
              
              
              562
              
              
              
              6.47
              %
              
              
              11,856
              
              
              
              418
              
              
              
              7.11
              %Total
                  interest-bearing liabilities
              
              
              565,117
              
              
              
              12,539
              
              
              
              4.47
              %
              
              
              456,664
              
              
              
              9,123
              
              
              
              4.03
              %Noninterest-bearing
                  checking
              
              
              62,237
              
              
              
              
              
              
              
              
              
              
              
              68,636Other
                  liabilities
              
              
              4,581
              
              
              
              
              
              
              
              
              
              
              
              3,047Stockholders'
                  equity
              
              
              51,164
              
              
              
              
              
              
              
              
              
              
              
              48,039Total
                  liabilities and stockholders' equity
              
              $
              683,099
              
              
              
              
              
              
              
              
              
              
              $
              576,386**Net
                  interest income**
              
              
              
              
              
              $
              11,039
              
              
              
              
              
              
              
              
              
              
              $
              9,910**Rate
                  spread**
              
              
              
              
              
              
              
              
              
              
              2.86
              %
              
              
              
              
              
              
              
              
              
              
              3.01
              %**Net
                  interest income as a percent of average earning
                  assets**
              
              
              
              
              
              
              
              
              
              
              3.43
              %
              
              
              
              
              
              
              
              
              
              
              3.67
              %


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





*Provision
      for Loan Losses*.   A provision for loan losses was recorded
      in the amount of $2.9 million, or 1.03% basis points (annualized) on average
      loans during the first half of 2007 as compared to $1.1 million, or 45 basis
      points (annualized) on average loans for the first half of 2006.  The
      increased provision recorded for the first half 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
      June 30, 2007 totaled $7,175,809 and was 1.23% of total loans outstanding on
      that date.  Total net charge-offs for the six-month period ended June
      30, 2007 were $2,619,633, or 92 basis points, annualized, on average loans
      and
      were $797,539, or 39 basis points, annualized, on average loans during the
      same
      period a year ago.





*Noninterest
      Income*.   Noninterest income was $2.9 million during the
      first half of 2007.   This was a $432,046, or 17.4%, increase
      compared to the first half of 2006.  The majority of the increase
      relates to trust services fee income and service charge income. Trust services
      fees increased $169,992 from the first six months of 2006 to $1.6 million for
      the six-month period ended June 30, 2007, reflective of an increase of $95.9
      million, or 19.0%, in assets under management. Service charge income increased
      by $169,661, or 53.0%, due primarily to an increase in over-draft fees in
      connection with the over-draft protection program and also due to an increase
      in
      service charges on Health Savings deposit accounts.





*Noninterest
      Expense*.   Noninterest expense was $10.5 million for the
      first six months of 2007 while noninterest expense for the first half of 2006
      was $8.4 million.  The main components of noninterest expense for the
      first half of 2007 were salaries and benefits of $6.0 million, occupancy and
      equipment costs of $1.3 million, other expense of $1.0 million, and loan and
      professional costs of $726,000.  The salary and benefits and occupancy
      and equipment expense represent mainly infrastructure costs for human resource
      needs to operate the Bank, rent expense and equipment
      depreciation.   The 17.9% increase in salaries and benefits
      reflects a 12.4% growth in full-time employees, year over year, as part of
      our
      expansion activities throughout the last twelve months, and benefit cost
      increases.  The $441,425 increase in other expenses is primarily due
      to an increase in FDIC insurance premiums.  Premiums expenses in the
      first half of 2007 exceeded $235,000, which was an increase of over $200,000
      from the same period prior year.  Loan and professional expenses
      increased by $176,051, or 32.0%, primarily due to Indianapolis start-up costs
      and legal and consulting fees for the 2007 proxy reporting relating to the
      new
      compensation disclosure requirements.





23
 *Index*





*Income
      Taxes.* During the six-month periods ended June 30, 2007
      and 2006, we recorded $29,815 and $827,690 in income tax benefit and income
      tax
      expense, respectively.  The effective tax rate recorded was 0% through
      the first six-months of 2007 as compared to 30.3% for the first six-months
      of
      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 second 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 $145.0 million, or 22.4% of our total funding, at June
      30, 2007.   Total deposits at June 30, 2007 were $595.6 million
      and the loan to deposit ratio was 97.7%.   Total borrowings at
      June 30, 2007 were $51.4 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 $50.5 million and $51.0 million at
      June 30, 2007 and December 31, 2006, respectively. Affecting the decrease in
      stockholders’ equity during the first six months of 2007 were dividend payments
      of $358,000, or $0.088 per share, and a $687,000 decrease in the unrealized
      loss
      on securities available for sale, net of tax.  This was partially
      offset by $394,000 in net income.  We also issued 36,500 shares of
      common stock from stock options exercised for $473,418 and recorded $43,861
      of
      stock option compensation expense per FAS123R.  Additionally, we
      purchased 14,735 shares of Treasury Stock at a weighted average price of $15.25,
      including fees, during the first six-months of 2007.





During
      the first six months of 2007, the Company paid dividends twice.  The
      dividend declared and paid was $0.044 per share in each quarter and amounted
      to
      an annual total of $358,000.  The ability of the Company to pay future
      cash and stock dividends is subject to limitations under various laws and
      regulations and to prudent and sound banking practices, however we anticipate
      continuing to pay dividends on a quarterly basis for the foreseeable
      future.




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





**June
                30, 2007**
            
            
            **December
                31, 2006**Well-
            
            
            Minimum
            
            
            
            
            
            Well-
            
            
            MinimumActual
            
            
            Capitalized
            
            
            Required
            
            
            Actual
            
            
            Capitalized
            
            
            Required**The
                Company**Leverage
                capital
            
            
            9.81
            %
            
            
            5.00
            %
            
            
            4.00
            %
            
            
            10.46
            %
            
            
            5.00
            %
            
            
            4.00
            %Tier
                1 risk-based
            
            
            11.35
            %
            
            
            6.00
            %
            
            
            4.00
            %
            
            
            11.94
            %
            
            
            6.00
            %
            
            
            4.00
            %Total
                risk-based
            
            
            12.46
            %
            
            
            10.00
            %
            
            
            8.00
            %
            
            
            13.06
            %
            
            
            10.00
            %
            
            
            8.00
            %****
            
            
            
            
            
            
            
            
            
            
            
            ******The
                Bank**
            
            
            
            
            
            
            
            
            
            ****
            
            
            
            
            
            
            
            
            
            
            
            ****Leverage
                capital
            
            
            8.01
            %
            
            
            5.00
            %
            
            
            4.00
            %
            
            
            8.23
            %
            
            
            5.00
            %
            
            
            4.00
            %Tier
                1 risk-based
            
            
            9.29
            %
            
            
            6.00
            %
            
            
            4.00
            %
            
            
            9.37
            %
            
            
            6.00
            %
            
            
            4.00
            %Total
                risk-based
            
            
            10.48
            %
            
            
            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 June 30, 2007, the rates on
      existing off-balance-sheet instruments were equivalent to current market rates,
      considering the underlying credit standing of the counterparties.





24
 *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
      six
      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.





25
 *Index*





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


**Rate
        Sensitivity Analysis**


**Within**
            
            
            **Three
                to**
            
            
            **One
                to**
            
            
            **After****Three**
            
            
            **Twelve**
            
            
            **Five**
            
            
            **Five**($
                in thousands)
            
            **Months**
            
            
            **Months**
            
            
            **Years**
            
            
            **Years**
            
            
            **Total****Assets**Federal
                funds sold, short-term investments and interest- earning
                deposits
            
            $
            10,786
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            10,786Securities
                available for sale
            
            
            30
            
            
            
            6,596
            
            
            
            41,767
            
            
            
            19,502
            
            
            
            67,895FHLBI
                and FRB stock
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            3,113
            
            
            
            3,113Fixed
                rate loans
            
            
            25,979
            
            
            
            47,340
            
            
            
            148,148
            
            
            
            52,740
            
            
            
            274,207Variable
                rate loans
            
            
            108,687
            
            
            
            105,983
            
            
            
            100,324
            
            
            
            2,037
            
            
            
            317,031Allowance
                for loan losses
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (7,176
            )Other
                assets
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            35,785Total
                assets
            
            $
            145,482
            
            
            $
            159,919
            
            
            $
            290,239
            
            
            $
            77,392
            
            
            $
            701,641**Liabilities**Interest-bearing
                checking
            
            $
            2,483
            
            
            $
            6,464
            
            
            $
            24,743
            
            
            $
            14,715
            
            
            $
            48,405Savings
                accounts
            
            
            1,007
            
            
            
            2,595
            
            
            
            7,662
            
            
            
            1,946
            
            
            
            13,210Money
                market accounts
            
            
            8,954
            
            
            
            23,143
            
            
            
            67,515
            
            
            
            16,824
            
            
            
            116,436Time
                deposits < $100,000
            
            
            11,584
            
            
            
            44,509
            
            
            
            38,653
            
            
            
            26
            
            
            
            94,772Time
                deposits $100,000 and over
            
            
            60,833
            
            
            
            91,607
            
            
            
            94,260
            
            
            
            -
            
            
            
            246,700Short-term
                borrowings
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -FHLB
                advances
            
            
            15,150
            
            
            
            9,500
            
            
            
            9,200
            
            
            
            -
            
            
            
            33,850Junior
                subordinated debt
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            17,527
            
            
            
            17,527Noninterest-bearing
                checking
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            76,035Other
                liabilities
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            4,170Total
                liabilities
            
            
            100,011
            
            
            
            177,818
            
            
            
            242,033
            
            
            
            51,038
            
            
            
            651,105**Stockholders'
                Equity**
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            50,536Total
                sources of funds
            
            $
            100,011
            
            
            $
            177,818
            
            
            $
            242,033
            
            
            $
            51,038
            
            
            $
            701,641Net
                asset (liability) GAP
            
            $
            45,471
            
            
            $
            (17,899
            )
            
            $
            48,206
            
            
            $
            26,354
            
            
            $**Cumulative
                GAP**
            
            $
            45,471
            
            
            $
            27,572
            
            
            $
            75,778
            
            
            $
            102,132
            
            
            $**Percent
                of cumulative GAP to total assets**
            
            
            6.5
            %
            
            
            3.9
            %
            
            
            10.8
            %
            
            
            14.6
            %








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





26
 *Index*








**Principal
                Amount Maturing in:**($
                in thousands)
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            **Fair
                Value****06/30/08**
            
            
            **06/30/09**
            
            
            **06/30/10**
            
            
            **06/30/11**
            
            
            **06/30/12**
            
            
            **Thereafter**
            
            
            **Total**
            
            
            **6/30/2007**Rate
                sensitive assets:Fixed
                interest rate loans
            
            $
            73,319
            
            
            $
            48,011
            
            
            $
            34,800
            
            
            $
            30,688
            
            
            $
            24,973
            
            
            $
            62,416
            
            
            $
            274,207
            
            
            $
            269,048Average
                interest rate
            
            
            7.27
            %
            
            
            6.89
            %
            
            
            6.84
            %
            
            
            6.91
            %
            
            
            6.96
            %
            
            
            5.69
            %
            
            
            6.72
            %Variable
                interest rate loans
            
            
            214,670
            
            
            
            59,640
            
            
            
            18,817
            
            
            
            10,602
            
            
            
            8,480
            
            
            
            4,822
            
            
            $
            317,031
            
            
            
            317,031Average
                interest rate
            
            
            8.42
            %
            
            
            8.10
            %
            
            
            8.21
            %
            
            
            8.10
            %
            
            
            7.88
            %
            
            
            8.13
            %
            
            
            8.32
            %Fixed
                interest rate securities
            
            
            6,625
            
            
            
            8,958
            
            
            
            10,453
            
            
            
            11,101
            
            
            
            3,983
            
            
            
            26,775
            
            
            $
            67,895
            
            
            
            66,973Average
                interest rate
            
            
            5.08
            %
            
            
            4.80
            %
            
            
            4.86
            %
            
            
            4.57
            %
            
            
            4.92
            %
            
            
            4.62
            %
            
            
            4.76
            %Other
                interest bearing assets
            
            
            10,786
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            $
            10,786
            
            
            
            10,786Average
                interest rate
            
            
            6.13
            %
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            6.13
            %Rate
                sensitive liabilities:Interest
                bearing checking
            
            
            8,947
            
            
            
            7,124
            
            
            
            5,814
            
            
            
            4,748
            
            
            
            3,882
            
            
            
            17,891
            
            
            $
            48,406
            
            
            
            48,406Average
                interest rate
            
            
            1.50
            %
            
            
            1.51
            %
            
            
            1.52
            %
            
            
            1.52
            %
            
            
            1.53
            %
            
            
            1.54
            %
            
            
            1.52
            %Savings
                accounts
            
            
            3,602
            
            
            
            2,627
            
            
            
            1,908
            
            
            
            1,387
            
            
            
            1,008
            
            
            
            2,678
            
            
            $
            13,210
            
            
            
            13,210Average
                interest rate
            
            
            1.11
            %
            
            
            1.11
            %
            
            
            1.11
            %
            
            
            1.11
            %
            
            
            1.11
            %
            
            
            1.11
            %
            
            
            1.11
            %Money
                market accounts
            
            
            32,098
            
            
            
            23,329
            
            
            
            16,843
            
            
            
            12,171
            
            
            
            8,801
            
            
            
            23,194
            
            
            $
            116,436
            
            
            
            116,436Average
                interest rate
            
            
            4.01
            %
            
            
            4.02
            %
            
            
            4.04
            %
            
            
            4.07
            %
            
            
            4.09
            %
            
            
            4.15
            %
            
            
            4.06
            %Time
                deposits
            
            
            208,532
            
            
            
            110,006
            
            
            
            22,751
            
            
            
            34
            
            
            
            123
            
            
            
            26
            
            
            $
            341,472
            
            
            
            340,239Average
                interest rate
            
            
            5.08
            %
            
            
            5.48
            %
            
            
            4.11
            %
            
            
            4.32
            %
            
            
            4.55
            %
            
            
            4.05
            %
            
            
            5.14
            %Fixed
                interest rate borrowings
            
            
            9,500
            
            
            
            4,000
            
            
            
            5,200
            
            
            
            -
            
            
            
            -
            
            
            
            17,527
            
            
            $
            36,227
            
            
            
            34,751Average
                interest rate
            
            
            5.19
            %
            
            
            5.00
            %
            
            
            4.97
            %
            
            
            -
            
            
            
            -
            
            
            
            6.49
            %
            
            
            5.77
            %Variable
                interest rate borrowings
            
            
            15,150
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            $
            15,150
            
            
            
            15,150Average
                interest rate
            
            
            538.00
            %
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            5.38
            %





**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.





27
 *Index*





**PART
      II.  OTHER INFORMATION**





**Item
      1.    LEGAL
      PROCEEDINGS**





No
      material litigation





**Item
      1a.   RISK FACTORS**





No
      material changes from the Risk Factors disclosed in our Annual Report on Form
      10-K for the year ended December 31, 2006.





**Item
      4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY
      HOLDERS**





(a)
            The
                annual meeting of the shareholders of the Company was held on May
                15,
                2007.





(b)
            The
                following directors were elected at the meeting to serve until the
                annual
                meeting of shareholders in the year2010:





Votes
                For
            
            
            Votes
                WithheldR.V.
                Prasad Mantravadi. MD
            
            
            3,291,518
            
            
            
            20,426William
                G. Niezer
            
            
            3,274,644
            
            
            
            37,300John
                V. Tippmann, Sr
            
            
            3,287,645
            
            
            
            24,299











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





Keith
                E. Busse
            2008
            
            
            Debra
                A. Niezer
            2007Kathryn
                D. Callen
            2009
            
            
            Joseph
                D. Ruffolo
            2009Michael
                S. Gouloff
            2008
            
            
            Irene
                A. Walters
            2008Jerome
                F. Henry, Jr.
            2009








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





The
      shareholders voted 3,297,972 in the affirmative and 8,180 in the negative,
      with
      5,793 abstentions, to ratify the appointment of Crowe Chizek and Company LLC
      as
      auditors of the Company for 2007.








**Item
      6.   EXHIBITS**





(a)
            Exhibits.





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


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





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


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





28
 *Index*





**SIGNATURES**





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





TOWER
                FINANCIAL CORPORATIONDated:  August
                8, 2007
            
            /
                s /  Donald F. SchenkelDonald
                F. Schenkel, Chairman of the Board,President
                and Chief Executive OfficerDated:  August
                8, 2007
            
            /
                s /  Richard R. SawyerRichard
                R. SawyerChief
                Financial Officer, and Secretary






29