**Exhibit
      13**
































Home
      Federal Bancorp








**Annual
      Report 2006**



































where

































other
      areas of change, transformation and progress











As
      we
      move away from dependence on the fluctuating income stream generated through
      residential mortgage





sales,
      we
      are focusing on enhancing revenue opportunities in our full-service brokerage
      and trust operations as





well
      as
      in other retail product fee income. As an example, our brokerage operation
      was
      recently recognized for





performing
      in the top ten percent of similar Raymond James organizations nationwide.








One
      of
      the most rewarding aspects of HomeFederal’s 2006 performance was the continued,
      measured





growth
      of
      our operations in the Indianapolis market. During the year we opened a major
      new
      commercial loan





office
      in
      the city’s downtown financial district, hiring a number of experienced bankers
      familiar with the market.





Through
      the cultivation of profitable new business relationships, our efforts in the
      Indianapolis market generated a





substantial
      portion of HomeFederal’s 2006 loan growth. We have made a significant commitment
      to serving the





small
      business community, and our investments have generated tangible results.








As
      we
      continue to develop our commercial loan portfolio, we are
      maintaining strong asset quality ratios, an





ongoing
      benchmark of our business plan. In 2006, we built a team of experienced
      professionals, led by our Chief





Credit
      Officer, with substantial background in credit risk management in our Central
      Indiana markets. As a result




-
          4 -





of
      our
      focus on this area, HomeFederal’s asset quality continued to improve, as
      non-performing loans as a





percentage
      of total loans were reduced to.54%, the lowest level in the past five
      years.








Another
      growth area for HomeFederal is municipal deposits. Our efforts to obtain core
      public fund





accounts
      met with considerable success in 2006, and we intend to further develop this
      segment of our business,





which
      typically results in significant, long-term business relationships.








our
      ever-changing marketplace








HomeFederal’s
      existing market footprint positions the Bank well for additional growth
      opportunities. In June,





Indiana
      outdistanced four other states to become the successful bidder for a $550
      million Honda Motor Company





assembly
      plant. The plant, which will create at least 2,000 direct, high-paying jobs,
      is
      to be built in Greensburg, a





key
      market for HomeFederal. In Columbus, Cummins Inc. announced plans to begin
      production of a new family of





light-duty,
      clean-diesel engines — employing more than 600 people. These significant
      economic development





programs
      underscore what we and our HomeFederal predecessors have known for many years:
      our region is an





excellent
      place in which to invest, grow and prosper.








-
          5 -





looking
      forward








During
      2006 we were pleased to welcome to our Board of Directors Bill Blaser, partner
      in a respected Indianapolis





accounting
      firm, who will serve as the Board’s financial expert. As he joins our
      HomeFederal team, we can only be





encouraged
      by our prospects for the future in the economically robust region we
      serve.








In
      2007
      we intend to increase our efforts throughout our area, especially in the
      rapidly-developing





Indianapolis
      region. We will continue to adapt technology to meet the specialized needs
      of
      new customers. We are





committed
      to maintaining our regulatory compliance initiatives in this increasingly
      regulated industry. We will





continue
      our internal training programs to provide the best-qualified professionals
      to
      meet the needs of each of our





organization’s
      stakeholders. We will continue our stock buyback program to improve our capital
      management. And





we
      will
      also exercise every tool at our disposal to maintain the high levels of customer
      service and organizational





success
      that have been associated with this organization throughout its almost 100
      year
      history.








We
      look
      forward to sharing with you more reports of our region’s ongoing success and
      prosperity—and





HomeFederal’s
      share of it  — in
      the
      year ahead.








Sincerely,




/s/John
      K. Keach, Jr.


John
      K. Keach, Jr


*Chairman
      of the Board and*


*Chief
      Executive Officer*








-
          6 -





Financial
      statements








-
          7 -





**SUMMARY
      OF SELECTED CONSOLIDATED FINANCIAL DATA**


(dollars
      in thousands except per share data & offices)








**Year**
              **Ended**
            
            **Year**
              **Ended**
            
            **Year**
              **Ended**
            
            **Year**
              **Ended**
            
            **Six**
              **Months**
              **Ended**
            
            **Year**
              **Ended****Dec
                2006**
            
            **Dec
                2005**
            
            **Dec
                2004**
            
            **Dec
                2003**
            
            **Dec
                2002**
            
            **June
                2002****Selected
                Balance Sheet Data:**Total
                assets
            
            $
            904,467
            
            $
            850,786
            
            $
            868,207
            
            $
            853,328
            
            $
            886,505
            
            $
            856,012Cash
                and due from banks
            
            
            106,063
            
            
            53,736
            
            
            52,320
            
            
            34,178
            
            
            53,692
            
            
            44,478Loans
                held for sale
            
            
            6,925
            
            
            4,795
            
            
            2,617
            
            
            6,272
            
            
            30,560
            
            
            6,302Securities
                available for sale
            
            
            56,887
            
            
            123,351
            
            
            124,790
            
            
            123,638
            
            
            114,440
            
            
            114,989Securities
                held to maturity
            
            
            1,635
            
            
            1,806
            
            
            1,779
            
            
            1,828
            
            
            3,026
            
            
            3,493Portfolio
                loans, net
            
            
            675,662
            
            
            608,688
            
            
            629,490
            
            
            630,672
            
            
            628,883
            
            
            631,815Deposits
            
            
            727,159
            
            
            655,314
            
            
            640,181
            
            
            588,666
            
            
            609,358
            
            
            577,480Borrowings
            
            
            84,131
            
            
            101,041
            
            
            139,899
            
            
            169,162
            
            
            187,744
            
            
            188,680Shareholders'
                equity
            
            
            71,281
            
            
            73,038
            
            
            77,364
            
            
            84,022
            
            
            77,794
            
            
            77,086**Selected
                Operations Data:**Total
                interest income
            
            $
            50,355
            
            $
            44,976
            
            $
            42,746
            
            $
            45,602
            
            $
            26,240
            
            $
            56,298Total
                interest expense
            
            
            24,644
            
            
            19,817
            
            
            19,159
            
            
            22,264
            
            
            13,145
            
            
            30,635Net
                interest income
            
            
            25,711
            
            
            25,159
            
            
            23,587
            
            
            23,338
            
            
            13,095
            
            
            25,663Provision
                for loan losses
            
            
            850
            
            
            808
            
            
            1,770
            
            
            1,268
            
            
            1,221
            
            
            1,423Net
                interest income after provision for loan losses
            
            
            24,861
            
            
            24,351
            
            
            21,817
            
            
            22,070
            
            
            11,874
            
            
            24,240Gain
                on sale of loans
            
            
            1,430
            
            
            1,539
            
            
            2,651
            
            
            7,628
            
            
            3,740
            
            
            4,456Gain
                (loss) on sale of securities
            
            
            (1,956
            )
            
            -
            
            
            -
            
            
            (83
            )
            
            4
            
            
            92Gain
                on sale of mortgage servicing
            
            
            1,957
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -Other
                non interest income
            
            
            10,872
            
            
            9,684
            
            
            7,767
            
            
            7,133
            
            
            3,125
            
            
            7,841Non
                interest expenses
            
            
            27,906
            
            
            26,503
            
            
            24,528
            
            
            22,085
            
            
            10,375
            
            
            20,045Income
                before income taxes
            
            
            9,258
            
            
            9,071
            
            
            7,707
            
            
            14,663
            
            
            8,368
            
            
            16,584Income
                tax provision
            
            
            2,817
            
            
            2,969
            
            
            2,544
            
            
            5,020
            
            
            3,071
            
            
            6,245**Net
                Income**
            
            $
            6,441
            
            $
            6,102
            
            $
            5,163
            
            $
            9,643
            
            $
            5,297
            
            $
            10,339Basic
                earnings per common share
            
            $
            1.74
            
            $
            1.57
            
            $
            1.25
            
            $
            2.26
            
            $
            1.23
            
            $
            2.34Diluted
                earnings per common share
            
            $
            1.70
            
            $
            1.53
            
            $
            1.21
            
            $
            2.15
            
            $
            1.17
            
            $
            2.25Cash
                dividends per share
            
            $
            0.79
            
            $
            0.75
            
            $
            0.75
            
            $
            0.70
            
            $
            0.31
            
            $
            0.58**Selected
                Financial and Statistical Data:**Return
                on average assets (2)
            
            
            0.75
            %
            
            0.71
            %
            
            0.60
            %
            
            1.10
            %
            
            1.21
            %
            
            1.20
            %Return
                on average shareholders' equity (2)
            
            
            9.00
            %
            
            8.19
            %
            
            6.50
            %
            
            11.95
            %
            
            13.59
            %
            
            13.73
            %Interest
                rate spread during the period (2)
            
            
            3.24
            %
            
            3.19
            %
            
            2.97
            %
            
            2.84
            %
            
            3.19
            %
            
            3.20
            %Net
                interest margin on average earning assets (2)
            
            
            3.29
            %
            
            3.22
            %
            
            3.00
            %
            
            2.91
            %
            
            3.26
            %
            
            3.27
            %Average
                shareholders' equity to average assets
            
            
            8.31
            %
            
            8.68
            %
            
            9.17
            %
            
            9.20
            %
            
            8.93
            %
            
            8.76
            %Efficiency
                ratio (1)
            
            
            73.41
            %
            
            72.85
            %
            
            72.13
            %
            
            58.09
            %
            
            51.97
            %
            
            52.68
            %Nonperforming
                loans to total loans
            
            
            0.54
            %
            
            0.70
            %
            
            2.01
            %
            
            0.60
            %
            
            0.71
            %
            
            0.57
            %Nonperforming
                assets to total assets
            
            
            0.46
            %
            
            0.54
            %
            
            1.71
            %
            
            0.66
            %
            
            0.70
            %
            
            0.70
            %Loss
                allowance to nonperforming loans
            
            
            175.90
            %
            
            155.78
            %
            
            61.23
            %
            
            193.11
            %
            
            151.12
            %
            
            171.34
            %Loss
                allowance to total loans
            
            
            0.95
            %
            
            1.09
            %
            
            1.23
            %
            
            1.16
            %
            
            1.08
            %
            
            1.01
            %Dividend
                payout ratio
            
            
            45.23
            %
            
            47.67
            %
            
            59.22
            %
            
            31.08
            %
            
            25.12
            %
            
            24.45
            %Loan
                servicing portfolio
            
            $
            36,977
            
            $
            588,503
            
            $
            605,040
            
            $
            611,636
            
            $
            564,856
            
            $
            551,402Allowance
                for loan losses
            
            $
            6,598
            
            $
            6,753
            
            $
            7,864
            
            $
            7,506
            
            $
            7,172
            
            $
            6,451Number
                of full service offices
            
            
            19
            
            
            19
            
            
            18
            
            
            18
            
            
            17
            
            
            17





(1)
            Non
                interest expense as a percentage of the sum of net interest income
                and non
                interest income.


(2)
            For
                comparative purposes, the December 2002 ratios have been
                annualized.


-
          8 -


**QUARTERLY
      RESULTS OF OPERATIONS**


(dollars
      in thousands except share data)


The
      following table presents certain selected unaudited data relating to results
      of
      operations for the three month periods ending on the dates
      indicated.





**Fiscal
                Year Ended December 31, 2006 (Three months ended)**
            
            **Mar
                31 2006**
            
            **Jun
                30 2006**
            
            **Sep
                30 2006**
            
            **Dec
                31 2006**Total
                interest income
            
            $
            11,629
            
            $
            12,014
            
            $
            12,997
            
            $
            13,715Total
                interest expense
            
            
            5,302
            
            
            5,764
            
            
            6,602
            
            
            6,976Net
                interest income
            
            
            6,327
            
            
            6,250
            
            
            6,395
            
            
            6,739Provision
                for loan losses
            
            
            117
            
            
            220
            
            
            196
            
            
            317Net
                interest income after provision for loan losses
            
            
            6,210
            
            
            6,030
            
            
            6,199
            
            
            6,422Gain
                on sale of loans
            
            
            355
            
            
            354
            
            
            356
            
            
            365Loss
                on sale of securities
            
            
            -
            
            
            -
            
            
            (1,956
            )
            
            -Gain
                on sale of mortgage servicing
            
            
            -
            
            
            -
            
            
            -
            
            
            1,957Other
                non interest income
            
            
            2,410
            
            
            2,921
            
            
            2,772
            
            
            2,769Non
                interest expenses
            
            
            6,702
            
            
            7,052
            
            
            6,888
            
            
            7,264Income
                before income taxes
            
            
            2,273
            
            
            2,253
            
            
            483
            
            
            4,249Income
                tax provision
            
            
            749
            
            
            713
            
            
            142
            
            
            1,213**Net
                Income**
            
            $
            1,524
            
            $
            1,540
            
            $
            341
            
            $
            3,036Basic
                earnings per common share
            
            $
            0.40
            
            $
            0.42
            
            $
            0.09
            
            $
            0.83Diluted
                earnings per common share
            
            $
            0.39
            
            $
            0.40
            
            $
            0.09
            
            $
            0.81Cash
                dividends per share
            
            $
            0.188
            
            $
            0.200
            
            $
            0.200
            
            $
            0.200Stock
                sales price range: High (1)
            
            $
            26.98
            
            $
            28.56
            
            $
            28.50
            
            $
            28.55Low
            
            $
            24.92
            
            $
            26.60
            
            $
            26.00
            
            $
            26.90








**Fiscal
                Year Ended December 31, 2005 (Three months ended)**
            
            **Mar
                31 2005**
            
            **Jun
                30 2005**
            
            **Sep
                30 2005**
            
            **Dec
                31 2005**Total
                interest income
            
            $
            10,773
            
            $
            11,142
            
            $
            11,504
            
            $
            11,557Total
                interest expense
            
            
            4,703
            
            
            4,791
            
            
            5,071
            
            
            5,252Net
                interest income
            
            
            6,070
            
            
            6,351
            
            
            6,433
            
            
            6,305Provision
                for loan losses
            
            
            146
            
            
            112
            
            
            331
            
            
            219Net
                interest income after provision for loan losses
            
            
            5,924
            
            
            6,239
            
            
            6,102
            
            
            6,086Gain
                on sale of loans
            
            
            343
            
            
            346
            
            
            459
            
            
            391Other
                non interest income
            
            
            2,308
            
            
            2,407
            
            
            2,403
            
            
            2,566Non
                interest expenses
            
            
            6,564
            
            
            6,803
            
            
            6,541
            
            
            6,595Income
                before income taxes
            
            
            2,011
            
            
            2,189
            
            
            2,423
            
            
            2,448Income
                tax provision
            
            
            662
            
            
            736
            
            
            815
            
            
            756**Net
                Income**
            
            $
            1,349
            
            $
            1,453
            
            $
            1,608
            
            $
            1,692Basic
                earnings per common share
            
            $
            0.34
            
            $
            0.37
            
            $
            0.42
            
            $
            0.44Diluted
                earnings per common share
            
            $
            0.33
            
            $
            0.36
            
            $
            0.41
            
            $
            0.43Cash
                dividends per share
            
            $
            0.188
            
            $
            0.188
            
            $
            0.188
            
            $
            0.188Stock
                sales price range: High (1)
            
            $
            26.10
            
            $
            25.49
            
            $
            25.45
            
            $
            25.60Low
            
            $
            25.00
            
            $
            24.00
            
            $
            24.25
            
            $
            24.28





(1)
            The
                Company's common stock trades on the NASDAQ National Market under
                the
                symbol "HOMF."


As
      of December
      31, 2006 ,
      the
      Company had
      396 holders
      of record of its shares.





-
          9 -





**MANAGEMENT'S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**


**AND
      RESULTS OF OPERATIONS**





**FORWARD
      LOOKING STATEMENTS**


This
      Annual Report contains statements, which constitute forward looking statements
      within the meaning of the Private Securities Litigation Reform Act of 1995.
      These statements appear in a number of places in this Annual Report and include
      statements regarding the intent, belief, outlook, estimate or expectations
      of
      the Company (as defined below), its directors or its officers primarily with
      respect to future events and the future financial performance of the Company.
      Readers of this Annual Report are cautioned that any such forward looking
      statements are not guarantees of future events or performance and involve risks
      and uncertainties, and that actual results may differ materially from those
      in
      the forward looking statements as a result of various factors. The accompanying
      information contained in this Annual Report identifies important factors that
      could cause such differences. These factors include changes in interest rates,
      charge-offs and loan loss provision, loss of deposits and loan demand to
      other financial institutions, substantial changes in financial markets, changes
      in real estate values and the real estate market, regulatory changes, changes
      in
      the financial condition of issuers of the Company’s investments and borrowers,
      changes in the economic condition of the Company’s market area, increases in
      compensation and employee expenses, or unanticipated results in pending legal
      or
      regulatory proceedings.





The
      following financial information presents an analysis of the asset and liability
      structure of Home Federal Bancorp and a discussion of the results of operations
      for each of the periods presented in the Annual Report as well as a discussion
      of Home Federal Bancorp’s sources of liquidity and capital
      resources.





**HOLDING
      COMPANY BUSINESS**


Home
      Federal Bancorp (the “Company") is organized as a bank holding company
      authorized to engage in activities permissible for a financial holding company
      and owns all of the outstanding capital stock of HomeFederal Bank (the “Bank").
      The business of the Bank and therefore, the Company, is providing consumer
      and
      business banking services to certain markets in the south-central portions
      of
      the State of Indiana. The Company does business through 19 full service banking
      offices.





**GENERAL**


The
      Company's earnings in recent years reflect the fundamental changes that have
      occurred in the regulatory, economic and competitive environment in which
      commercial banks operate. The Company's earnings are primarily dependent upon
      its net interest income. Interest income is a function of the average balances
      of loans and investments outstanding during a given period and the average
      yields earned on such loans and investments. Interest expense is a function
      of
      the average amount of deposits and borrowings outstanding during the same period
      and the average rates paid on such deposits and borrowings. Net interest income
      is the difference between interest income and interest expense.





The
      Company is subject to interest rate risk to the degree that its interest-bearing
      liabilities, primarily deposits and borrowings with short- and medium-term
      maturities, mature or reprice more rapidly, or on a different basis, than its
      interest-earning assets. While having liabilities that mature or reprice more
      frequently on average than assets will be beneficial in times of declining
      interest rates, such an asset/liability structure will result in lower net
      income or net losses during periods of rising interest rates, unless offset
      by
      other factors such as non interest income. The Company's net income is also
      affected by such factors as fee income and gains or losses on sale of
      loans.





**OVERVIEW**


In
      reviewing the Company’s performance in 2006, several
      factors contributed to the results for the year. The primary area of focus
      during 2006 was to
      restructure the Company’s balance sheet. During the year, the Company made
      strategic investments in personnel resources in the Indianapolis market in
      an
      effort to provide current and future growth of commercial loans and deposits.
      To
      fund the growth in loans and to pay down higher cost wholesale funding sources,
      management restructured the Company’s mix of earning assets by selling low
      yielding investment securities. By taking steps to restructure the mix of the
      Company’s earning assets and interest bearing liabilities, the Company hopes to
      continue to improve its net interest margin. During 2006, the Company focused
      on
      generating higher yielding commercial and commercial real estate loans while
      decreasing balances of lower yielding investment securities, residential
      mortgage loans and indirect auto loans. As a result, commercial and commercial
      real estate loans increased $66.2 million while residential mortgage loans
      decreased $12.7 million, and securities available for sale decreased $66.5
      million. During 2006, the Company also focused on shifting the mix of funding
      sources to retail deposits and away from wholesale funding. As a result, retail
      deposits grew $84.5 million while Federal Home Loan Bank (“FHLB”) borrowings
      decreased $18.0 million, and wholesale deposits decreased $12.7 million. By
      shifting funding to generally less costly retail deposits, the Company was
      able
      to minimize the increase in interest cost during 2006. The rate paid on interest
      bearing liabilities increased by 65 basis points during 2006 while the yield
      on
      interest earning assets increased by  70
      basis
      points, resulting in a 7 basis point increase in net interest margin to 3.29%
      for 2006.





Total
      non
      interest income increased $1.1 million in 2006 due primarily to increases in
      deposit fees and investment advisory revenue. Deposit fees increased $1.8
      million or 40.4% for the year due to the implementation of a new overdraft
      privilege product during the year along with deposit account growth. Investment
      advisory revenue increased $238,000 or 21.1% for the year due to increased
      production in established markets and the acquisition of a book of business
      located on the south side of Indianapolis in November 2005.





Total
      non
      interest expenses increased $1.4 million for 2006 in large part due to increased
      compensation expense and occupancy expenses associated with the establishment
      of
      a commercial lending office in downtown Indianapolis. As a result of the
      addition of this commercial lending office, the Company’s commercial and
      commercial real estate loan portfolio in the Indianapolis market increased
      $75.1
      million during 2006.





In
      2007
      and subsequent years, the Company faces several challenges. The major challenges
      for 2007 will be deposit growth, the impact of the interest rate environment
      on
      net interest margins, and the increasing cost of regulatory compliance. Deposit
      growth has been strong for the Company in recent years. However, competitive
      pressures will make deposit growth more challenging for 2007. With 2007
      beginning with an inverted yield curve, it will be a challenge to maintain
      current levels of net interest margin. Thus, the extent to which the Company
      can
      promote earning asset growth and shift the balance sheet away from residential
      mortgage loans and wholesale funding sources toward commercial loans and retail
      deposits will have a major impact on net interest margin for 2007. Finally,
      the
      Company will closely monitor expenses in 2007, but costs associated with
      regulatory compliance - added personnel and system costs - are expected to
      continue to increase.





-
          10 -


**ASSET/LIABILITY
      MANAGEMENT**


The
      Company follows a program designed to decrease its vulnerability to material
      and
      prolonged increases in interest rates. This strategy includes 1) selling certain
      longer term, fixed rate loans from its portfolio; 2) increasing the origination
      of adjustable rate loans; 3) improving its interest rate gap by increasing
      the
      interest rate sensitivity by shortening the maturities of its interest-earning
      assets and extending the maturities of its interest-bearing liabilities; and
      4)
      increasing its non interest income.





A
      significant part of the Company's program of asset and liability management
      has
      been the increased emphasis on the origination of adjustable rate and/or
      short-term loans, which include adjustable rate residential construction loans,
      commercial loans, and consumer-related loans. The Company continues to originate
      fixed rate residential mortgage loans. However, management’s strategy is to sell
      substantially all residential mortgage loans that the Company originates.
      Beginning in 2006, the Company sells the servicing on mortgage loans sold,
      thereby increasing non interest income. The proceeds of these loan sales are
      used to reinvest in other interest-earning assets or to repay wholesale
      borrowings.





The
      Company continues to assess methods to stabilize interest costs and match the
      maturities of liabilities to assets. Due to the inverted yield curve, customer
      preference for short term certificates of deposit and promotional rate
      transaction accounts has resulted in shorter maturities for retail deposits.
      Retail deposit specials are competitively priced to attract deposits in the
      Company’s market area. However, when retail deposit funds become unavailable due
      to competition, the Company employs FHLB advances and brokered deposits to
      maintain the necessary liquidity to fund lending operations.





With
      the
      growth in retail deposits, the Company has decreased its reliance on wholesale
      funding sources like FHLB advances. However, by decreasing reliance on wholesale
      funding sources, the Company has significantly shortened the maturity of its
      interest-bearing liabilities.





The
      Company applies early withdrawal penalties to protect the maturity and cost
      structure of its deposits and utilizes longer term, fixed rate borrowings when
      the cost and availability permit the proceeds of such borrowings to be invested
      profitably.





-
          11 -


**INTEREST
      RATE SPREAD**


The
      following table sets forth information concerning the Company's interest-earning
      assets, interest-bearing liabilities, net interest income, interest rate spreads
      and net yield on average interest-earning assets during the periods indicated
      (including amortization of net deferred fees which are considered adjustments
      of
      yields). Average balance calculations were based on daily balances. (dollars
      in
      thousands)





**Year
                Ended**
            
            **Year
                Ended**
            
            **Year
                Ended****Dec
                2006**
            
            **Dec
                2005**
            
            **Dec
                2004****Average**
              **Balance**
            
            **Interest**
            
            **Average**
              **Yield/Rate**
            
            **Average**
              **Balance**
            
            **Interest**
            
            **Average**
              **Yield/Rate**
            
            **Average**
              **Balance**
            
            **Interest**
            
            **Average**
              **Yield/Rate**Assets:Interest-earning
                assets:Residential
                mortgage loans
            
            $
            177,687
            
            $
            10,939
            
            
            6.16
            %
            $
            185,815
            
            $
            10,828
            
            
            5.83
            %
            $
            198,228
            
            $
            10,926
            
            
            5.51
            %Commercial
                mortgage loans
            
            
            215,633
            
            
            14,312
            
            
            6.64
            %
            
            217,251
            
            
            13,697
            
            
            6.30
            %
            
            229,131
            
            
            13,811
            
            
            6.03
            %Second
                and home equity loans
            
            
            96,104
            
            
            7,021
            
            
            7.31
            %
            
            82,416
            
            
            5,656
            
            
            6.86
            %
            
            77,868
            
            
            5,439
            
            
            6.98
            %Commercial
                loans
            
            
            126,282
            
            
            10,015
            
            
            7.93
            %
            
            105,550
            
            
            6,939
            
            
            6.57
            %
            
            99,294
            
            
            5,544
            
            
            5.58
            %Other
                consumer loans
            
            
            36,297
            
            
            2,659
            
            
            7.33
            %
            
            34,846
            
            
            2,490
            
            
            7.15
            %
            
            34,437
            
            
            2,652
            
            
            7.70
            %Securities
            
            
            105,604
            
            
            4,246
            
            
            4.02
            %
            
            131,046
            
            
            4,652
            
            
            3.55
            %
            
            125,743
            
            
            4,109
            
            
            3.27
            %Short-term
                investments
            
            
            23,459
            
            
            1,163
            
            
            4.96
            %
            
            23,299
            
            
            714
            
            
            3.06
            %
            
            20,518
            
            
            265
            
            
            1.29
            %**Total
                interest-earning assets (1)**
            
            
            **781,066**
            
            $
            50,355
            
            
            6.46
            %
            
            **780,223**
            
            $
            44,976
            
            
            **5.76**
            **%**
            
            **785,219**
            
            $
            42,746
            
            
            **5.44**
            **%**Allowance
                for loan losses
            
            
            (6,696
            )
            
            
            
            
            
            
            
            (7,408
            )
            
            
            
            
            
            
            
            (7,943
            )Cash
                and due from banks
            
            
            22,996
            
            
            
            
            
            
            
            
            25,343
            
            
            
            
            
            
            
            
            25,122Bank
                premises and equipment
            
            
            17,568
            
            
            
            
            
            
            
            
            16,632
            
            
            
            
            
            
            
            
            14,913Other
                assets
            
            
            47,853
            
            
            
            
            
            
            
            
            42,957
            
            
            
            
            
            
            
            
            49,831**Total
                assets**
            
            $
            862,787
            
            
            
            
            
            
            
            $
            857,747
            
            
            
            
            
            
            
            $
            867,142Liabilities:Interest-bearing
                liabilities:Deposits:Transaction
                accounts
            
            $
            360,133
            
            $
            6,574
            
            
            1.83
            %
            $
            340,964
            
            $
            2,981
            
            
            0.87
            %
            $
            314,519
            
            $
            1,442
            
            
            0.46
            %Certificate
                accounts
            
            
            307,608
            
            
            12,805
            
            
            4.16
            %
            
            306,789
            
            
            10,284
            
            
            3.35
            %
            
            303,917
            
            
            9,390
            
            
            3.09
            %FHLB
                advances
            
            
            83,157
            
            
            4,284
            
            
            5.15
            %
            
            108,525
            
            
            5,743
            
            
            5.29
            %
            
            141,210
            
            
            7,627
            
            
            5.40
            %Other
                borrowings
            
            
            15,100
            
            
            981
            
            
            6.50
            %
            
            14,346
            
            
            809
            
            
            5.64
            %
            
            15,127
            
            
            700
            
            
            4.63
            %**Total
                interest-bearing liabilities**
            
            
            **765,998**
            
            $
            24,644
            
            
            3.22
            %
            
            **770,624**
            
            $
            19,817
            
            
            **2.57**
            **%**
            
            **774,773**
            
            $
            19,159
            
            
            **2.47**
            **%**Other
                liabilities
            
            
            24,101
            
            
            
            
            
            
            
            
            11,020
            
            
            
            
            
            
            
            
            11,268**Total
                liabilities**
            
            
            **790,099**
            
            
            
            
            
            
            
            
            **781,644**
            
            
            
            
            
            
            
            
            **786,041****Total
                shareholders’ equity**
            
            
            **72,688**
            
            
            
            
            
            
            
            
            **76,103**
            
            
            
            
            
            
            
            
            **81,101****Total
                liabilities and shareholders’ equity**
            
            $
            862,787
            
            
            
            
            
            
            
            $
            857,747
            
            
            
            
            
            
            
            $
            867,142**Net
                Interest Income**
            
            
            
            
            $
            25,711
            
            
            
            
            
            
            
            $
            25,159
            
            
            
            
            
            
            
            $
            23,587**Net
                Interest Rate Spread**
            
            
            
            
            
            
            
            
            **3.24**
            **%**
            
            
            
            
            
            
            
            **3.19**
            **%**
            
            
            
            
            
            
            
            **2.97**
            **%****Net
                Earning Assets**
            
            $
            15,068
            
            
            
            
            
            
            
            $
            9,599
            
            
            
            
            
            
            
            $
            10,446**Net
                Interest Margin (2)**
            
            
            
            
            
            
            
            
            **3.29**
            **%**
            
            
            
            
            
            
            
            **3.22**
            **%**
            
            
            
            
            
            
            
            **3.00**
            **%****Average
                Interest-earning****Assets
                to Average****Interest-bearing
                Liabilities**
            
            
            **101.97**
            **%**
            
            
            
            
            
            
            
            **101.25**
            **%**
            
            
            
            
            
            
            
            **101.35**
            **%**





(1)
            Average
                balances are net of non-performing
                loans.


(2)
            Net
                interest income divided by the average balance of interest-earning
                assets.


-
          12 -





**RATE/VOLUME
      ANALYSIS**


The
      following table sets forth the changes in the Company's interest income and
      interest expense resulting from changes in interest rates and changes in the
      volume of interest-earning assets and interest-bearing liabilities. Changes
      not
      solely attributable to volume or rate changes have been allocated in proportion
      to the changes due to volume or rate. (dollars in thousands)








**Year
                Ended**
            **Year
                Ended****Dec
                2006 vs. Dec 2005**
            **Dec
                2005 vs. Dec 2004****Increase/(Decrease)**
            **Increase/(Decrease)****Due
                to**
              **Rate**
            
            **Due
                to**
              **Volume**
            
            **Total**
              **Change**
            
            **Due
                to**
              **Rate**
            
            **Due
                to**
              **Volume**
            
            **Total**
              **Change****Interest
                Income on Interest-earning Assets:**Residential
                mortgage loans
            $
            495
            $
            (384)
            $
            111
            $
            1,038
            $
            (1,136)
            $
            (98)Commercial
                mortgage loans
            
            716
            
            (101)
            
            615
            
            894
            
            (1,008)
            
            (114)Second
                and home equity loans
            
            382
            
            983
            
            1,365
            
            (92)
            
            309
            
            217Commercial
                loans
            
            1,576
            
            1,500
            
            3,076
            
            1,030
            
            365
            
            1,395Other
                consumer loans
            
            64
            
            105
            
            169
            
            (193)
            
            31
            
            (162)Securities
            
            876
            
            (1,282)
            
            (406)
            
            365
            
            178
            
            543Short-term
                investments
            
            444
            
            5
            
            449
            
            409
            
            40
            
            449**Total**
            
            4,553
            
            826
            
            5,379
            
            3,451
            
            (1,221)
            
            2,230**Interest
                Expense on Interest-bearing Liabilities:**Deposits:Transaction
                accounts
            
            3,416
            
            177
            
            3,593
            
            1,409
            
            130
            
            1,539Certificate
                accounts
            
            2,494
            
            27
            
            2,521
            
            804
            
            90
            
            894FHLB
                advances
            
            (148)
            
            (1,311)
            
            (1,459)
            
            (151)
            
            (1,733)
            
            (1,884)Other
                borrowings
            
            127
            
            45
            
            172
            
            143
            
            (34)
            
            109**Total**
            
            5,889
            
            (1,062)
            
            4,827
            
            2,205
            
            (1,547)
            
            658**Net
                Change in Net Interest Income**
            $
            **(1,336)**
            $
            **1,888**
            $
            **552**
            $
            1,246
            $
            326
            $
            1,572





-
          13 -





**RESULTS
      OF OPERATIONS**


Comparison
      of Year Ended December 31, 2006 and Year
      Ended December 31, 2005:





**General**


The
      Company reported net income of $6 .4  million
      for the year ended December 31, 2006 .
      This
      compared to net income of $ 6.1  million
      for the year ended December 31, 2005 ,
      representing an increase of $339 ,000 or
      5 .6 %.





**Net
      Interest Income**


Net
      interest income increased $552,000 , or 2.2%,
      for the year ended December 31, 2006, compared to the year ended December 31,
      2005. The increase in net interest income was primarily due to the changing
      mix
      of the Company’s interest-earning assets and interest-bearing liabilities. Total
      interest income for the year ended December 31, 2006, increased $5.4 million,
      or
      12.0%, as compared to the year ended December 31, 2005. The average balance
      of
      total interest-earning assets increased $843,000 for the
      year, and the yield on interest-earning assets increased 70 basis points for
      the
      year. The majority of the increase in interest income was a result of the
      increased yield on interest-earning assets. The yield on interest-earning assets
      increased during 2006 due to the impact of rising interest rates during the
      year
      along with a shift away from lower yielding investment securities into higher
      yielding commercial and commercial real estate loans. Total interest expense
      for
      the year ended December 31, 2006 increased $4.8 million, or 24.4%, as compared
      to the year ended December 31, 2005. The increase was due primarily to the
      impact of rising interest rates during the year. During periods of rising
      interest rates, banks generally see rates on interest-bearing liabilities
      increase more rapidly than rates on interest-earning assets. However, during
      2006, growth in generally lower cost retail deposits provided funding for loan
      growth and funds to repay generally higher cost wholesale funding sources.
      The
      continued growth in checking and money market accounts increased the balance
      of
      interest-bearing transaction accounts $45.0 million while retail certificates
      of
      deposit increased $31.0 million for the year. The increase in retail deposits
      was used to pay down higher costing FHLB borrowings, which decreased $18.0
      million during the year ended December 31, 2006. As a result of the mix shift
      noted above along with rising interest rates during the year, the yield on
      interest-earning assets increased 70 basis points for the year while the rate
      paid on interest-bearing liabilities increased  65
      basis
      points. The Company was able to increase its net interest margin 7 basis points
      to 3.29% for 2006.





**Provision
      for Loan Losses**


Provision
      for loan losses was $ 850,000 for the
      year ended December 31, 2006 ,
      an increase
      of $42,000 from
      $ 808,000 in 2005 .
      In
      spite of the growth during 2006 in normally higher risk commercial loans, the
      Company was able to retain the provision for loan losses at a level comparable
      to the prior year due to improved credit quality ratios. Non-performing assets
      to total assets decreased to .46% at December 31, 2006 from .54% at December
      31,
      2005, and nonperforming loans to gross loans decreased to .54% at December
      31,
      2006 from .70% at December 31, 2005. Net charge offs for 2006 were $1.0 million
      compared to $1.9 million for 2005. The higher amount of charge offs during
      2005
      was primarily due to charge offs associated with two large problem commercial
      loans.





**Non
      Interest Income**


Non
      interest income increased $1.1 million, or 9.6%, for the year. The net increase
      in non interest income for 2006 was due primarily to increases in deposit fees
      partially offset by a decrease in miscellaneous income. Total deposit fees
      increased $1.8 million, or 40.4%, for the year due to the enhanced overdraft
      privilege product as well as an increase in deposit accounts. Investment
      advisory fees increased $238,000, or 21.2%, for the year due to increased
      production in established markets along with brokerage production from a
      business acquired in the Indianapolis market during November 2005. The increases
      listed above were partially offset by a decrease in miscellaneous income.
      Miscellaneous income decreased $689,000 for the year primarily due to a decrease
      of $473,000 in joint venture partnership income. The Company has historically
      been involved in a limited number of real estate joint venture partnerships
      and
      the revenue has decreased as the Company wound down the remaining partnerships.
      The Company divested of the three remaining real estate joint venture
      partnerships during the fourth quarter of 2006.





During
      2006, gain on sale of loans totaled $1.4 million representing a decrease of
      $110,000 or 7.1%, compared to the prior year. During the fourth quarter of
      2006,
      the Company recognized a gain of $2.0 million associated with the sale of the
      Company’s mortgage servicing portfolio and the corresponding mortgage servicing
      rights. In conjunction with the decision to sell the mortgage servicing
      portfolio, management began to sell residential mortgage originations on a
      servicing released basis. As a result of the sale of the mortgage servicing
      portfolio, management anticipates a decrease in fee income associated with
      the
      mortgage servicing portfolio including reductions in servicing fees and
      complementary fees such as insurance revenue and late charge fee income.
      However, as management sells new mortgage originations on a servicing released
      basis, the gain on sale of loans should increase as the Company receives a
      larger gain on the sale of servicing released loans when compared to gains
      recorded for the same loans with servicing retained.





During
      the third quarter of 2006, the Company recognized a loss of $2.0 million
      associated with the sale of investment securities. The Company chose to sell
      the
      securities and recognize the loss to provide funding for anticipated future
      loan
      growth. At December 31, 2006, management has the intent and ability to hold
      the
      remaining securities in an unrealized loss position to recovery, which may
      be
      maturity.





**Non
      Interest Expenses**


Non
      interest expenses totaled $27.9 million for the year ended December 31, 2006,
      an
      increase of $1.4 million, or 5.3%, compared to the year ended December 31,
      2005.
      The expense increases were primarily related to an increase in compensation
      and
      employee benefits expenses which increased $1.4 million for the year. The
      increase in compensation and employee benefits was a result of additional salary
      and incentive compensation expense for the new commercial lending and commercial
      credit staff in Indianapolis, additional commission costs associated with
      increased investment advisory service fees and normal annual salary increases.
      This increase was partially offset by an adjustment in the third quarter due
      to
      a change in the Company’s vacation policy resulting in a $260,000 decrease in
      the vacation accrual. Occupancy and equipment expenses increased $229,000 due
      to
      the addition of the new commercial loan office in downtown Indianapolis and
      costs associated with the Company’s new operations center . Service
      bureau expense decreased $511,000 due to renegotiated contracts with the current
      service provider. Marketing expense increased $158.000 due primarily to
      additional amounts spent to more aggressively advertise and promote retail
      deposit products during 2006. Miscellaneous expenses increased $129,000 due
      primarily to additional expenses of approximately $160,000 ancillary to the
      sale
      of the mortgage servicing portfolio.






-
          14 -




**Income
      Taxes**


Income
      tax expense totaled $2.8 million for the year ended December 31, 2006, a
      decrease of $152,000 or 5.1%, compared to the year ended December 31, 2005.
      The
      expense decrease was primarily related to the reduction to the Company’s
      effective tax rate due to the impact of the sale of available for sale
      securities resulting in a decrease to the state apportionment factor for Indiana
      during the year. The state tax impact of the securities sale resulted in a
      reduction in the Company’s effective tax rate to 30.4% in 2006 compared to 32.7%
      in 2005.




**RESULTS
      OF OPERATIONS**


Comparison
      of Year Ended December 31, 2005 and Year Ended December 31, 2004:





**General**


The
      Company reported net income of $6.1 million for the year ended December 31,
      2005. This compared to net income of $5.2 million for the year ended December
      31, 2004, representing an increase of $939,000, or 18.2%.





**Net
      Interest Income**


Net
      interest income increased $1.6 million, or 6.7%, for the year ended December
      31,
      2005, compared to the year ended December 31, 2004. The increase in net interest
      income was primarily due to the changing mix of the Company’s interest-earning
      assets and interest-bearing liabilities. Total interest income for the year
      ended December 31, 2005, increased $2.2 million, or 5.2%, as compared to the
      year ended December 31, 2004. The average balance of total interest-earning
      assets decreased $5.0 million for the year. However, this decrease was offset
      by
      a 32 basis point increase in yield on interest-earning assets for the year
      due
      primarily to the impact of rising interest rates throughout 2005. The balances
      of lower yielding residential mortgage loans and commercial real estate mortgage
      loans decreased $9.1 million and $20.1 million, respectively, while home equity
      loans increased $7.5 million. Total interest expense for the year ended December
      31, 2005 increased $658,000, or 3.4%, as compared to the year ended December
      31,
      2004. The increase was due primarily to the impact of rising interest rates
      throughout 2005. During 2005, growth in retail deposits provided funds to repay
      higher cost wholesale funding sources. The continued growth in checking and
      money market accounts increased the balance of interest-bearing transaction
      accounts $27.6 million while retail certificates of deposit increased $30.5
      million for the year. The increase in retail deposits was used to pay down
      higher costing FHLB advances which decreased $38.8 million during the year
      ended
      December 31, 2005. As a result of the mix shift noted above along with rising
      interest rates during the year, the yield on interest-earning assets increased
      32 basis points for the year while the rate paid on interest-bearing liabilities
      increased 10 basis points. The Company was able to minimize the increase in
      rates paid on interest-bearing liabilities which resulted in an increase in
      net
      interest margin of 22 basis points to 3.22% for 2005.




**Provision
      for Loan Losses**


Provision
      for loan losses was $808,000 for the year ended December 31, 2005, a decrease
      of
      $962,000 from $1.8 million in 2004. The decrease in provision for loan losses
      resulted from the overall improvement in the credit quality of the loan
      portfolio as compared to the prior year. Non-performing assets to total assets
      decreased to 0.54% at December 31, 2005 from 1.71% at December 31, 2004, and
      nonperforming loans to gross loans decreased to .70% at December 31, 2005 from
      2.01% at December 31, 2004. During 2004, two large commercial loans totaling
      $7.2 million were classified as non-performing and additional provision for
      loan
      losses was recorded to cover anticipated losses on these loans. The final
      disposition of these two commercial loans occurred during 2005 and there was
      no
      significant impact of these loans on the provision for loan losses during 2005.





**Non
      Interest Income**


Non
      interest income was $11.2 million for the year ended December 31, 2005, an
      increase of $805,000, or 7.7%, compared to the year ended December 31, 2004.
      The
      increase in non interest income was due primarily to increases in deposit
      service fees and investment advisory revenue. Total deposit fees increased
      $678,000, or 18.4%, during 2005 due primarily to growth in transaction accounts
      for the year. Total investment advisory revenue increased $132,000, or 13.3%,
      due to increased production in established markets along with fee income from
      a
      business acquired in the Indianapolis market during November 2005. In addition,
      income from joint ventures increased $271,000, to $443,000, for 2005. Sales
      results from these projects were stronger in 2005 resulting in the increased
      income.





During
      2005, fee income associated with mortgage banking activities has fluctuated
      significantly as compared to 2004. Mortgage banking fee income is comprised
      of
      two primary sources - gain on sale of loans originated and sold in the secondary
      market and loan servicing income. Gain on sale of loans was $1.5 million for
      the
      year ended December 31, 2005, a decrease of $1.1 million, or 41.9%, compared
      to
      the year ended December 31, 2004. The decrease is due primarily to significantly
      lower levels of mortgage originations in 2005 compared to 2004. Mortgage loan
      origination levels during the first half of 2004 were inflated by higher levels
      of refinance activity due to historically low interest rate levels. Loan
      servicing income was $1.4 million for the year ended December 31, 2005, an
      increase of $700,000, or 107.0%, compared to the year ended December 31, 2004.
      The primary reason for the increase in loan servicing fees related to the timing
      and fluctuation in the impairment charge/recovery. The originated mortgage
      servicing rights asset is reviewed for impairment each quarter. The impairment
      charge is the recognition of the change in the value of mortgage servicing
      rights that result from changes in interest rates and loan prepayment speeds.
      For 2005, the impairment recovery was $549,000 compared to $95,000 in
      2004.





**Non
      Interest Expenses**


Non
      interest expenses totaled $26.5 million for the year ended December 31, 2005,
      an
      increase of $2.0 million, or 8.1%, compared to the year ended December 31,
      2004.
      The expense increases were primarily related to compensation and employee
      benefits, occupancy and equipment, and marketing. Compensation and employee
      benefits increased $1.1 million due to personnel cost associated with staffing
      of new branch office locations on the south side of Indianapolis and increased
      expenses related to the Company’s pension plans. Occupancy and equipment
      expenses increased $513,000 due to the addition of a new branch office on the
      south side of Indianapolis and costs associated with the relocation of the
      Company’s operations center to a new facility during 2005. Marketing expense
      increased $392,000 due primarily to additional amounts spent to promote new
      branch offices on the south side of Indianapolis and to promote the free
      checking product. Miscellaneous expenses decreased $298,000 due primarily to
      a
      reduction in professional fees. In the prior year, non-recurring professional
      fees were incurred to assist in the implementation, documentation and testing
      related to compliance with requirements of Sarbanes Oxley
      legislation.







-
          15 -




**FINANCIAL
      CONDITION**


The
      Company's total assets increased $53.7 million to $904.5 million at December
      31,
      2006, from $850.8 million at December 31, 2005. Total loans increased $66.8
      million or 10.9% for the year. Commercial and commercial mortgage loans
      increased $66.2 million or 21.1% for the year. The growth in commercial and
      commercial mortgage loans was driven by growth from the Indianapolis market
      -
      commercial and commercial mortgage loans in Indianapolis increased $77 million
      during 2006. The growth in the Indianapolis market was driven by hiring two
      senior commercial lenders in the Indianapolis market in May and one commercial
      lender during the third quarter. In addition, home equity and second mortgage
      loan balances grew $14.8 million or 17% during the year. Residential mortgage
      balances decreased $12.8 million for the year as the Company began selling
      substantially all mortgage originations beginning in the third
      quarter.





Total
      investment securities decreased $66.5 million for the year. During the third
      quarter, the Company sold $65.5 million of investment securities. A portion
      of
      the proceeds from the sale of investment securities was used to pay off $25
      million in Federal Home Loan Bank advances. The remaining proceeds along with
      excess cash balances are being held in a money market account with the Federal
      Home Loan Bank. The total balance in the account was $66.3 million at year-end.
      It is anticipated that these funds will be needed to fund future loan growth
      and
      to pay down higher cost wholesale funding sources as they mature.





Total
      retail deposits increased $84.5 million or 14% for the year. The increase for
      the year in retail deposits is comprised of interest bearing transaction and
      money market accounts which increased $45.0 million, consumer certificates
      of
      deposit which increased $31.0 million and non-interest bearing checking accounts
      which increased $8.5 million. The increase in interest bearing transaction
      accounts during the year was primarily the result of an increase in public
      fund
      checking account balances due to a substantial new relationship. Advances with
      the Federal Home Loan Bank decreased $18.0 million for the year and public
      fund
      certificates decreased $12.5 million for the year. These wholesale funding
      sources were replaced by lower cost retail deposits.





As
      of
      December 31, 2006, shareholders’ equity was $71.3 million, a decrease of $1.8
      million compared to the prior year. During 2006, the Company repurchased 310,163
      shares representing approximately 8.1% of shares outstanding at the beginning
      of
      2006 at a total cost of $8.6 million.





**Fourth
      Quarter 2006 Results**


The
      Company had fourth quarter 2006 earnings of $3,036,000 or $0.81 diluted earnings
      per common share compared to earnings of $1,692,000, or $0.43 diluted earnings
      per common share for the fourth quarter of 2005. The Company’s net income for
      the fourth quarter included a pre-tax gain of $1,957,000 resulting from the
      sale
      of its mortgage servicing portfolio and the related mortgage servicing rights.
      Net interest income increased $434,000 or 6.9% to $6,739,000 for the fourth
      quarter of 2006. Net interest margin increased 6 basis points to 3.34% for
      the
      quarter. The sale of investment securities which occurred in September 2006
      had
      a positive impact on net interest margin during the fourth quarter. Non interest
      income, excluding the gain on sale of the mortgage servicing portfolio,
      increased $177,000 or 6.0% for the fourth quarter. The increase in non interest
      income for the fourth quarter was due primarily to increases in deposit fees
      partially offset by a decrease in loan servicing income. Total deposit fees
      increased $508,000 or 44.8% for the fourth quarter due to the implementation
      of
      an enhanced overdraft privilege product along with an increased number of
      deposit accounts. This increase was partially offset by a decrease of $222,000
      in loan servicing income. During the fourth quarter of 2005, the Company
      recorded a recovery of $189,000 of an impairment reserve established in prior
      years. Non interest expenses increased $669,000 or 10.1% for the fourth quarter.
      Compensation and employee benefits expense increased $470,000 or 12.7% for
      the
      fourth quarter due primarily to additional salary and incentive compensation
      expense for the new commercial lending and commercial credit staff in
      Indianapolis and normal annual salary increases. Total other operating expenses,
      excluding compensation and employee benefits expense, have increased $199,000
      for the fourth quarter. The increase for the fourth quarter was a result of
      approximately $160,000 of expenses ancillary to the sale of the mortgage
      servicing portfolio.




**INTEREST
      RATE SENSITIVITY**


Interest
      rate risk is the exposure to adverse changes in net interest income due to
      changes in interest rates. Interest rate sensitivity for the Company is a result
      of repricing, option, and basis risks. Repricing risk represents timing
      mismatches in the Company’s ability to alter contractual rates earned on
      financial assets or paid on liabilities in response to changes in market
      interest rates. For example, if interest-bearing liabilities reprice or mature
      more quickly than interest-earning assets, an increase in market rates could
      adversely affect net interest income. Conversely, if interest-bearing
      liabilities reprice or mature more quickly than interest-earning assets, a
      decrease in market rates could positively affect net interest income. Option
      risk arises from embedded options present in many financial instruments such
      as
      loan prepayment options and deposit early withdrawal options. These provide
      customers opportunities to take advantage of directional changes in rates,
      which
      could have an adverse impact on the Company’s net interest income. Basis risk
      refers to the potential for changes in the underlying relationship between
      market rates or indices, which subsequently result in a narrowing of the spread
      earned on a loan or investment relative to its cost of funds.







-
          16 -




Net
      interest income represents the Company’s principal component of income.
      Consistency of the Company’s net interest income is largely dependent upon the
      effective management of interest rate risk. The Company has established risk
      measures, limits and policy guidelines in its Interest Rate Risk Management
      Policy. The responsibility for management of interest rate risk resides with
      the
      Company’s Asset/Liability Committee, (“ALCO”), with oversight by the Board of
      Directors. The Company uses an earnings simulation analysis that measures the
      sensitivity of net interest income to various interest rate movements. The
      base-case scenario is established using current interest rates. The comparative
      scenarios assume an immediate parallel shock in increments of 100 basis point
      rate movements. The interest rate scenarios are used for analytical purposes
      and
      do not necessarily represent management’s view of future market movements.
      Rather, these are intended to provide a measure of the degree of volatility
      interest rate movements may introduce into the earnings of the Company. Modeling
      the sensitivity of earnings to interest rate risk is highly dependent on
      numerous assumptions embedded in the model. These assumptions include, but
      are
      not limited to, management’s best estimates of the effect of changing interest
      rates on the prepayment speeds of certain assets and liabilities, projections
      for activity levels in each of the product lines offered by the Company and
      historical behavior of deposit rates and balances in relation to changes in
      interest rates. These assumptions are inherently uncertain, and as a result,
      the
      model cannot precisely measure net interest income or precisely predict the
      impact of fluctuations in interest rates on net interest income. Actual results
      will differ from simulated results due to timing, magnitude, and frequency
      of
      interest rate changes as well as changes in market conditions. The Company’s
      12-month net interest income sensitivity profile as of fiscal year-end December
      31, 2006 and December 31, 2005 is as follows:





As
                Of
            
            Dec
                2006
            
            Dec
                2005Changes
                in Rates
            
            Net
                Interest
              Income
                % Change
            
            Net
                Interest
              Income
                % Change
            
            Interest
                Rate
              Risk
                Management
              Policy
                Guidelines+
                300 basis points
            
            
            1.75
            
            
            3.14
            
            
            (20.00
            )+
                200 basis points
            
            
            1.94
            
            
            2.63
            
            
            (15.00
            )+
                100 basis points
            
            
            1.36
            
            
            1.05
            
            
            (7.50
            )-
                100 basis points
            
            
            (1.77
            )
            
            (2.14
            )
            
            (7.50
            )-
                200 basis points
            
            
            (4.60
            )
            
            (4.26
            )
            
            (15.00
            )-
                300 basis points
            
            
            (8.15
            )
            
            (5.79
            )
            
            (20.00
            )








-
          17 -




**ASSET
      QUALITY**


In
      accordance with the Company's classification of assets policy, management
      evaluates the loan and investment portfolio each month to identify assets that
      may contain probable losses. In addition, management evaluates the adequacy
      of
      its allowance for loan losses.





**NON-PERFORMING
      ASSETS**


The
      following table sets forth information concerning non-performing assets of
      the
      Company. Real estate owned includes property acquired in settlement of
      foreclosed loans that is carried at net realizable value. (dollars in
      thousands)





As
                Of
            
            Dec
                2006
            
            Dec
                2005
            
            Dec
                2004
            
            Dec
                2003
            
            Dec
                2002Non-accruing
                loans:Residential
                mortgage loans
            
            $
            1,637
            
            $
            1,656
            
            $
            1,249
            
            $
            832
            
            $
            1,749Commercial
                mortgage loans
            
            
            413
            
            
            212
            
            
            5,633
            
            
            247
            
            
            137Second
                and home equity loans
            
            
            200
            
            
            308
            
            
            410
            
            
            591
            
            
            606Commercial
                loans
            
            
            490
            
            
            754
            
            
            2,094
            
            
            647
            
            
            566Other
                consumer loans
            
            
            112
            
            
            140
            
            
            149
            
            
            182
            
            
            206Total
            
            
            2,852
            
            
            3,070
            
            
            9,535
            
            
            2,499
            
            
            3,26490
                days past due and still accruing loans:Residential
                mortgage loans
            
            
            459
            
            
            456
            
            
            168
            
            
            1,125
            
            
            1,166Commercial
                loans
            
            
            -
            
            
            -
            
            
            -
            
            
            5
            
            
            -Total
            
            
            459
            
            
            456
            
            
            168
            
            
            1,130
            
            
            1,166Troubled
                debt restructured
            
            
            440
            
            
            809
            
            
            3,141
            
            
            258
            
            
            316Total
                non-performing loans
            
            
            3,751
            
            
            4,335
            
            
            12,844
            
            
            3,887
            
            
            4,746Real
                estate owned
            
            
            436
            
            
            271
            
            
            2,019
            
            
            1,739
            
            
            1,472**Total
                Non-Performing Assets**
            
            $
            4,187
            
            $
            4,606
            
            $
            14,863
            
            $
            5,626
            
            $
            6,218Non-performing
                assets to total assets
            
            
            0.46
            %
            
            0.54
            %
            
            1.71
            %
            
            0.66
            %
            
            0.70
            %Non-performing
                loans to total loans
            
            
            0.54
            %
            
            0.70
            %
            
            2.01
            %
            
            0.60
            %
            
            0.71
            %Allowance
                for loan losses to non-performing loans
            
            
            175.90
            %
            
            155.78
            %
            
            61.23
            %
            
            193.11
            %
            
            151.12
            %





In
      addition, at December 31, 2006
      and
      2005 ,
      there
      were $ 20.5 million
      and $14.8 million,
      respectively, in current performing loans that were classified as special
      mention or substandard for which potential weaknesses exist, which may result
      in
      the future inclusion of such items in the non-performing category.







-
          18 -




**ALLOWANCE
      FOR LOAN LOSSES**


The
      provision for loan losses for the fiscal year ended December 31, 2006 was
      $ 850,000 ,
      which
      resulted in an allowance for loan losses balance of $ 6.6 million
      as of December 31, 2006 as
      compared to $ 6.8 million
      as of December
      31, 2005 .
      The
      allowance for loan losses as a percentage of total loans decreased to
      0. 95% at
      December 31, 2006 from 1.09% at
      December 31, 2005 .
      During
      2006, the loan portfolio increased $66.8 million with the growth occurring
      in
      generally higher risk commercial loans. However, management determined the
      decrease in the allowance for loan losses to be reasonable due to the improved
      credit quality ratios noted in the previous table along with a reduced net
      charge off ratio of 0.15% of total loans for 2006.




The
      following table sets forth an analysis of the allowance for loan
      losses.





As
                Of
            
            Dec
                2006
            
            Dec
                2005
            
            Dec
                2004
            
            Dec
                2003
            
            Dec
                2002Balance
                at beginning of period
            
            $
            6,753
            
            $
            7,864
            
            $
            7,506
            
            $
            7,172
            
            $
            6,451Provision
                for loan losses
            
            
            850
            
            
            808
            
            
            1,770
            
            
            1,268
            
            
            1,221Loan
                charge-offs:Residential
                mortgage loans
            
            
            (84
            )
            
            (264
            )
            
            (88
            )
            
            (176
            )
            
            (74
            )Commercial
                mortgage loans
            
            
            -
            
            
            (893
            )
            
            (28
            )
            
            (60
            )
            
            -Second
                and home equity loans
            
            
            (67
            )
            
            (158
            )
            
            (136
            )
            
            (163
            )
            
            (44
            )Commercial
                loans
            
            
            (470
            )
            
            (422
            )
            
            (993
            )
            
            (255
            )
            
            (240
            )Other
                consumer loans
            
            
            (706
            )
            
            (311
            )
            
            (279
            )
            
            (425
            )
            
            (186
            )Total
                charge-offs
            
            
            (1,327
            )
            
            (2,048
            )
            
            (1,524
            )
            
            (1,079
            )
            
            (544
            )Recoveries:Residential
                mortgage loans
            
            
            14
            
            
            10
            
            
            16
            
            
            28
            
            
            18Commercial
                mortgage loans
            
            
            6
            
            
            42
            
            
            9
            
            
            -
            
            
            -Second
                and home equity loans
            
            
            2
            
            
            1
            
            
            2
            
            
            -
            
            
            -Commercial
                loans
            
            
            109
            
            
            26
            
            
            51
            
            
            65
            
            
            1Other
                consumer loans
            
            
            191
            
            
            50
            
            
            34
            
            
            52
            
            
            25Total
                recoveries
            
            
            322
            
            
            129
            
            
            112
            
            
            145
            
            
            44Net
                charge-offs
            
            
            (1,005
            )
            
            (1,919
            )
            
            (1,412
            )
            
            (934
            )
            
            (500
            )**Balance
                at end of period**
            
            $
            6,598
            
            $
            6,753
            
            $
            7,864
            
            $
            7,506
            
            $
            7,172Net
                charge-offs to average loans
            
            
            0.15
            %
            
            0.31
            %
            
            0.22
            %
            
            0.14
            %
            
            0.08
            %Allowance
                for loan losses to total loans
            
            
            0.95
            %
            
            1.09
            %
            
            1.23
            %
            
            1.16
            %
            
            1.08
            %





**ALLOCATION
      OF THE ALLOWANCE FOR LOAN LOSSES**


The
      following table indicates the portion of the allowance for loan loss management
      has allocated to each loan type: (dollars in thousands)





As
                Of
            
            Dec
                2006
            
            Dec
                2005
            
            Dec
                2004
            
            Dec
                2003
            
            Dec
                2002Residential
                mortgage loans
            
            $
            1,355
            
            $
            1,858
            
            $
            1,243
            
            $
            1,535
            
            $
            1,972Commercial
                mortgage loans
            
            
            1,233
            
            
            1,718
            
            
            2,919
            
            
            1,839
            
            
            1,352Second
                and home equity loans
            
            
            640
            
            
            567
            
            
            633
            
            
            712
            
            
            674Commercial
                loans
            
            
            2,623
            
            
            1,813
            
            
            2,216
            
            
            2,491
            
            
            1,936Other
                consumer loans
            
            
            747
            
            
            797
            
            
            853
            
            
            929
            
            
            879Unallocated
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            359**Total
                allowance for loan losses**
            
            $
            6,598
            
            $
            6,753
            
            $
            7,864
            
            $
            7,506
            
            $
            7,172




The
      unallocated allowance is assigned to the various loan categories as follows.
      First a portion of the unallocated allowance is assigned based on management’s
      perception of probable risk in the different loan categories. At December 31,
      2006, this included $300,000, $150,000 and $200,000 assigned to seconds and
      home
      equity loans, consumer loans and commercial mortgage loans, respectively. The
      $1.1 million remainder of the unallocated allowance is assigned to the various
      loan categories based on principal balance of the loan categories.




-
          19 -




**LIQUIDITY
      AND CAPITAL RESOURCES**


The
      Company maintains its liquid assets at a level believed adequate to meet
      requirements of normal daily activities, repayment of maturing debt and
      potential deposit outflows. Cash flow projections are regularly reviewed and
      updated to assure that adequate liquidity is maintained. Cash for these purposes
      is generated through the sale or maturity of securities and loan prepayments
      and
      repayments, and may be generated through increases in deposits or borrowings.
      Loan payments are a relatively stable source of funds, while deposit flows
      are
      influenced significantly by the level of interest rates and general money market
      conditions.





Borrowings
      may be used to compensate for reductions in other sources of funds such as
      deposits. As a member of the FHLB System, the Company may borrow from the FHLB
      of Indianapolis. At December 31, 2006 ,
      the
      Company had $68 .7 million
      in borrowings from the FHLB of Indianapolis. As of that date, the Company had
      commitments of approximately $187.4 million to fund lines of credit and
      undisbursed portions of loans in process, loan originations of approximately
      $32 .9 million,
      letters of credit of $4.5 million, and commitments to sell loans of $15.2
      million. In the opinion of management, the Company has sufficient cash flow
      and
      borrowing capacity to meet current and anticipated funding
      commitments.




**SIGNIFICANT
      COMMITMENTS**


In
      the
      normal course of business, the Company is a party to various activities that
      contain credit and market risk that are not reflected in the financial
      statements. Such activities include commitments to extend credit, selling loans,
      borrowing funds, and standby letters of credit. Commitments to borrow or extend
      credit, including loan commitments and standby letters of credit, do not
      necessarily represent future cash requirements in that these commitments often
      expire without being drawn upon. Management believes that none of these
      arrangements exposes the Company to any greater risk of loss than already
      reflected on our balance sheet so accordingly no reserves have been established
      for these commitments. Commitments are summarized as follows: (dollars in
      thousands)





**CONTRACTUALLY
                OBLIGATED PAYMENTS AND OTHER COMMITMENTS****Less
                Than**
              **1
                year**
            
            **1-3
                years**
            
            **4-5
                years**
            
            **Greater
                Than**
              **5
                years**
            
            **Total****Contractually
                obligated payments due by period:**Certificates
                of deposits
            
            $
            234,670
            
            $
            69,812
            
            $
            11,475
            
            $
            2,058
            
            $
            318,015Long
                term debt
            
            
            9,250
            
            
            33,850
            
            
            23,250
            
            
            17,781
            
            
            84,131Long
                term compensation obligations
            
            
            219
            
            
            438
            
            
            424
            
            
            1,778
            
            
            2,859Rental
                obligations
            
            
            80
            
            
            249
            
            
            303
            
            
            4
            
            
            636**Commitments
                to extend credit:**Commercial
                mortgage loans and commercial loans
            
            
            123,734
            
            
            -
            
            
            -
            
            
            -
            
            
            123,734Residential
                mortgage loans
            
            
            23,184
            
            
            -
            
            
            -
            
            
            -
            
            
            23,184Revolving
                home equity lines of credit
            
            
            52,616
            
            
            -
            
            
            -
            
            
            -
            
            
            52,616Other
            
            
            20,812
            
            
            -
            
            
            -
            
            
            -
            
            
            20,812Standby
                letters of credit
            
            
            4,457
            
            
            -
            
            
            -
            
            
            -
            
            
            4,457**Commitments
                to sell loans:**Residential
                mortgage loans
            
            
            8,976
            
            
            -
            
            
            -
            
            
            -
            
            
            8,976Commercial
                mortgage loans and commercial loans
            
            
            6,262
            
            
            -
            
            
            -
            
            
            -
            
            
            6,262**Total**
            
            $
            484,260
            
            $
            104,349
            
            $
            35,452
            
            $
            21,621
            
            $
            645,682





**OFF-BALANCE
      SHEET ARRANGEMENTS**


The
      term
“off-balance sheet arrangement” generally means any transaction, agreement, or
      other contractual arrangement to which an entity unconsolidated with the Company
      is a party under which the Company has (i) any obligation arising under a
      guarantee contract, derivative instrument or variable interest; or (ii) a
      retained or contingent interest in assets transferred to such entity or similar
      arrangement that serves as credit, liquidity or market risk support for such
      assets. The Company does not have any off-balance sheet arrangements with
      unconsolidated entities that have or are reasonably likely to have a current
      or
      future effect on the Company’s financial condition, change in financial
      condition, revenues or expenses, results of operations, liquidity, capital
      expenditures or capital resources that are material to investors, except as
      related to the guarantee of Capital Securities issued by the Company’s
      unconsolidated Delaware Trust subsidiary, Home Federal Statutory Trust I, as
      disclosed in note 10 to the consolidated financial statements.





**JOINT
      VENTURES**


The
      Company has invested in joint ventures through its subsidiaries, Home Savings
      Corporation (“HSC”) and HomeFed Financial Corp. On December 31, 2001, the Bank
      changed its charter from a Federal savings bank charter to an Indiana commercial
      bank charter. Commercial banks are not permitted to participate in real estate
      development joint ventures. The Company divested itself of these investments
      during the fourth quarter of 2006. The Company is not required to divest itself
      of its investment in Family Financial Holdings, Inc. or Heritage
      Woods.






-
          20 -




**DERIVATIVE
      FINANCIAL INSTRUMENTS**


Statement
      of Financial Accounting Standards No. 133, (“SFAS 133”), “Accounting for
      Derivative Instruments and Hedging Activities,” as amended, which establishes
      accounting and reporting standards for derivative instruments, including certain
      derivative instruments embedded in other contracts requires all derivatives,
      whether designated as a hedge, or not, to be recorded on the balance sheet
      at
      fair value. The Company designates its fixed rate and variable rate interest
      rate swaps as fair value and cash flow hedge instruments, respectively. If
      the
      derivative is designated as a fair value hedge, the changes in fair value of
      the
      derivative are recognized in earnings. If the derivative is designated as a
      cash
      flow hedge, the changes in fair value of the derivative are recorded in
      Accumulated Other Comprehensive Income (“AOCI”), net of income taxes. The
      Company has only limited involvement with derivative financial instruments
      and
      does not use them for trading purposes. The Company has interest rate lock
      commitments for the origination of loans held for sale which are not material
      to
      the Company’s consolidated financial statements. See Note 1 for further
      discussion of derivative financial instruments.





**IMPACT
      OF INFLATION**


The
      consolidated financial statements and related data presented herein have been
      prepared in accordance with accounting principles generally accepted in the
      United States of America. These principles require the measurement of financial
      position and operating results in terms of historical dollars, without
      considering changes in the relative purchasing power of money over time due
      to
      inflation. The primary assets and liabilities of commercial banks such as the
      Company are monetary in nature. As a result, interest rates have a more
      significant impact on the Company’s performance than the effects of general
      levels of inflation. Interest rates do not necessarily move in the same
      direction or with the same magnitude as the price of goods and services. In
      the
      current interest rate environment, liquidity, maturity structure and quality
      of
      the Company's assets and liabilities are critical to the maintenance of
      acceptable performance levels.





**NEW
      ACCOUNTING PRONOUNCEMENTS**





In
      February 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS
      No. 155, “Accounting for Certain Hybrid Financial Instruments, an amendment
      of FASB Statement No. 133 and 140.” This Statement amends FASB Statements
      No. 133, “Accounting for Derivative Instruments and Hedging Activities,”
and No. 140 as well as resolves issues addressed in Statement No. 133
      Implementation Issue No. D1, “Application of Statement No. 133 to
      Beneficial Interests in Securitized Financial Assets.” Specifically, this
      Statement: i) permits fair value remeasurement for any hybrid financial
      instrument that contains an embedded derivative that otherwise would require
      bifurcation; ii) clarifies which interest-only strips and principal-only strips
      are not subject to the requirements of Statement No. 133; iii) establishes
      a requirement to evaluate interests in securitized financial assets to identify
      interests that are freestanding derivatives or that are hybrid financial
      instruments that contain an embedded derivative requiring bifurcation; iv)
      clarifies that concentrations of credit risk in the form of subordination are
      not embedded derivatives; and v) amends Statement No. 140 to eliminate the
      prohibition on a qualifying special purpose entity from holding a derivative
      financial instrument that pertains to a beneficial interest other than another
      derivative financial instrument. This Statement is effective for all financial
      instruments acquired or issued after the beginning of the first fiscal year
      that
      begins after September 15, 2006. Management believes the adoption of this
      Statement will not have a material effect on the Company’s consolidated
      financial statements.





In
      March
      2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial
      Assets, an amendment of FASB Statement No. 140.” This Statement amends FASB
      Statement No. 140 and requires that all separately recognized servicing
      rights be initially measured at fair value, if practicable. For each class
      of
      separately recognized servicing assets and liabilities, this Statement permits
      the Company to choose either to report servicing assets and liabilities at
      fair
      value or at amortized cost. Under the fair value approach, servicing assets
      and
      liabilities will be recorded at fair value at each reporting date with changes
      in fair value recorded in earnings in the period in which the changes occur.
      Under the amortized cost method, servicing assets and liabilities are amortized
      in proportion to and over the period of estimated net servicing income or net
      servicing loss and are assessed for impairment based on fair value at each
      reporting date. This Statement is effective as of the beginning of the first
      fiscal year that begins after September 15, 2006. Management believes the
      adoption of this Statement will not have a material effect on the Company’s
      consolidated financial statements.





FASB
      staff position FAS 123(R)-4, “ Classification
      of Options and Similar Instruments Issued as Employee Compensation That Allow
      for Cash Settlement upon the Occurrence of a Contingent Event,” was posted
      February 3, 2006. **** This
      FASB
      Staff Position (“FSP”) addresses the classification of options and similar
      instruments issued as employee compensation that allow for cash settlement
      upon
      the occurrence of a contingent event that is not controlled by the employee.
      The
      guidance in this FSP amends paragraphs 32 and A229 of FASB Statement No. 123
      (revised 2004), “Share-Based Payment.” The guidance in this FSP shall be applied
      upon initial adoption of Statement 123(R). The guidance in this FSP is
      applicable only for options issued as part of employee compensation
      arrangements. Paragraphs 32 and A229 of Statement 123(R) require options or
      similar instruments to be classified as liabilities if “the entity can be
      required under any circumstances ** to
      settle
      the option or similar instrument by transferring cash or other assets”. Since an
      entity may be required in at least one circumstance (that is, a change in
      control) to settle its options or similar instruments issued as employee
      compensation in cash,
      the
      option or similar instrument would be classified as a liability when the change
      in control occurs pursuant to paragraphs 32 and A229 of Statement
      123(R).  Management
      has determined the adoption of FSP FAS 123(R)-4 did not have a material effect
      on the Company’s consolidated financial statements.





In
      June
      2006, the FASB issued
      Interpretation No. 48, “Accounting for Uncertainty in Income Taxes  -
      an
      Interpretation of FASB Statement No. 109.” The interpretation prescribes a
      recognition threshold and measurement attribute for the financial statement
      recognition and measurement of a tax position taken or expected to be taken
      in a
      tax return. The new interpretation is effective for fiscal years beginning
      after
      December 15, 2006. Management has determined the adoption of this Interpretation
      will not have a material impact on the Company’s consolidated financial
      statements.





In
      September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.”
This Statement is effective for fiscal years beginning after November 15,
      2007, and interim periods within those fiscal years. This Statement defines
      fair
      value, establishes a framework for measuring fair value and expands disclosures
      about fair value measurements. This Statement emphasizes that fair value is
      a
      market-based measurement and should be determined based on assumptions that
      a
      market participant would use when pricing an asset or liability. This Statement
      clarifies that market participant assumptions should include assumptions about
      risk as well as the effect of a restriction on the sale or use of an asset.
      Additionally, this Statement establishes a fair value hierarchy that provides
      the highest priority to quoted prices in active markets and the lowest priority
      to unobservable data.  Management
      is currently in the process of determining what effect the provisions of this
      statement will have on the Company’s financial position or results of
      operations.






-
          21 -




In
      September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for
      Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB
      Statements No. 87, 88, 106, and 132(R).” This Statement requires an employer to
      recognize the overfunded or underfunded status of a defined benefit
      postretirement plan (other than a multiemployer plan) as an asset or liability
      in its balance sheet and to recognize changes in that funded status in the
      year
      in which the changes occur through accumulated other comprehensive income.
      This
      Statement also requires an employer to measure the funded status of a plan
      as of
      the date of its year-end statement of financial position, with limited
      exceptions. Additional disclosures about certain effects on net periodic benefit
      cost for the next fiscal year that arise from delayed recognition of the gains
      or losses, prior service costs or credits, and transition asset or obligation
      is
      also required. This Statement is effective as of the end of the fiscal year
      ending after December 15, 2006. The adoption of this Statement did not have
      a
      material impact on the Company’s consolidated financial statements, increasing
      AOCI, net of tax of $592,000 and liabilities $980,000.





In
      February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
      Financial Assets and Financial Liabilities—including an amendment of FASB
      Statement No. 115,” **** which
      is
      effective as of the beginning of an entity’s first fiscal year that begins after
      November 15, 2007. The fair value option established by this Statement permits
      all entities to choose to measure eligible items at fair value at specified
      election dates. A business entity shall report unrealized gains and losses
      on
      items for which the fair value option has been elected in earnings (or another
      performance indicator if the business entity does not report earnings) at each
      subsequent reporting date. The fair value option a) may be applied instrument
      by
      instrument, with a few exceptions, such as investments otherwise accounted
      for
      by the equity method; b) is irrevocable (unless a new election date occurs);
      and
      c) is applied only to entire instruments and not to portions of instruments.
      Management is currently in the process of determining what effect the provisions
      of this statement will have on the Company’s financial position or results of
      operations.





**CRITICAL
      ACCOUNTING POLICIES**


The
      notes
      to the consolidated financial statements contain a summary of the Company’s
      significant accounting policies. Certain of these policies are critical to
      the
      portrayal of the Company’s financial condition, since they require management to
      make difficult, complex or subjective judgments, some of which may relate to
      matters that are inherently uncertain. Management believes that its critical
      accounting policies include a determination of the allowance for loan losses,
      the valuation of mortgage servicing rights (“MSRs”), and the valuation of
      securities.





**Allowance
      for Loan Losses**


A
      loan is
      considered impaired when it is probable the Company will be unable to collect
      all contractual principal and interest payments due in accordance with the
      terms
      of the loan agreement. Impaired loans are measured based on the loan’s
      discounted cash flow or the estimated fair value of the collateral if the loan
      is collateral dependent. The amount of impairment, if any, and any subsequent
      changes are included in the allowance for loan losses.





The
      allowance for loan losses is established through a provision for loan losses.
      Loan losses are charged against the allowance when management believes the
      loans
      are uncollectible. Subsequent recoveries, if any, are credited to the allowance.
      The allowance for loan losses is maintained at a level management considers
      to
      be adequate to absorb probable loan losses inherent in the portfolio, based
      on
      evaluations of the collectibility and historical loss experience of loans.
      The
      allowance is based on ongoing assessments of the probable estimated losses
      inherent in the loan portfolio. The Company’s methodology for assessing the
      appropriate allowance level consists of several key elements, as described
      below.





All
      delinquent loans that are 90 days past due are included on the Asset Watch
      List.
      The Asset Watch List is reviewed quarterly by the Asset Watch Committee for
      any
      classification beyond the regulatory rating based on a loan’s
      delinquency.





Commercial
      and commercial real estate loans are individually risk rated pursuant to the
      loan policy. Homogeneous loans such as consumer and residential mortgage loans
      are not individually risk rated by management. They are pooled based on
      historical portfolio data that management believes will provide a good basis
      for
      the loans' quality. For all loans not listed individually on the Asset Watch
      List, historical loss rates based on the last four years are the basis for
      developing expected charge-offs for each pool of loans.





Historical
      loss rates for commercial and consumer loans may be adjusted for significant
      factors that, in management’s judgment, reflect the impact of any current
      conditions on loss recognition. Factors which management considers in the
      analysis include the effects of the local economy, trends in the nature and
      volume of loans (delinquencies, charge-offs, nonaccrual and problem loans),
      changes in the internal lending policies and credit standards, collection
      practices, and examination results from bank regulatory agencies and the
      Company’s credit review function.





Finally,
      a portion of the allowance is maintained to recognize the imprecision in
      estimating and measuring loss when evaluating allowances for individual loans
      or
      pools of loans. This unallocated allowance is  based
      on
      factors such as current economic conditions, trends in the Company’s loan
      portfolio delinquency, losses and recoveries, level of under performing and
      non-performing loans, and concentrations of loans in any one industry. The
      unallocated allowance is assigned to the various loan categories based on
      management’s perception of probable risk in the different loan categories and
      the principal balance of the loan categories.





**Valuation
      of Mortgage Servicing Rights**


The
      Company recognizes the rights to service mortgage loans as separate assets,
      which are included in other assets in the consolidated balance sheet. The total
      cost of loans when sold is allocated between loans and MSR’s based on the
      relative fair values of each. MSR’s are subsequently carried at the lower of the
      initial carrying value, adjusted for amortization, or fair value. MSR’s are
      evaluated for impairment based on the fair value of those rights. The Company
      uses a present value cash flow valuation model to establish the fair value
      of
      the MSR’s. Factors included in the calculation of fair value of the MSR’s
      include estimating the present value of future net cash flows, market loan
      prepayment speeds for similar loans, discount rates, servicing costs, and other
      economic factors. Servicing rights are amortized over the estimated period
      of
      net servicing revenue. It is likely that these economic factors will change
      over
      the life of the MSR’s, resulting in different valuations of the MSR’s. The
      differing valuations will affect the carrying value of the MSR’s on the balance
      sheet as well as the income recorded from loan servicing in the income
      statement. During 2006, the Company sold its current mortgage servicing
      portfolio and related nonrecourse mortgage servicing rights for a gain on sale
      of $2.0 million.






-
          22 -




**Valuation
      of Securities**


Securities
      are classified as held-to-maturity or available-for-sale on the date of
      purchase. Only those securities classified as held-to-maturity are reported
      at
      amortized cost. Available-for-sale securities are reported at fair value with
      unrealized gains and losses included in accumulated other comprehensive income,
      net of related deferred income taxes, on the consolidated balance sheets. The
      fair value of a security is determined based on quoted market prices. If quoted
      market prices are not available, fair value is determined based on quoted prices
      of similar instruments. Realized securities gains or losses are reported within
      noninterest income in the consolidated statements of income. The cost of
      securities sold is based on the specific identification method.
      Available-for-sale and held-to-maturity securities are reviewed quarterly for
      possible other-than-temporary impairment. The review includes an analysis of
      the
      facts and circumstances of each individual investment such as the severity
      of
      loss, the length of time the fair value has been below cost, the expectation
      for
      that security’s performance, the creditworthiness of the issuer and the
      Company’s intent and ability to hold the security to recovery, which may be
      maturity. A decline in value that is considered to be other-than-temporary
      is
      recorded as a loss within noninterest income in the consolidated statements
      of
      income. At December 31, 2006, 89% of the unrealized losses in the
      available-for-sale security portfolio were comprised of municipal bonds, agency
      mortgage-backed securities and collateralized mortgage obligations and agency
      bonds. Management believes the price movements in these securities are dependent
      upon the movement in market interest rates. Management also maintains the intent
      and ability to hold securities in an unrealized loss position to the earlier
      of
      the recovery of losses or maturity.





**SUBSEQUENT
      EVENT**


On
      February 16, 2007, the Bank **** entered
      into a separation agreement with an executive vice president of the Bank and
      the
      Company. Pursuant
      to the agreement, six months following the date of the agreement, the Bank
      will
      pay the executive vice president a lump sum payment in the amount of
      $753,431 .
      The
      Bank also will reimburse the executive vice president for attorney fees and
      outplacement services up to a maximum aggregate amount of $35,000. As a result,
      the Company will record a pre-tax charge of $788,431 in operating expenses
      during the first quarter of 2007. In addition, on February 16, 2007, the Company
      paid the executive vice president a net cash payment of $548,167 for 78,744
      shares of Company common stock which were acquired by the executive vice
      president on that date upon the exercise of vested stock options. The lump
      sum
      cash payment represented $28.75 per share less the option exercise price. The
      net cash payment associated with the acquisition of 78,744 shares of the Company
      common stock will result in a net reduction of shareholders’ equity of $548,167
      during the first quarter of 2007 .






**MANAGEMENT'S
      ASSESSMENT AS TO THE EFFECTIVENESS OF INTERNAL CONTROL OVER FINANCIAL
      REPORTING**


The
      management of Home Federal Bancorp (the “Company”) is responsible for
      establishing and maintaining adequate internal control over financial reporting.
      Internal control over financial reporting as defined in Rule 13A-15(f) or
      15d-15(f) promulgated under the Securities Exchange Act of 1934 as a process
      designed by, or under the supervision of, a company’s principal executive and
      principal financial officers and effected by a company’s board of directors,
      management and other personnel, to provide reasonable assurance regarding the
      reliability of financial reporting and the preparation of financial statements
      for external purposes in accordance with accounting principles generally
      accepted in the United States of America (“Generally Accepted Accounting
      Principles”) and includes those policies and procedures that:





·
            Pertain
                to the maintenance of records that in reasonable detail accurately
                and
                fairly reflect the transactions and dispositions of the assets of
                the
                company;





·
            Provide
                reasonable assurance that transactions are recorded as necessary
                to permit
                preparation of financial statements in accordance with generally
                accepted
                accounting principles, and that receipts and expenditures of the
                company
                are being made only in accordance with authorizations of management
                and
                directors of the company; and





·
            Provide
                reasonable assurance regarding prevention or timely detection of
                unauthorized acquisition, use or disposition of the company’s assets that
                could have a material effect on the financial
                statements.





Because
      of its inherent limitations, internal control over financial reporting may
      not
      prevent or detect misstatements. Projections of any evaluation of effectiveness
      to future periods are subject to the risk that controls may become inadequate
      because of changes in conditions, or that the degree of compliance with the
      policies or procedures may deteriorate.





The
      Company’s management assessed the effectiveness of the Company’s internal
      control over financial reporting as of December 31, 2006 .
      In
      making this assessment, the Company’s management used the criteria set forth by
      the Committee of Sponsoring Organizations of the Treadway Commission (COSO)
      in
      Internal Control-Integrated Framework.





Based
      on
      our assessment, management believes that, as of December 31, 2006 ,
      the
      Company’s internal control over financial reporting is effective based on those
      criteria.





The
      Company’s independent registered public accounting firm has issued an audit
      report on our assessment of the Company’s internal control over financial
      reporting. This report follows.


-
          23 -


**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**







To
      the
      Board of Directors and Shareholders


Home
      Federal Bancorp


Columbus,
      Indiana





We
      have
      audited management’s assessment, included in the accompanying Management’s
      Assessment as to the Effectiveness of Internal Control over Financial Reporting
      that Home Federal Bancorp and subsidiaries (the “Company”) maintained effective
      internal control over financial reporting as of December 31, 2006, based on
      criteria established in *Internal
      Control - Integrated Framework* issued
      by
      the Committee of Sponsoring Organizations of the Treadway Commission. The
      Company’s management is responsible for maintaining effective internal control
      over financial reporting and for its assessment of the effectiveness of internal
      control over financial reporting. Our responsibility is to express an opinion
      on
      management’s assessment and an opinion on the effectiveness of the Company’s
      internal control over financial reporting based on our audit.





We
      conducted our audit in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether effective
      internal control over financial reporting was maintained in all material
      respects. Our audit included obtaining an understanding of internal control
      over
      financial reporting, evaluating management’s assessment, testing, and evaluating
      the design and operating effectiveness of internal control, and performing
      such
      other procedures as we considered necessary in the circumstances. We believe
      that our audit provides a reasonable basis for our opinions.





A
      company’s internal control over financial reporting is a process designed by, or
      under the supervision of, the company’s principal executive and principal
      financial officers, or persons performing similar functions, and effected by
      the
      company’s board of directors, management, and other personnel to provide
      reasonable assurance regarding the reliability of financial reporting and the
      preparation of financial statements for external purposes in accordance with
      generally accepted accounting principles. A company’s internal control over
      financial reporting includes those policies and procedures that (1) pertain
      to
      the maintenance of records that, in reasonable detail, accurately and fairly
      reflect the transactions and dispositions of the assets of the company; (2)
      provide reasonable assurance that transactions are recorded as necessary to
      permit preparation of financial statements in accordance with generally accepted
      accounting principles, and that receipts and expenditures of the company are
      being made only in accordance with authorizations of management and directors
      of
      the company; and (3) provide reasonable assurance regarding prevention or timely
      detection of unauthorized acquisition, use, or disposition of the company’s
      assets that could have a material effect on the financial
      statements.





Because
      of the inherent limitations of internal control over financial reporting,
      including the possibility of collusion or improper management override of
      controls, material misstatements due to error or fraud may not be prevented
      or
      detected on a timely basis. Also, projections of any evaluation of the
      effectiveness of the internal control over financial reporting to future periods
      are subject to the risk that the controls may become inadequate because of
      changes in conditions, or that the degree of compliance with the policies or
      procedures may deteriorate.





In
      our
      opinion, management’s assessment that the Company maintained effective internal
      control over financial reporting as of December 31, 2006, is fairly stated,
      in all material respects, based on the criteria established in *Internal
      Control - Integrated Framework* issued
      by
      the Committee of Sponsoring Organizations of the Treadway Commission. Also,
      in
      our opinion, the Company maintained, in all material respects, effective
      internal control over financial reporting as of December 31, 2006, based on
      the criteria established in *Internal
      Control - Integrated Framework* issued
      by
      the Committee of Sponsoring Organizations of the Treadway Commission.





We
      have
      also audited, in accordance with the standards of the Public Company Accounting
      Oversight Board (United States), the consolidated financial statements of the
      Company as of and for the year ended December 31, 2006, and our report
      dated March 15, 2007 expressed an unqualified opinion on those financial
      statements.




/s/
      Deloitte & Touche LLP


Cincinnati,
      Ohio


March
      15,
      2007


-
          24 -


**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**








To
      the
      Board of Directors and Shareholders of


Home
      Federal Bancorp


Columbus,
      Indiana





We
      have
      audited the accompanying consolidated balance sheets of Home Federal Bancorp
      and subsidiaries (the “Company”) as of December 31, 2006 and 2005, and the
      related consolidated statements of income, shareholders' equity, and cash flows
      for each of the three years in the period ended December 31, 2006. These
      consolidated financial statements are the responsibility of the Company's
      management. Our responsibility is to express an opinion on these financial
      statements based on our audits.





We
      conducted our audits in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether the financial
      statements are free of material misstatement. An audit includes examining,
      on a
      test basis, evidence supporting the amounts and disclosures in the financial
      statements. An audit also includes assessing the accounting principles used
      and
      significant estimates made by management, as well as evaluating the overall
      financial statement presentation. We believe that our audits provide a
      reasonable basis for our opinion.





In
      our
      opinion, such consolidated financial statements present fairly, in all material
      respects, the financial position of  Home Federal Bancorp and subsidiaries
      at December 31, 2006 and 2005, and the results of their operations and their
      cash flows for each of the three years in the period ended December 31, 2006,
      in
      conformity with accounting principles generally accepted in the United States
      of
      America.





We
      have
      also audited, in accordance with the standards of the Public Company Accounting
      Oversight Board (United States), the effectiveness of the Company's internal
      control over financial reporting as of December 31, 2006, based on the criteria
      established in *Internal
      Control—Integrated Framework* issued
      by the Committee of Sponsoring Organizations of the Treadway Commission and
      our
      report dated March 15, 2007 expressed an unqualified opinion on management's
      assessment of the effectiveness of the Company's internal control over financial
      reporting and an unqualified opinion on the effectiveness of the Company's
      internal control over financial reporting.








/s/
      Deloitte & Touche LLP


Cincinnati,
      Ohio


March
      15,
      2007


-
          25 -


**CONSOLIDATED
      BALANCE SHEETS**


(dollars
      in thousands except share data)





**December
                31, 2006**
            
            **December
                31,**
              **2005****Assets:**Cash
                and due from banks
            
            $
            106,063
            
            $
            53,736Securities
                available for sale at fair value (amortized cost $57,421
                and$126,146)
            
            
            56,887
            
            
            123,351Securities
                held to maturity at amortized cost (fair value $1,628
                and$1,796)
            
            
            1,635
            
            
            1,806Loans
                held for sale (fair value $7,055
                and$4,859)
            
            
            6,925
            
            
            4,795Portfolio
                loans:Commercial
                loans
            
            
            151,781
            
            
            105,825Commercial
                mortgage loans
            
            
            227,433
            
            
            207,144Residential
                mortgage loans
            
            
            166,003
            
            
            178,752Second
                & home equity loans
            
            
            102,713
            
            
            87,893Other
                consumer loans
            
            
            34,483
            
            
            36,126Unearned
                income
            
            
            (153
            )
            
            (299
            )Total
                portfolio loans
            
            
            682,260
            
            
            615,441Allowance
                for loan losses
            
            
            (6,598
            )
            
            (6,753
            )Portfolio
                loans, net
            
            
            675,662
            
            
            608,688Premises
                and equipment
            
            
            17,232
            
            
            17,781Accrued
                interest receivable
            
            
            4,679
            
            
            3,942Goodwill
            
            
            1,695
            
            
            1,695Servicing
                rights
            
            
            -
            
            
            2,725Other
                assets
            
            
            33,689
            
            
            32,267**Total
                Assets**
            
            $
            904,467
            
            $
            850,786**Liabilities:**Deposits:Demand
            
            $
            72,804
            
            $
            64,269Interest
                checking
            
            
            129,025
            
            
            82,991Savings
            
            
            41,710
            
            
            46,014Money
                market
            
            
            165,605
            
            
            162,350Certificates
                of deposits
            
            
            293,914
            
            
            262,888Retail
                deposits
            
            
            703,058
            
            
            618,512Brokered
                deposits
            
            
            22,357
            
            
            22,557Public
                fund certificates
            
            
            1,744
            
            
            14,245Wholesale
                deposits
            
            
            24,101
            
            
            36,802Total
                deposits
            
            
            727,159
            
            
            655,314FHLB
                borrowings
            
            
            68,667
            
            
            86,633Short
                term borrowings
            
            
            -
            
            
            166Long
                term debt
            
            
            -
            
            
            14,242Junior
                subordinated debt
            
            
            15,464
            
            
            -Accrued
                taxes, interest and expenses
            
            
            4,462
            
            
            2,084Other
                liabilities
            
            
            17,434
            
            
            19,309Total
                liabilities
            
            
            833,186
            
            
            777,748**Commitments
                and Contingencies****Shareholders'
                equity**No
                par preferred stock; Authorized:2,000,000sharesIssued
                and outstanding: NoneNo
                par common stock; Authorized:15,000,000sharesIssued
                and outstanding:3,610,218and3,815,657
            
            
            17,081
            
            
            15,152Retained
                earnings, restricted
            
            
            55,137
            
            
            59,723Accumulated
                other comprehensive loss, net
            
            
            (937
            )
            
            (1,837
            )Total
                shareholders' equity
            
            
            71,281
            
            
            73,038**Total
                Liabilities and Shareholders' Equity**
            
            $
            904,467
            
            $
            850,786





See
      notes
      to consolidated financial statements


-
          26 -


**CONSOLIDATED
      STATEMENTS OF INCOME**


(dollars
      in thousands except per share data)





**Year
                Ended**
            
            **Year
                Ended**
            
            **Year
                Ended****Dec
                2006**
            
            **Dec
                2005**
            
            **Dec
                2004****Interest
                Income:**Short
                term investments
            
            $
            1,163
            
            $
            714
            
            $
            265Securities
            
            
            4,246
            
            
            4,652
            
            
            4,109Commercial
                loans
            
            
            10,015
            
            
            6,939
            
            
            5,544Commercial
                mortgage loans
            
            
            14,312
            
            
            13,697
            
            
            13,811Residential
                mortgage loans
            
            
            10,939
            
            
            10,828
            
            
            10,926Second
                and home equity loans
            
            
            7,021
            
            
            5,656
            
            
            5,439Other
                consumer loans
            
            
            2,659
            
            
            2,490
            
            
            2,652Total
                interest income
            
            
            50,355
            
            
            44,976
            
            
            42,746**Interest
                Expense:**Checking
                and savings accounts
            
            
            1,592
            
            
            543
            
            
            375Money
                market accounts
            
            
            4,982
            
            
            2,438
            
            
            1,067Certificates
                of deposit
            
            
            11,343
            
            
            8,080
            
            
            7,270Total
                interest on retail deposits
            
            
            17,917
            
            
            11,061
            
            
            8,712Brokered
                deposits
            
            
            1,118
            
            
            1,326
            
            
            1,633Public
                funds
            
            
            344
            
            
            878
            
            
            487Total
                interest on wholesale deposits
            
            
            1,462
            
            
            2,204
            
            
            2,120Total
                interest on deposits
            
            
            19,379
            
            
            13,265
            
            
            10,832FHLB
                borrowings
            
            
            4,284
            
            
            5,743
            
            
            7,627Other
                borrowings
            
            
            5
            
            
            1
            
            
            1Long
                term debt
            
            
            650
            
            
            808
            
            
            699Junior
                subordinated debt
            
            
            326
            
            
            -
            
            
            -Total
                interest expense
            
            
            24,644
            
            
            19,817
            
            
            19,159Net
                interest income
            
            
            25,711
            
            
            25,159
            
            
            23,587Provision
                for loan losses
            
            
            850
            
            
            808
            
            
            1,770Net
                interest income after provision for loan losses
            
            
            24,861
            
            
            24,351
            
            
            21,817**Non
                Interest Income:**Gain
                on sale of loans
            
            
            1,430
            
            
            1,539
            
            
            2,651Loss
                on sale of securities
            
            
            (1,956
            )
            
            -
            
            
            -Gain
                on sale of mortgage servicing
            
            
            1,957
            
            
            -
            
            
            -Investment
                advisory services
            
            
            1,363
            
            
            1,125
            
            
            993Service
                fees on deposit accounts
            
            
            6,124
            
            
            4,363
            
            
            3,685Loan
                servicing income, net of impairment
            
            
            1,233
            
            
            1,354
            
            
            654Miscellaneous
            
            
            2,152
            
            
            2,842
            
            
            2,435Total
                non interest income
            
            
            12,303
            
            
            11,223
            
            
            10,418**Non
                Interest Expenses:**Compensation
                and employee benefits
            
            
            15,900
            
            
            14,502
            
            
            13,419Occupancy
                and equipment
            
            
            3,908
            
            
            3,679
            
            
            3,166Service
                bureau expense
            
            
            1,506
            
            
            2,017
            
            
            1,843Marketing
            
            
            1,268
            
            
            1,110
            
            
            718Miscellaneous
            
            
            5,324
            
            
            5,195
            
            
            5,382Total
                non interest expenses
            
            
            27,906
            
            
            26,503
            
            
            24,528Income
                before income taxes
            
            
            9,258
            
            
            9,071
            
            
            7,707Income
                tax provision
            
            
            2,817
            
            
            2,969
            
            
            2,544**Net
                Income**
            
            $
            6,441
            
            $
            6,102
            
            $
            5,163**Basic
                Earnings per Common Share**
            
            $
            1.74
            
            $
            1.57
            
            $
            1.25**Diluted
                Earnings per Common Share**
            
            $
            1.70
            
            $
            1.53
            
            $
            1.21**Basic
                weighted average number of shares**
            
            
            **3,707,325**
            
            
            **3,897,501**
            
            
            **4,117,085****Dilutive
                weighted average number of shares**
            
            
            **3,788,556**
            
            
            **3,993,055**
            
            
            **4,263,123****Dividends
                per share**
            
            $
            0.79
            
            $
            0.75
            
            $
            0.75





See
      notes
      to consolidated financial statements


-
          27 -


**CONSOLIDATED
      STATEMENTS OF SHAREHOLDERS' EQUITY**


(dollars
      in thousands except share data)





Shares
              Outstanding
            
            Common
              Stock
            
            Retained
              Earnings
            
            Accumulated
              Other
              Comprehensive
              Income
                (Loss)
            
            Total
              Shareholders'
              Equity**Balance
                at December 2003**
            
            
            4,312,805
            
            $
            12,616
            
            $
            71,436
            
            $
            (30
            )
            $
            84,022Comprehensive
                income:Net
                income
            
            
            
            
            
            
            
            
            5,163
            
            
            
            
            
            5,163Change
                in unrealized loss on securities available for sale, net of
                reclassification adjustment and tax effect of  $233
            
            
            
            
            
            
            
            
            
            
            
            (449
            )
            
            (449
            )Change
                in fair value of cash flow hedge, net of tax of  $125
            
            
            
            
            
            
            
            
            
            
            
            191
            
            
            191Total
                comprehensive income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            4,905Stock
                options exercised
            
            
            83,485
            
            
            1,293
            
            
            
            
            
            
            
            
            1,293Stock
                repurchased
            
            
            (368,299
            )
            
            (549
            )
            
            (9,404
            )
            
            
            
            
            (9,953
            )Tax
                benefit related to exercise of non-qualified stock options
            
            
            
            
            
            154
            
            
            
            
            
            
            
            
            154Cash
                dividends ($.750 per share)
            
            
            
            
            
            
            
            
            (3,057
            )
            
            
            
            
            (3,057
            )**Balance
                at December 2004**
            
            
            4,027,991
            
            
            13,514
            
            
            64,138
            
            
            (288
            )
            
            77,364Comprehensive
                income:Net
                income
            
            
            
            
            
            
            
            
            6,102
            
            
            
            
            
            6,102Change
                in unrealized loss on securities available for sale, net of
                reclassification adjustment and tax effect of  $864
            
            
            
            
            
            
            
            
            
            
            
            (1,637
            )
            
            (1,637
            )Change
                in fair value of cash flow hedge, net of tax of  $58
            
            
            
            
            
            
            
            
            
            
            
            88
            
            
            88Total
                comprehensive income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            4,553Stock
                options exercised
            
            
            109,066
            
            
            1,846
            
            
            
            
            
            
            
            
            1,846Stock
                repurchased
            
            
            (321,400
            )
            
            (478
            )
            
            (7,608
            )
            
            
            
            
            (8,086
            )Tax
                benefit related to exercise of non-qualified stock options
            
            
            
            
            
            270
            
            
            
            
            
            
            
            
            270Cash
                dividends ($.750 per share)
            
            
            
            
            
            
            
            
            (2,909
            )
            
            
            
            
            (2,909
            )**Balance
                at December 2005**
            
            
            **3,815,657**
            
            
            **15,152**
            
            
            **59,723**
            
            
            **(1,837**
            **)**
            
            **73,038**Comprehensive
                income:Net
                income
            
            
            
            
            
            
            
            
            6,441
            
            
            
            
            
            6,441Change
                in unrealized loss on securities available for sale, net of
                reclassification adjustment and tax effect of  $781
            
            
            
            
            
            
            
            
            
            
            
            1,481
            
            
            1,481Change
                in fair value of cash flow hedge, net of tax of  $7
            
            
            
            
            
            
            
            
            
            
            
            11
            
            
            11Total
                comprehensive income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            7,933Cumulative
                effect in change in accounting for SRP obligations, net of tax of 
                $388
            
            
            
            
            
            
            
            
            
            
            
            (592
            )
            
            (592
            )Stock
                options exercised
            
            
            104,724
            
            
            1,962
            
            
            
            
            
            
            
            
            1,962Stock
                repurchased
            
            
            (310,163
            )
            
            (462
            )
            
            (8,114
            )
            
            
            
            
            (8,576
            )Stock
                compensation expense
            
            
            
            
            
            296
            
            
            
            
            
            
            
            
            296Tax
                benefit related to exercise of non-qualified stock options
            
            
            
            
            
            133
            
            
            
            
            
            
            
            
            133Cash
                dividends ($.788 per share)
            
            
            
            
            
            
            
            
            (2,913
            )
            
            
            
            
            (2,913
            )**Balance
                at December 2006**
            
            
            **3,610,218**
            
            $
            17,081
            
            $
            55,137
            
            $
            (937
            )
            $
            71,281





See
      notes
      to consolidated financial statements


-
          28 -


**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**


(dollars
      in thousands)





**Year
                Ended**
            
            **Year
                Ended**
            
            **Year
                Ended****Dec
                2006**
            
            **Dec
                2005**
            
            **Dec
                2004****Cash
                Flows From Operating Activities:**Net
                income
            
            $
            6,441
            
            $
            6,102
            
            $
            5,163Adjustments
                to reconcile net income to net cash from operating
                activities:Accretion
                of discounts, amortization and depreciation
            
            
            1,816
            
            
            1,808
            
            
            2,161Provision
                for loan losses
            
            
            850
            
            
            808
            
            
            1,770Stock
                based compensation expense
            
            
            296
            
            
            -
            
            
            -(Benefit)/provision
                for deferred income taxes
            
            
            (2,041
            )
            
            174
            
            
            (518
            )Net
                gain from sale of loans
            
            
            (1,430
            )
            
            (1,539
            )
            
            (2,651
            )Net
                loss from sale of securities
            
            
            1,956
            
            
            -
            
            
            -(Income)/loss
                from joint ventures and net (gain)/loss from real estate
                owned
            
            
            114
            
            
            (566
            )
            
            (384
            )Loan
                fees deferred (recognized), net
            
            
            (418
            )
            
            (216
            )
            
            (79
            )Proceeds
                from sale of loans held for sale
            
            
            96,389
            
            
            97,079
            
            
            143,661Origination
                of loans held for sale
            
            
            (97,089
            )
            
            (97,717
            )
            
            (137,355
            )Increase
                in accrued interest and other assets
            
            
            (2,346
            )
            
            (1,351
            )
            
            (1,004
            )Increase
                (decrease) in other liabilities
            
            
            (86
            )
            
            7,443
            
            
            (524
            )**Net
                Cash From Operating Activities**
            
            
            **4,452**
            
            
            **12,025**
            
            
            **10,240****Cash
                Flows From Investing Activities:**Net
                principal received (disbursed) on loans
            
            
            (55,080
            )
            
            22,062
            
            
            8,607Proceeds
                from:Maturities/Repayments
                of:Securities
                held to maturity
            
            
            268
            
            
            461
            
            
            523Securities
                available for sale
            
            
            25,086
            
            
            25,895
            
            
            26,266Sales
                of:Securities
                available for sale
            
            
            105,649
            
            
            10,048
            
            
            23,256Real
                estate owned and other asset sales
            
            
            778
            
            
            1,706
            
            
            1,422Federal
                Home Loan Bank stock
            
            
            1,636
            
            
            -
            
            
            -Purchases
                of:Loans
            
            
            (11,268
            )
            
            (1,720
            )
            
            (9,116
            )Securities
                held to maturity
            
            
            (100
            )
            
            (490
            )
            
            (471
            )Securities
                available for sale
            
            
            (64,151
            )
            
            (37,208
            )
            
            (51,998
            )Return
                of investment in joint ventures
            
            
            586
            
            
            1,507
            
            
            2,124Investment
                in cash surrender value of life insurance
            
            
            -
            
            
            (655
            )
            
            -Acquisition
                of property and equipment
            
            
            (1,078
            )
            
            (2,353
            )
            
            (3,400
            )**Net
                Cash From Investing Activities**
            
            
            **2,326**
            
            
            **19,253**
            
            
            **(2,787**
            **)****Cash
                Flows From (Used In) Financing Activities:**Net
                increase in deposits
            
            
            71,845
            
            
            17,158
            
            
            51,515Proceeds
                from advances from FHLB
            
            
            65,000
            
            
            14,000
            
            
            19,500Repayment
                of advances from FHLB
            
            
            (82,966
            )
            
            (52,813
            )
            
            (48,350
            )Repayment
                of long term debt
            
            
            (14,242
            )
            
            -
            
            
            -Proceeds
                from issuance of junior subordinated debt
            
            
            15,464
            
            
            -
            
            
            -Net
                proceeds from (net repayment of) overnight borrowings
            
            
            (166
            )
            
            (45
            )
            
            (413
            )Common
                stock options exercised
            
            
            1,962
            
            
            1,846
            
            
            1,293Repurchase
                of common stock
            
            
            (8,576
            )
            
            (8,086
            )
            
            (9,953
            )Excess
                tax benefit related to stock based compensation
            
            
            133
            
            
            270
            
            
            154Payment
                of dividends on common stock
            
            
            (2,905
            )
            
            (2,192
            )
            
            (3,057
            )**Net
                Cash From (Used In) Financing Activities**
            
            
            **45,549**
            
            
            **(29,862**
            **)**
            
            **10,689****NET
                INCREASE IN CASH AND CASH EQUIVALENTS**
            
            
            **52,327**
            
            
            **1,416**
            
            
            **18,142**Cash
                and cash equivalents, beginning of period
            
            
            53,736
            
            
            52,320
            
            
            34,178**Cash
                and Cash Equivalents, End of Period**
            
            $
            106,063
            
            $
            53,736
            
            $
            52,320**Supplemental
                Information:**Cash
                paid for interest
            
            $
            24,692
            
            $
            19,955
            
            $
            19,207Cash
                paid for income taxes
            
            $
            2,380
            
            $
            2,236
            
            $
            1,939Assets
                acquired through foreclosure
            
            $
            1,114
            
            $
            1,262
            
            $
            2,086Sale
                of joint venture, financed by the Company
            
            $
            1,058
            
            $
            -
            
            $
            -Goodwill
                and identifiable intangible assets
            
            $
            -
            
            $
            400
            
            $
            -Real
                estate owned transferred to property and equipment, net
            
            $
            -
            
            $
            1,173
            
            $
            -Dividends
                payable
            
            $
            725
            
            $
            717
            
            $
            -





See
      notes
      to consolidated financial statements


-
          29 -


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


For
      The
      Years Ended December 31, 2006, 2005 and 2004





**1.**
            **SUMMARY
                OF SIGNIFICANT ACCOUNTING
                POLICIES**


The
      accounting policies of Home Federal Bancorp and subsidiaries  (the
“Company") conform to accounting principles generally accepted in the United
      States of America and prevailing practices within the banking industry. A
      summary of the more significant accounting policies follows:





**Basis
      of Presentation**


The
      consolidated financial statements include the accounts of the Company and its
      wholly-owned subsidiaries, HomeFed Financial Corp. and HomeFederal Bank (the
      “Bank") and its wholly-owned subsidiaries. All significant intercompany balances
      and transactions have been eliminated.





Description
      of Business


The
      Company is a bank holding company. The Company provides financial services
      to south-central Indiana through its main office in Columbus and 18 other full
      service banking offices and a commercial loan office in Indianapolis. The
      Company also has a fully owned subsidiary,  Home Investments, Inc., a
      Nevada corporation, that holds, services, manages, and invests a portion of
      the
      Bank’s investment portfolio.





Use
      of
      Estimates


The
      preparation of financial statements in conformity with accounting principles
      generally accepted in the United States of America requires management to make
      estimates and assumptions that affect the amounts reported in the financial
      statements and accompanying notes. Actual results could differ from those
      estimates. Estimates most susceptible to change in the near term include the
      allowance for loan losses, the valuation of mortgage servicing rights, and
      the
      valuation of securities.





**Cash
      and Cash Equivalents**


All
      highly liquid investments with an original maturity of three months or less
      are
      considered to be cash equivalents.





**Securities**


Securities
      are required to be classified as held to maturity, available for sale or
      trading. Debt securities that the Company has the positive intent and ability
      to
      hold to maturity are classified as held to maturity. Debt and equity securities
      not classified as either held to maturity or trading securities are classified
      as available for sale. Only those securities classified as held to maturity
      are
      reported at amortized cost, with those available for sale and trading reported
      at fair value with unrealized gains and losses included in shareholders' equity
      or income, respectively. Premiums and discounts are amortized over the
      contractual lives of the related securities using the level yield method. Gain
      or loss on sale of securities is based on the specific identification
      method.





**Loans
      Held for Sale**


Loans
      held for sale consist of mortgage loans conforming to established guidelines
      and
      held for sale to the secondary market. Mortgage loans held for sale are carried
      at the lower of cost or fair value determined on an aggregate basis. Gains
      and
      losses on the sale of these mortgage loans are included in non interest
      income.





**Valuation
      of Mortgage Servicing Rights**


The
      Company recognizes the rights to service mortgage loans as separate assets,
      which are included in other assets in the consolidated balance sheet. The total
      cost of loans when sold is allocated between loans and MSR’s, based on the
      relative fair values of each. MSR’s are subsequently carried at the lower of the
      initial carrying value, adjusted for amortization, or fair value. MSR’s are
      evaluated for impairment based on the fair value of those rights. The Company
      uses a present value cash flow valuation model to establish the fair value
      of
      the MSR’s. Factors included in the calculation of fair value of the MSR’s
      include estimating the present value of future net cash flows, market loan
      prepayment speeds for similar loans, discount rates, servicing costs, and other
      economic factors. Servicing rights are amortized over the estimated period
      of
      net servicing revenue. It is likely that these economic factors will change
      over
      the life of the MSR’s, resulting in different valuations of the MSR’s. The
      differing valuations will affect the carrying value of the MSR’s on the balance
      sheet as well as the income recorded from loan servicing in the consolidated
      statements of income. During 2006, the Company sold its mortgage servicing
      portfolio and related nonrecourse mortgage servicing rights for a gain on sale
      of $2.0 million .





**Loans**


Interest
      on real estate, commercial and installment loans is accrued over the term of
      the
      loans on a level yield basis. The recognition of interest income is discontinued
      when, in management’s judgment, the interest will not be collectible in the
      normal course of business.





**Loan
      Origination Fees**


Nonrefundable
      origination fees, net of certain direct origination costs, are deferred and
      recognized as a yield adjustment over the contractual life of the underlying
      loan. Any unamortized fees on loans sold are credited to gain on sale of loans
      at the time of sale.








**Uncollected
      Interest**


A
      reversal of uncollected interest is generally provided on loans which are more
      than 90 days past due. The only loans which are 90 days past due and are still
      accruing interest, are loans where the Company is guaranteed reimbursement
      of
      interest by either a mortgage insurance contract or by a government agency.
      If
      neither of these criteria is met, a charge to interest income equal to all
      interest previously accrued and unpaid is made, and income is subsequently
      recognized only to the extent that cash payments are received until, in
      management's judgment, the borrower's ability to make periodic interest and
      principal payments returns to normal, in which case the loan is returned to
      accrual status.




-
          30 -




**Allowance
      for Loan Losses**


A
      loan is
      considered impaired when it is probable the Company will be unable to collect
      all contractual principal and interest payments due in accordance with the
      terms
      of the loan agreement. Impaired loans are measured based on the loan’s
      discounted cash flow or the estimated fair value of the collateral if the loan
      is collateral dependent. The amount of impairment, if any, and any subsequent
      changes are included in the allowance for loan losses.




The
      allowance for loan losses is established through a provision for loan losses.
      Loan losses are charged against the allowance when management believes the
      loans
      are uncollectible. Subsequent recoveries, if any, are credited to the allowance.
      The allowance for loan losses is maintained at a level management considers
      to
      be adequate to absorb probable loan losses inherent in the portfolio, based
      on
      evaluations of the collectibility and historical loss experience of loans.
      The
      allowance is based on ongoing assessments of the probable estimated losses
      inherent in the loan portfolio. The Company’s methodology for assessing the
      appropriate allowance level consists of several key elements, as described
      below.





All
      delinquent loans that are 90 days past due are included on the Asset Watch
      List.
      The Asset Watch List is reviewed quarterly by the Asset Watch Committee for
      any
      classification beyond the regulatory rating based on the loans'
      delinquency.





Commercial
      and commercial real estate loans are individually risk rated pursuant to the
      loan policy. Homogeneous loans such as consumer and residential mortgage loans
      are not individually risk rated by management. They are pooled based on
      historical portfolio data that management believes will provide a good basis
      for
      the loans' quality. For all loans not listed individually on the Asset Watch
      List, historical loss rates based on the last four years are the basis for
      developing expected charge-offs for each pool of loans.





Historical
      loss rates for commercial and consumer loans may be adjusted for significant
      factors that, in management’s judgment, reflect the impact of any current
      conditions on loss recognition. Factors which management considers in the
      analysis include the effects of the local economy, trends in the nature and
      volume of loans (delinquencies, charge-offs, nonaccrual and problem loans),
      changes in the internal lending policies and credit standards, collection
      practices, and examination results from bank regulatory agencies and the
      Company’s credit review function.





Finally,
      a portion of the allowance is maintained to recognize the imprecision in
      estimating and measuring loss when evaluating allowances for individual loans
      or
      pools of loans. This unallocated allowance is based on factors such as current
      economic conditions, trends in the Company’s loan portfolio delinquency, losses
      and recoveries, level of under performing and non-performing loans, and
      concentrations of loans in any one industry. The unallocated allowance is
      assigned to the various loan categories based on management’s perception of
      probable risk in the different loan categories and the principal balance of
      the
      loan categories.




-
          31 -




**Valuation
      of Securities**


Securities
      are classified as held-to-maturity or available-for-sale on the date of
      purchase. Only those securities classified as held-to-maturity are reported
      at
      amortized cost. Available-for-sale securities are reported at fair value with
      unrealized gains and losses included in accumulated other comprehensive income,
      net of related deferred income taxes, on the consolidated balance sheets. The
      fair value of a security is determined based on quoted market prices. If quoted
      market prices are not available, fair value is determined based on quoted prices
      of similar instruments. Realized securities gains or losses are reported within
      noninterest income in the consolidated statements of income. The cost of
      securities sold is based on the specific identification method.
      Available-for-sale and held-to-maturity securities are reviewed quarterly for
      possible other-than-temporary impairment. The review includes an analysis of
      the
      facts and circumstances of each individual investment such as the severity
      of
      loss, the length of time the fair value has been below cost, the expectation
      for
      that security’s performance, the creditworthiness of the issuer and the
      Company’s intent and ability to hold the security to recovery, which may be
      maturity. A decline in value that is considered to be other-than-temporary
      is
      recorded as a loss within noninterest income in the consolidated statements
      of
      income. At December 31, 2006, 89% of the unrealized losses in the
      available-for-sale security portfolio were comprised of municipal bonds, agency
      mortgage-backed securities and collateralized mortgage obligations and agency
      bonds. Management believes the price movements in these securities are dependent
      upon the movement in market interest rates. Management also maintains the intent
      and ability to hold securities in an unrealized loss position to the earlier
      of
      the recovery of losses or maturity.





**Real
      Estate Owned**


Real
      estate owned represents real estate acquired through foreclosure or deed in
      lieu
      of foreclosure and is recorded at the lower of fair value less cost to sell
      or
      carrying amount. When property is acquired, it is recorded at net realizable
      value at the date of acquisition, with any resulting write-down charged against
      the allowance for loan losses. Any subsequent deterioration of the property
      is
      charged directly to real estate owned expense, which is included in
      miscellaneous noninterest expenses on the consolidated statements of income.
      Costs relating to the development and improvement of real estate owned are
      capitalized, whereas costs relating to holding and maintaining the properties
      are charged to expense.





**Premises
      and Equipment**


Premises
      and equipment are carried at cost less accumulated depreciation. Depreciation
      is
      computed on the straight-line method over estimated useful lives that range
      from
      three to thirty-nine years. Leasehold improvements are amortized over the
      shorter of the life of the lease or the life of the asset.  In
      accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of
      Long-Lived Assets,” the Company tests its long-lived assets for impairment
      through both a probability-weighted and primary-asset approach whenever events
      or changes in circumstances dictate. Maintenance, repairs and minor improvements
      are charged to non interest expenses as incurred.





**Derivative
      Financial Instruments**


Statement
      of Financial Accounting Standards (“SFAS”) No. 133, “Accounting for Derivative
      Instruments and Hedging Activities,” as amended, establishes accounting and
      reporting standards for derivative instruments, including certain derivative
      instruments embedded in other contracts. The Company records all derivatives,
      whether designated as a hedge, or not, on the balance sheet at fair value.
      The
      Company designates its fixed rate and variable rate interest rate swaps as
      fair
      value and cash flow hedge instruments, respectively. If the derivative is
      designated as a fair value hedge, the changes in fair value of the derivative
      and of the hedged item attributable to the hedged risk are recognized in
      earnings. If the derivative is designated as a cash flow hedge, the changes
      in
      fair value of the derivative and of the hedged item attributable to the hedged
      risk are recorded in Accumulated Other Comprehensive Income, (“AOCI”), net of
      income taxes.





The
      Company has only limited involvement with derivative financial instruments
      and
      does not use them for trading purposes. The Company has entered into interest
      rate swap agreements as a means of managing its interest rate exposure on
      certain fixed rate commercial loans and variable rate debt obligations. As
      of
      December 31 ,
      2006 ,
      the
      notional amount of the Company’s two outstanding fair value interest rate swaps
      on commercial loans was $ 4.8 million
      with maturities in 2008 and 2009 ,
      as
      discussed in Note 3. The Company’s cash flow interest rate swap matured in 2006.





As
      of
      December 31, 2006 ,
      the
      fair value of the derivative designated in the fair value hedge was a liability
      of $ 86,000 .
      The
      total income statement impact resulting from the ineffectiveness from the fair
      value hedge was zero. The Company has adopted the short cut method of hedge
      accounting, which allows management to assume there is no ineffectiveness
      resulting from the fair value hedge in accordance with SFAS No.
      133.





Goodwill
      and Other Intangible Assets


In
      accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” the
      Company annually, as of September 30 th ,
      evaluates goodwill for impairment. Management determined that there was no
      impairment charge resulting from its annual impairment test.





In
      the
      fourth quarter of 2005, the Company purchased a retail brokerage business on
      the
      south side of Indianapolis. This purchase increased goodwill $300,000. This
      purchase also included an intangible asset, customer list, valued at $200,000
      which is being amortized over four years using the straight line method. The
      impairment analysis for the brokerage business goodwill is performed annually
      as
      of December 31.





**Income
      Taxes**


The
      Company and its wholly-owned subsidiaries file consolidated income tax returns.
      Deferred income tax assets and liabilities are determined using the balance
      sheet method and are reported in other assets in the Consolidated Balance
      Sheets. Under this method, the net deferred tax asset or liability is based
      on
      the tax effects of the differences between the book and tax basis of assets
      and
      liabilities and recognizes enacted changes in tax rates and laws. Deferred
      tax
      assets are recognized to the extent they exist and are subject to a valuation
      allowance based on management’s judgment that realization is
      more-likely-than-not.





**Changes
      in Presentation**


Certain
      amounts and items appearing in the prior periods’ financial statements have been
      reclassified to conform to the current presentation. Such items include
      reclassification between non interest income and non interest expenses, and
      do
      not impact net income. Other items include reclassification between liability
      accounts which do not impact total assets, total liabilities or total
      shareholders’ equity and reclassification between net cash from operating
      activities and net cash from financing activities which do not impact net income
      or cash and cash equivalents.




-
          32 -


**Earnings
      per Common Share**


Earnings
      per share of common stock are based on the weighted average number of basic
      shares and dilutive shares outstanding during the year.





The
      following is a reconciliation of the weighted average common shares for the
      basic and diluted earnings per share computations:





**Year
                Ended**
              **Dec
                2006**
            
            **Year
                Ended**
              **Dec
                2005**
            
            **Year
                Ended**
              **Dec
                2004**Basic
                Earnings per Share:Weighted
                average common shares
            
            
            3,707,325
            
            
            3,897,501
            
            
            4,117,085Diluted
                Earnings per Share:Weighted
                average common shares
            
            
            3,707,325
            
            
            3,897,501
            
            
            4,117,085Dilutive
                effect of stock options
            
            
            81,231
            
            
            95,554
            
            
            146,038Weighted
                average common and incremental shares
            
            
            3,788,556
            
            
            3,993,055
            
            
            4,263,123





Anti-dilutive
      options are summarized as follows:





**As
                Of**
            
            **Dec
                2006**
            
            **Dec
                2005**
            
            **Dec
                2004**Anti-dilutive
                options
            
            
            10,000
            
            
            128,974
            
            
            92,599





**Comprehensive
      Income**


The
      following is a summary of the Company's accumulated other comprehensive income:
      (dollars in thousands)





Accumulated
                BalanceYear
                Ended
              Dec
                2006
            
            Year
                Ended
              Dec
                2005
            
            Year
                Ended
              Dec
                2004Unrealized
                holding losses from securities available for sale
            
            $
            (534
            )
            $
            (2,796
            )
            $
            (296
            )Cumulative
                effect in change in accounting for SRP obligations
            
            
            (980
            )
            
            -
            
            
            -Unrealized
                losses from cash flow hedge
            
            
            -
            
            
            (18
            )
            
            (163
            )Net
                unrealized losses
            
            
            (1514
            )
            
            (2,814
            )
            
            (459
            )Tax
                effect
            
            
            577
            
            
            977
            
            
            171**Accumulated
                other comprehensive loss, net of tax**
            
            $
            (937
            )
            $
            (1,837
            )
            $
            (288
            )





**Segments**


In
      accordance with SFAS No. 131, “Disclosures about Segments of an Enterprise and
      Related Information,” management has concluded that the Company is comprised of
      a single operating segment, community banking activities, and has disclosed
      all
      required information relating to its one operating segment. Management considers
      parent company activity to represent an overhead function rather than an
      operating segment. The Company operates in one geographical area and does not
      have a single external customer from which it derives 10 percent or more of
      its
      revenue.


-
          33 -


**Stock
      Based Compensation**


The
      Company has stock-based employee compensation plans, which are described more
      fully in Note 14. Prior to January 1, 2006, the Company accounted for the plans
      under the recognition and measurement provisions of APB Opinion No. 25,
“Accounting for Stock Issued to Employees”, and related Interpretations (“APB
      25”). Accordingly, because all stock options granted had an exercise price equal
      to the market value of the underlying common stock on the date of the grant,
      no
      expense related to employee stock options was recognized. Effective January
      1,
      2006, the Company adopted the fair value recognition provisions of Statement
      of
      Financial Accounting Standards No. 123(R) “Share-Based Payment” (“SFAS 123(R)”).
      Under the modified prospective method of adoption selected by the Company,
      compensation expense related to stock options is recognized beginning January
      1,
      2006 for any new awards issued after this date, as well as for any
      previously-issued awards vesting on or after January 1, 2006. Compensation
      cost
      in previous periods related to stock options continues to be disclosed on a
      pro-forma basis only. As required by SFAS 123(R), the Company also estimates
      forfeitures over the vesting period of awards.





The
      following table illustrates the effect on net income and earnings per share
      if
      the Company had applied the fair value recognition provisions of SFAS Statement
      No. 123, “Accounting for Stock-Based Compensation,” to stock-based employee
      compensation. (dollars in thousands)




(dollars
                in thousands, except share data)
            
            **Year**
              **Ended**
              **Dec
                2005**
            
            **Year**
              **Ended**
              **Dec
                2004**Net
                income, as reported
            
            $
            6,102
            
            $
            5,163Deduct:
                Total stock-based employee compensation expense determined under
                fair
                value based method for all awards, net of related tax
                effects
            
            
            (226
            )
            
            (55
            )Pro
                Forma Net Income
            
            $
            **5,876**
            
            $
            **5,108**Earnings
                per share:Basic---as
                reported
            
            $
            1.57
            
            $
            1.25Basic---pro
                forma
            
            $
            1.51
            
            $
            1.24Diluted---as
                reported
            
            $
            1.53
            
            $
            1.21Diluted---pro
                forma
            
            $
            1.47
            
            $
            1.20





The
      pro
      forma amounts are not representative of the effects on reported net income
      for
      current or future years.





**New
      Accounting Pronouncements**





In
      February 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS
      No. 155, “Accounting for Certain Hybrid Financial Instruments, an amendment
      of FASB Statement No. 133 and 140.” This Statement amends FASB Statements
      No. 133, “Accounting for Derivative Instruments and Hedging Activities,”
and No. 140 as well as resolves issues addressed in Statement No. 133
      Implementation Issue No. D1, “Application of Statement No. 133 to
      Beneficial Interests in Securitized Financial Assets.” Specifically, this
      Statement: i) permits fair value remeasurement for any hybrid financial
      instrument that contains an embedded derivative that otherwise would require
      bifurcation; ii) clarifies which interest-only strips and principal-only strips
      are not subject to the requirements of Statement No. 133; iii) establishes
      a requirement to evaluate interests in securitized financial assets to identify
      interests that are freestanding derivatives or that are hybrid financial
      instruments that contain an embedded derivative requiring bifurcation; iv)
      clarifies that concentrations of credit risk in the form of subordination are
      not embedded derivatives; and v) amends Statement No. 140 to eliminate the
      prohibition on a qualifying special purpose entity from holding a derivative
      financial instrument that pertains to a beneficial interest other than another
      derivative financial instrument. This Statement is effective for all financial
      instruments acquired or issued after the beginning of the first fiscal year
      that
      begins after September 15, 2006. Management believes the adoption of this
      Statement will not have a material effect on the Company’s consolidated
      financial statements.




In
      March
      2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial
      Assets, an amendment of FASB Statement No. 140.” This Statement amends FASB
      Statement No. 140 and requires that all separately recognized servicing
      rights be initially measured at fair value, if practicable. For each class
      of
      separately recognized servicing assets and liabilities, this Statement permits
      the Company to choose either to report servicing assets and liabilities at
      fair
      value or at amortized cost. Under the fair value approach, servicing assets
      and
      liabilities will be recorded at fair value at each reporting date with changes
      in fair value recorded in earnings in the period in which the changes occur.
      Under the amortized cost method, servicing assets and liabilities are amortized
      in proportion to and over the period of estimated net servicing income or net
      servicing loss and are assessed for impairment based on fair value at each
      reporting date. This Statement is effective as of the beginning of the first
      fiscal year that begins after September 15, 2006. Management believes the
      adoption of this Statement will not have a material effect on the Company’s
      consolidated financial statements.




FASB
      staff position FAS 123(R)-4, “ Classification
      of Options and Similar Instruments Issued as Employee Compensation That Allow
      for Cash Settlement upon the Occurrence of a Contingent Event,” was posted
      February 3, 2006. **** This
      FASB
      Staff Position (“FSP”) addresses the classification of options and similar
      instruments issued as employee compensation that allow for cash settlement
      upon
      the occurrence of a contingent event that is not controlled by the employee.
      The
      guidance in this FSP amends paragraphs 32 and A229 of FASB Statement No. 123
      (revised 2004), “Share-Based Payment.” The guidance in this FSP shall be applied
      upon initial adoption of Statement 123(R). The guidance in this FSP is
      applicable only for options issued as part of employee compensation
      arrangements. Paragraphs 32 and A229 of Statement 123(R) require options or
      similar instruments to be classified as liabilities if “the entity can be
      required under any circumstances ** to
      settle
      the option or similar instrument by transferring cash or other assets.” Since an
      entity may be required in at least one circumstance (that is, a change in
      control) to settle its options or similar instruments issued as employee
      compensation in cash,
      the
      option or similar instrument would be classified as a liability when the change
      in control occurs pursuant to paragraphs 32 and A229 of Statement
      123(R).  Management
      has determined the adoption of FSP FAS 123(R)-4 did not have a material effect
      on the Company’s consolidated financial statements.





-
          34 -




In
      June
      2006, the FASB issued
      Interpretation No. 48, “Accounting for Uncertainty in Income Taxes  -
      an
      Interpretation of FASB Statement No. 109.” The interpretation prescribes a
      recognition threshold and measurement attribute for the financial statement
      recognition and measurement of a tax position taken or expected to be taken
      in a
      tax return. The new interpretation is effective for fiscal years beginning
      after
      December 15, 2006. Management has determined the adoption of this interpretation
      will not have a material impact on the Company’s consolidated financial
      statements.





In
      September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.”
This Statement is effective for fiscal years beginning after November 15,
      2007, and interim periods within those fiscal years. This Statement defines
      fair
      value, establishes a framework for measuring fair value and expands disclosures
      about fair value measurements. This Statement emphasizes that fair value is
      a
      market-based measurement and should be determined based on assumptions that
      a
      market participant would use when pricing an asset or liability. This Statement
      clarifies that market participant assumptions should include assumptions about
      risk as well as the effect of a restriction on the sale or use of an asset.
      Additionally, this Statement establishes a fair value hierarchy that provides
      the highest priority to quoted prices in active markets and the lowest priority
      to unobservable data.  Management
      is currently in the process of determining what effect the provisions of the
      new
      interpretation will have on the Company’s financial position or results of
      operations.





In
      September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for
      Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB
      Statements No. 87, 88, 106, and 132(R).” This Statement requires an employer to
      recognize the overfunded or underfunded status of a defined benefit
      postretirement plan (other than a multiemployer plan) as an asset or liability
      in its balance sheet and to recognize changes in that funded status in the
      year
      in which the changes occur through accumulated other comprehensive income.
      This
      Statement also requires an employer to measure the funded status of a plan
      as of
      the date of its year-end balance sheet, with limited exceptions. Additional
      disclosures about certain effects on net periodic benefit cost for the fiscal
      year that arise from delayed recognition of the gains or losses, prior service
      costs or credits, and transition asset or obligation is also required. This
      Statement is effective as of the end of the first fiscal year ending after
      December 15, 2006. Management has determined the adoption of this Statement
      did
      not have a material effect on the Company's consolidated financial statements,
      increasing AOCI, net of tax of $592,000 and liabilities $980,000.





In
      February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
      Financial Assets and Financial Liabilities—including an amendment of FASB
      Statement No. 115,” **** which
      is
      effective as of the beginning of an entity’s first fiscal year that begins after
      November 15, 2007. The fair value option established by this Statement permits
      all entities to choose to measure eligible items at fair value at specified
      election dates. A business entity shall report unrealized gains and losses
      on
      items for which the fair value option has been elected in earnings (or another
      performance indicator if the business entity does not report earnings) at each
      subsequent reporting date. The fair value option a) may be applied instrument
      by
      instrument, with a few exceptions, such as investments otherwise accounted
      for
      by the equity method; b) is irrevocable (unless a new election date occurs);
      and
      c) is applied only to entire instruments and not to portions of instruments.
      Management is currently in the process of determining what effect the provisions
      of this statement will have on the Company’s financial position or results of
      operations.




-
          35 -


**2.****SECURITIES**


Securities
      are summarized as follows: (dollars in thousands)




**Dec
                  2006**
              
              **Dec
                  2005****Amortized**
              
              **Gross
                  Unrealized**
              
              **Fair**
              
              **Amortized**
              
              **Gross
                  Unrealized**
              
              **Fair****Cost**
              
              **Gains**
              
              **(Losses)**
              
              **Value**
              
              **Cost**
              
              **Gains**
              
              **(Losses)**
              
              **Value****Held
                  to Maturity:**Municipal
                  bonds
              
              $
              775
              
              $
              -
              
              $
              -
              
              $
              775
              
              **$**
              775
              
              $
              -
              
              $
              -
              
              $
              775Certificate
                  of deposit
              
              
              100
              
              
              -
              
              
              -
              
              
              100
              
              
              100
              
              
              -
              
              
              -
              
              
              100Mortgage
                  backed securities
              
              
              760
              
              
              7
              
              
              (14
              )
              
              753
              
              
              931
              
              
              11
              
              
              (21
              )
              
              921**Total
                  Held to Maturity**
              
              $
              1,635
              
              $
              7
              
              $
              (14
              )
              $
              1,628
              
              **$**
              **1,806**
              
              $
              11
              
              $
              (21
              )
              $
              1,796**Available
                  for Sale:**Agency
                  bonds
              
              $
              6,063
              
              $
              4
              
              $
              (31
              )
              $
              6,036
              
              **$**
              44,742
              
              $
              -
              
              $
              (847
              )
              $
              43,895Municipal
                  bonds
              
              
              23,110
              
              
              51
              
              
              (160
              )
              
              23,001
              
              
              22,834
              
              
              14
              
              
              (349
              )
              
              22,499Collateralized
                  mortgage obligations
              
              
              7,012
              
              
              -
              
              
              (135
              )
              
              6,877
              
              
              23,645
              
              
              2
              
              
              (598
              )
              
              23,049Mortgage
                  backed securities
              
              
              14,073
              
              
              36
              
              
              (181
              )
              
              13,928
              
              
              28,117
              
              
              52
              
              
              (950
              )
              
              27,219Corporate
                  debt
              
              
              1,959
              
              
              6
              
              
              (30
              )
              
              1,935
              
              
              1,929
              
              
              -
              
              
              (33
              )
              
              1,896Bond
                  mutual funds
              
              
              5,129
              
              
              -
              
              
              (94
              )
              
              5,035
              
              
              4,804
              
              
              -
              
              
              (86
              )
              
              4,718Equity
                  securities
              
              
              75
              
              
              -
              
              
              -
              
              
              75
              
              
              75
              
              
              -
              
              
              -
              
              
              75**Total
                  Available for Sale**
              
              $
              57,421
              
              $
              97
              
              $
              (631
              )
              $
              56,887
              
              **$**
              **126,146**
              
              $
              68
              
              $
              (2,863
              )
              $
              123,351




Certain
      securities, with amortized cost of $ 2.2 million
      and fair value of $ 2.1 million
      at December 31,  2006,  and
      amortized cost of $6.6 million and fair value of $6.5 million at December 31,
      2005 were pledged as collateral for the Company's treasury, tax and loan
      account at the Federal Reserve, for Federal Home Loan Bank Advances, and for
      certain trust, IRA and KEOGH accounts.





-
          36 -




The
      amortized cost and fair value of securities at December 31, 2006 by
      contractual maturity are summarized as follows: (dollars in
      thousands)





**Held
                to Maturity**
            
            **Available
                for Sale****Amortized**
              **Cost**
            
            **Fair**
              **Value**
            
            **Yield**
            
            **Amortized**
              **Cost**
            
            **Fair**
              **Value**
            
            **Yield**Agency
                bonds:Due
                after 1 year through 5 years
            
            $
            -
            
            $
            -
            
            
            -
            
            $
            6,063
            
            $
            6,036
            
            
            4.58
            %Municipal
                bonds:Due
                after 1 year through 5 years
            
            
            260
            
            
            260
            
            
            7.35
            %
            
            7,495
            
            
            7,392
            
            
            4.72
            %Due
                after 5 years through 10 years
            
            
            515
            
            
            515
            
            
            7.57
            %
            
            15,615
            
            
            15,609
            
            
            5.51
            %Certificate
                of deposit:Due
                in one year or less
            
            
            100
            
            
            100
            
            
            5.35
            %
            
            -
            
            
            -
            
            
            -Collateralized
                mortgage obligations
            
            
            -
            
            
            -
            
            
            -
            
            
            7,012
            
            
            6,877
            
            
            4.32
            %Mortgage
                backed securities
            
            
            760
            
            
            753
            
            
            5.60
            %
            
            14,073
            
            
            13,928
            
            
            5.04
            %Corporate
                debt:Due
                after 10 years
            
            
            -
            
            
            -
            
            
            -
            
            
            1,959
            
            
            1,935
            
            
            5.90
            %Bond
                mutual funds
            
            
            -
            
            
            -
            
            
            -
            
            
            5,129
            
            
            5,035
            
            
            5.05
            %Equity
                securities
            
            
            -
            
            
            -
            
            
            -
            
            
            75
            
            
            75
            
            
            -**Total**
            
            $
            1,635
            
            $
            1,628
            
            
            6.48
            %
            $
            57,421
            
            $
            56,887
            
            
            5.01
            %





Activities
      related to the sales of securities available for sale are summarized as follows:
      (dollars in thousands)





**Year
                Ended**
            
            **Year
                Ended**
            
            **Year
                Ended****Dec
                2006**
            
            **Dec
                2005**
            
            **Dec
                2004**Proceeds
                from sales
            
            $
            105,649
            
            $
            10,048
            
            $
            23,256Gross
                losses on sales
            
            
            1,956
            
            
            -
            
            
            -






Taxable
      interest income and non-taxable interest income earned on the investment
      portfolio is summarized as follows: (in thousands)





**Year
                Ended**
            
            **Year
                Ended**
            
            **Year
                Ended****Dec
                2006**
            
            **Dec
                2005**
            
            **Dec
                2004**Taxable
                interest income
            
            $
            3,389
            
            $
            4,111
            
            $
            3,614Non-taxable
                interest income
            
            
            857
            
            
            541
            
            
            495**Total
                Interest Income**
            
            $
            4,246
            
            $
            4,652
            
            $
            4,109




Unrealized
      losses in the portfolio resulted from increases in
      market interest rates and not from deterioration in the creditworthiness of
      the
      issuer. Of the securities in a loss position at December 31, 2006, 100% are
      highly rated securities. The total number of security positions in the
      investment portfolio that were in an unrealized loss position at December 31, 2006 is 76. Unrealized
      losses will decline as interest rates fall to the purchased yield and as the
      securities approach maturity. At December 31, 2006, Management has the intent
      and ability to hold securities in an unrealized loss position to recovery,
      which
      may be maturity. Investments that have been in a continuous unrealized loss
      position for longer than one month as of December 31, 2006 are
      summarized as follows: (dollars in thousands)







**Less
                than**
              **Twelve
                Months**
            
            **Twelve
                Months**
              **Or
                Longer**
            
            **Total****Description
                of Securities**
            
            **Fair**
              **Value**
            
            **Unrealized**
              **Losses**
            
            **Fair**
              **Value**
            
            **Unrealized**
              **Losses**
            
            **Fair**
              **Value**
            
            **Unrealized**
              **Losses**Agency
                bonds
            
            $
            994
            
            $
            -
            
            $
            2,370
            
            $
            (31
            )
            $
            3,364
            
            $
            (31
            )Collateralized
                mortgage obligations
            
            
            382
            
            
            (1
            )
            
            6,494
            
            
            (134
            )
            
            6,876
            
            
            (135
            )Mortgage
                backed securities
            
            
            4,484
            
            
            (15
            )
            
            6,967
            
            
            (180
            )
            
            11,451
            
            
            (195
            )Corporate
                debt
            
            
            -
            
            
            -
            
            
            970
            
            
            (30
            )
            
            970
            
            
            (30
            )Municipal
                bonds
            
            
            2,198
            
            
            (7
            )
            
            14,298
            
            
            (153
            )
            
            16,496
            
            
            (160
            )Bond
                mutual funds
            
            
            -
            
            
            -
            
            
            3,880
            
            
            (94
            )
            
            3,880
            
            
            (94
            )**Total
                Temporarily Impaired Securities**
            
            $
            8,058
            
            $
            (24
            )
            $
            34,979
            
            $
            (621
            )
            $
            43,037
            
            $
            (645
            )





-
          37 -




**3.**
            **PORTFOLIO
                LOANS**





The
      Company originates both adjustable and fixed rate loans. The adjustable rate
      loans have interest rate adjustment limitations and are indexed to various
      indices. Adjustable residential mortgages are generally indexed to the one
      year
      Treasury constant maturity rate; adjustable consumer loans are generally indexed
      to the prime rate; adjustable commercial loans are generally indexed to either
      the prime rate or the one, three or five year Treasury constant maturity rate.
      Future market factors may affect the correlation of the interest rates the
      Company pays on the short-term deposits that have been primarily utilized to
      fund these loans.





The
      principal balance of loans on nonaccrual status totaled approximately
      $2 .9 million
      at December 31, 2006, $3.1
      million at December 31, 2005, and $9.5 at December 31, 2004. The Company would
      have recorded interest income of $372,000, $465,000,
      and $906,000  for
      the
      years ended December 31, 2006,
      2005 and
      2004. If loans on non-accrual status had been current in accordance with their
      original terms. Actual interest recognized was $133,000, $160,000, and $407,000  for
      the
      years ended December 31, 2006, 2005,
      and 2004, respectively. The Company agreed to modify the terms of certain
      loans to customers who were experiencing financial difficulties. Modifications
      included forgiveness of interest, reduced interest rates and/or extensions
      of
      the loan term. The principal balance at December 31, 2006, December
      31, 2005, and December 31, 2004 on these restructured loans was $440,000 $809,000,
      and $3.1 million, respectively.





The
      Company's primary lending area is south-central Indiana. Virtually all of the
      Company's loans originated and purchased are to borrowers located within the
      state of Indiana. Of the residential mortgages, $1.1 million and $1.3 million
      were collateralized by unimproved land at December 31, 2006 and 2005,
      respectively. The Company originates and purchases commercial mortgage loans,
      which totaled $227.4 million and $207.1 million at December 31, 2006
      and 2005,
      respectively. These loans are considered by management to be of somewhat greater
      risk of collectibility due to the dependency on income production or future
      development of the real estate. Of the commercial real estate loans,
      $18 .6 million
      and $19.6 million were collateralized by multi-family residential property
      at
      December 31, 2006
      and 2005,
      respectively, $43.7 million and $29.1 million were collateralized by property
      under construction at December 31, 2006 and 2005, respectively, and $403,000
      and
      $292,000 were collateralized by unimproved land at December 31, 2006 and 2005,
      respectively. The Company also purchases and originates commercial loans.
      Collateral for the Company's commercial loans includes manufacturing equipment,
      real estate, inventory, accounts receivable, and securities. Terms of these
      loans are normally for up to ten years and have adjustable rates tied to the
      reported prime rate and Treasury indices. Generally, commercial loans are
      considered to involve a higher degree of risk than residential
      real estate loans. However, commercial loans generally carry a higher yield
      and
      are made for a shorter term than real estate loans. As of December 31, 2006 and
      2005, the Company’s total loan portfolio consisted of commercial loans of
      $151 .8 million
      and $105.8 million, respectively.





Certain
      residential mortgage products have contractual features that may increase credit
      exposure to the Company in the event of a decline in housing prices. These
      type
      of mortgage products offered by the Company include high loan-to-value (“LTV”)
      ratios and multiple loans on the same collateral that when combined result
      in a
      high LTV. Typically a residential mortgage loan is combined with a home equity
      loan for a LTV at origination of over 90% and less than or equal to 100%. The
      balance including unused lines of these loans over 90% LTV at origination as
      of
      December 31, 2006 was $10.8 million.





The
      Company has entered into two fair value interest rate swap agreements with
      a
      counterparty hedging two fixed rate commercial loans. In the first agreement
      the
      Company will receive variable rate payments at the thirty-day London inter
      bank
      offering rate (“LIBOR”) index and make fixed rate payments at 6.28 %. The
      notional amount on the swap was $3.0 million as of December 31, 2006 .
      The
      thirty-day LIBOR was 5.32% at December 31, 2006 .
      The
      termination date of the first swap agreement is July 1, 2008. In the second
      agreement the Company will receive variable rate payments at thirty day LIBOR
      and make fixed rate payments at 6.24%. The notional amount of the swap was
      $1.8
      million as of December 31, 2006 .
      The
      termination date of the second swap agreement is January 2, 2009. The two
      interest rate swaps are settled on a net basis. The Company is exposed to
      losses, in the event of nonperformance by the counterparty, for the net interest
      rate differential when floating rates exceed the fixed maximum rate. However,
      the Company does not anticipate nonperformance by the counterparty.





Under
      the
      capital standards provisions of FIRREA, the loans-to-one-borrower limitation
      is
      generally 15% of unimpaired capital and surplus, which, for the Company,
      was approximately $13 .5 million
      and $13.4 million at December 31, 2006
      and 2005,
      respectively. As of December 31, 2006
      and 2005,
      the Company was in compliance with this limitation.





Aggregate
      loans to officers and directors included above were $5 .3 million
      and $3.9 million as of December 31, 2006 and
      2005,
      respectively. Such loans are made in the ordinary course of business and are
      made on substantially the same terms as those prevailing at the time for
      comparable transactions with other borrowers. For the year ended December 31, 2006 ,
      loans
      of $2 .4 million
      were disbursed to officers and directors and repayments of $1 .0 million
      were received from officers and directors.





-
          38 -


An
      analysis of the allowance for loan losses is as follows: (dollars in
      thousands)





Year
                Ended
              Dec
                2006
            
            Year
                Ended
              Dec
                2005
            
            Year
                Ended
              Dec
                2004Beginning
                balance
            
            $
            6,753
            
            $
            7,864
            
            $
            7,506Provision
                for loan losses
            
            
            850
            
            
            808
            
            
            1,770Charge-offs
            
            
            (1,327
            )
            
            (2,048
            )
            
            (1,524
            )Recoveries
            
            
            322
            
            
            129
            
            
            112**Ending
                Balance**
            
            $
            **6,598**
            
            $
            **6,753**
            
            $
            **7,864**








The
      following is a summary of information pertaining to impaired loans: (dollars
      in
      thousands)





**As
                Of**
            
            Dec
                2006
            
            Dec
                2005
            
            Dec
                2004Impaired
                loans with a valuation reserve
            
            $
            3,088
            
            $
            3,523
            
            $
            9,535Impaired
                loans with no valuation reserve
            
            
            204
            
            
            356
            
            
            3,141**Total
                Impaired Loans**
            
            $
            **3,292**
            
            $
            **3,879**
            ****
            **$**
            **12,676**Valuation
                reserve on impaired loans
            
            $
            381
            
            $
            570
            
            $
            1,280Average
                impaired loans
            
            $
            3,508
            
            $
            6,905
            
            $
            8,315





All
      loans
      were analyzed based on collateral analysis.





**4.**
            **MORTGAGE
                BANKING ACTIVITIES**


During
      2006, the Company sold its mortgage servicing portfolio and related nonrecourse
      mortgage servicing rights for a gain on sale of $2.0 million. At December 31,
      2006, the Company was servicing loans for others amounting to $37.0 million
      consisting of commercial and commercial real estate participations. Management
      believes the Company receives adequate compensation for the servicing of the
      participation loans and therefore no servicing rights are generated by this
      activity. At December 31, 200 5,
      the
      Company was servicing loans for others amounting to $588.5 million, consisting
      primarily of residential mortgage loans as well as commercial and commercial
      real estate participations. Net gain on sale of loans was $1,430 ,000 for the
      year ended December 31, 2006
      and $1,539,000
      for the year ended December 31, 2005. Servicing loans for others generally
      consists of collecting mortgage payments, maintaining escrow accounts,
      disbursing payments to investors and foreclosure processing. Loan servicing
      income includes servicing fees from investors and certain charges collected
      from
      borrowers, such as late payment fees.


The
      Bank
      is obligated to repurchase certain loans sold to and serviced for others that
      become delinquent as defined by the various agreements. At December 31, 2006 and
      2005, these obligations were approximately $9.3 million and $499,000,
      respectively. Management believes it is remote, that as of December 31, 2006,
      the Company would have to repurchase these obligations and therefore no reserve
      has been established for this purpose.





The
      following analysis reflects the changes in mortgage servicing rights retained:
      (dollars in thousands)




**Period
                Ended**
            
            Dec
                2006
            
            Dec
                2005Beginning
                carrying value
            
            $
            2,725
            
            $
            2,974Additions
            
            
            412
            
            
            556Amortization
            
            
            (1,128
            )
            
            (1,354
            )Net
                change in valuation allowance
            
            
            298
            
            
            549Sale
                of mortgage servicing rights
            
            
            (2,307
            )
            
            -**Ending
                Carrying Value**
            
            $
            -
            
            $
            **2,725**








**5.**
            **INVESTMENTS
                IN JOINT VENTURES**


The
      Company has invested in joint ventures through its subsidiaries, Home Savings
      Corporation (“HSC”) and HomeFed Financial Corp. On December 31, 2001,
      the Company changed its charter from a Federal savings bank charter to an
      Indiana commercial bank charter. Commercial banks are not permitted to
      participate in real estate development joint ventures. The Company divested
      of
      the three remaining real estate joint venture partnerships during 2006. The
      Bank
      made loans totaling $1.5 million to the joint venture partners in order to
      facilitate the divestures. The gain of $274,000 on the sale of the Home-Breeden
      joint venture is being recognized over the life of the loan in accordance with
      generally accepted accounting principles. The Company is not required to divest
      itself of its investment in Family Financial Holdings, Inc. or Heritage Woods.
      The investments are accounted for by the equity method. The Company’s interest
      in these investments is as follows: (dollars in thousands)




**As
                Of**
            
            Equity
              Interest
            
            Dec
                2006
            
            Dec
                20**05**Family
                Financial Holdings, Inc.
            
            
            14
            %
            $
            787
            
            $
            792Heritage
                Woods
            
            
            33
            %
            
            23
            
            
            27Home-Breeden
            
            
            50
            %
            
            -
            
            
            1,074Sycamore
                Springs
            
            
            33
            %
            
            -
            
            
            550Bloomington
                Technology
            
            
            50
            %
            
            -
            
            
            43**Total
                Investment**
            
            
            
            
            $
            810
            
            $
            2,486




-
          39 -




Summarized
      condensed unaudited financial statements for these joint ventures are as
      follows: (dollars in thousands)





As
                Of
            
            Dec
                2006
            
            Dec
                2005**Balance
                Sheets: (Unaudited)**Cash
            
            $
            967
            
            $
            2,064Investments
            
            
            3,263
            
            
            2,639Property
                and equipment, net
            
            
            448
            
            
            531Inventory
                of developed lots
            
            
            -
            
            
            3,206Other
                assets
            
            
            1,023
            
            
            1,134Total
                Assets
            
            $
            5,701
            
            $
            9,574Notes
                payable
            
            $
            369
            
            $
            2,009Insurance
                liabilities
            
            
            177
            
            
            136Other
                liabilities
            
            
            118
            
            
            108Total
                liabilities
            
            
            664
            
            
            2,253Shareholders’
                equity
            
            
            5,037
            
            
            7,321Total
                Liabilities and Shareholders’ Equity
            
            $
            5,701
            
            $
            9,574







Year
                Ended
              Dec
                2006
            
            Year
                Ended
              Dec
                2005
            
            Year
                Ended
              Dec
                2004**Income
                Statements****Income:
                (Unaudited)**Insurance
                premiums & commissions
            
            $
            242
            
            $
            261
            
            $
            335Investment
                income
            
            
            192
            
            
            230
            
            
            145Net
                lot sales
            
            
            326
            
            
            1,508
            
            
            673Other
                income
            
            
            122
            
            
            116
            
            
            119Total
                income
            
            
            882
            
            
            2,115
            
            
            1,272**Expenses:**Commissions
            
            
            89
            
            
            270
            
            
            230Insurance
                benefits
            
            
            50
            
            
            70
            
            
            98Interest
                expense
            
            
            112
            
            
            128
            
            
            120Other
                expense
            
            
            571
            
            
            668
            
            
            781Total
                expense
            
            
            822
            
            
            1,136
            
            
            1,229Net
                Income
            
            $
            60
            
            $
            979
            
            $
            43




As
      of
      December 31, 2006 there were no notes payable to HSC. As of December 31, 2005,
      $1.6 million was due to HSC. Notes payable to the Bank were $118 ,000
      and $202,000, at December 31, 2006
      and 2005,
      respectively.





**6.**
            **ACCRUED
                INTEREST RECEIVABLE**


Accrued
      interest receivable consists of the following: (dollars in
      thousands)





**As
                Of**
            
            Dec
                2006
            
            Dec
                2005Loans
            
            $
            3,959
            
            $
            3,089Securities
            
            
            434
            
            
            802Interest-bearing
                deposits
            
            
            286
            
            
            51**Total
                Accrued Interest Receivable**
            
            $
            4,679
            
            $
            3,942





**7.**
            **PREMISES
                AND EQUIPMENT**


Premises
      and equipment consists of the following: (dollars in thousands)





**As
                Of**
            
            Dec
                2006
            
            Dec
                2005Land
            
            $
            2,903
            
            $
            2,903Buildings
                and improvements
            
            
            19,594
            
            
            19,380Furniture
                and equipment
            
            
            9,975
            
            
            9,556Total
            
            
            32,472
            
            
            31,839Accumulated
                depreciation
            
            
            (15,240
            )
            
            (14,058
            )**Total
                Premises and Equipment**
            
            $
            17,232
            
            $
            17,781





Depreciation
      expense included in operations for the years ended December 31, 2006 ,
      2005
      and 2004 totaled $1.6 million,
      $1.6 million, and $1.5 million, respectively.





-
          40 -




Future
      minimum lease payments based on contractual terms are as follows: (dollars
      in
      thousands)





**Year
                Ended December**
            
            Amount2007
            
            $
            802008
            
            
            1172009
            
            
            1322010
            
            
            1352011
            
            
            168Thereafter
            
            
            4**Total
                Minimum Operating Lease Payments**
            
            $
            636





Many
      of
      the leases contain extension provisions.







**8.**
            **DEPOSITS**


Deposits
      are summarized as follows: (dollars in thousands)





Dec
                2006
            
            Dec
                2005Amount
            
            Weighted
                Average****Rate
            
            Amount
            
            Weighted
                Average****RateNon-interest
                bearing
            
            $
            72,804
            
            
            
            
            $
            64,269Checking
            
            
            129,025
            
            
            2.69
            %
            
            82,991
            
            
            1.06
            %Savings
            
            
            41,710
            
            
            0.15
            %
            
            46,014
            
            
            0.15
            %Money
                market
            
            
            165,605
            
            
            3.52
            %
            
            162,350
            
            
            2.55
            %Total
                transaction accounts
            
            
            409,144
            
            
            2.29
            %
            
            355,624
            
            
            1.43
            %Certificates
                of deposit:Less
                than one year
            
            
            127,888
            
            
            4.92
            %
            
            67,841
            
            
            3.59
            %12-23
                months
            
            
            34,709
            
            
            4.64
            %
            
            37,196
            
            
            3.23
            %24-35
                months
            
            
            72,849
            
            
            4.15
            %
            
            92,980
            
            
            3.04
            %36-59
                months
            
            
            10,084
            
            
            3.51
            %
            
            14,053
            
            
            3.47
            %60-120
                months
            
            
            72,485
            
            
            4.70
            %
            
            87,620
            
            
            4.73
            %Total
                certificate accounts
            
            
            318,015
            
            
            4.62
            %
            
            299,690
            
            
            3.70
            %**Total
                Deposits**
            
            $
            727,159
            
            
            3.31
            %
            $
            **655,3****14**
            
            
            2.47
            %







At
      December 31, 2006 and
      2005,
      certificates of deposit in amounts of $100,000 or more totaled $95 .2 million
      and $91.7 million, respectively.


A
      summary
      of certificate accounts by scheduled maturities at December 31, 2006 is as
      follows: (dollars in thousands)


2007
              
              2008
              
              2009
              
              2010
              
              2011
              
              Thereafter
              
              Total1.99%
                  or less
              
              $
              579
              
              $
              -
              
              $
              -
              
              $
              -
              
              $
              -
              
              $
              -
              
              $
              5792.00%
                  - 2.99%
              
              
              10,507
              
              
              428
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              10,9353.00%
                  - 3.99%
              
              
              41,747
              
              
              12,043
              
              
              3,226
              
              
              2,440
              
              
              353
              
              
              198
              
              
              60,0074.00%
                  - 4.99%
              
              
              46,125
              
              
              22,862
              
              
              12,876
              
              
              2,826
              
              
              4,581
              
              
              1,796
              
              
              91,0665.00%
                  - 5.99%
              
              
              135,060
              
              
              15,614
              
              
              2,204
              
              
              206
              
              
              1,069
              
              
              64
              
              
              154,217Over
                  6.00%
              
              
              652
              
              
              424
              
              
              135
              
              
              -
              
              
              -
              
              
              -
              
              
              1,211**Total
                  Certificate Accounts**
              
              $
              234,670
              
              $
              51,371
              
              $
              18,441
              
              $
              5,472
              
              $
              6,003
              
              $
              2,058
              
              $
              318,015






A
      summary
      of interest expense on deposits is as follows: (dollars in
      thousands)





Year
                Ended
              Dec
                2006
            
            Year
                Ended
              Dec
                2005
            
            Year
                Ended
              Dec
                2004Checking
            
            $
            1,522
            
            $
            467
            
            $
            283Savings
            
            
            70
            
            
            76
            
            
            92Money
                market
            
            
            4,982
            
            
            2,438
            
            
            1,067Certificates
                of deposit
            
            
            12,805
            
            
            10,284
            
            
            9,390Total
                Interest Expense
            
            $
            19,379
            
            $
            13,265
            
            $
            10,832





-
          41 -




**9.**
            **FEDERAL
                HOME LOAN BANK ADVANCES**


The
      Company was eligible to borrow from the FHLB additional amounts up to
      $34.3  million
      and $25.9  million
      at December 31, 2006 and
      2005,
      respectively. The following FHLB borrowings were secured by assets totaling
      $157.0 million. The assets include qualifying residential mortgage loans and
      loans on multi-family residential properties and securities. (dollars in
      thousands)





Maturing
                During
              Year
                Ended
              **December
                31**
            
            Amount
            
            Weighted
              Average
              Rate2007
            
            $
            9,250
            
            
            5.04
            %2008
            
            
            31,850
            
            
            4.89
            %2009
            
            
            2,000
            
            
            4.32
            %2010
            
            
            11,250
            
            
            5.08
            %2011
            
            
            12,000
            
            
            5.10
            %Thereafter
            
            
            2,317
            
            
            6.50
            %***Total
                FHLB Borrowings***
            
            $
            68,667
            
            
            5.02
            %








**10.**
            **OTHER
                BORROWINGS**


**Junior
      Subordinated Debt**


On
      September 15, 2006, the Company entered into several agreements providing for
      the private placement of $15,000,000 of Capital Securities due September 15,
      2036 (the “Capital Securities”). The Capital Securities were issued by the
      Company’s newly formed Delaware trust subsidiary, Home Federal Statutory Trust I
      (the “Trust”), to Bear, Stearns & Co., Inc. (the “Purchaser”). The Company
      bought $464,000 in Common Securities (the “Common Securities”) from the Trust.
      The proceeds of the sale of Capital Securities and Common Securities were used
      by the Trust to purchase $15,464,000 in principal amount of Junior Subordinated
      Debt Securities (the “Debentures”) from the Company pursuant to an Indenture
      (the “Indenture”) between the Company and LaSalle Bank National Association, as
      trustee (the “Trustee”).





The
      Common Securities and Capital Securities will mature in 30 years, will require
      quarterly distributions of interest and will bear a floating variable rate
      equal
      to the prevailing three-month LIBOR rate plus 1.65% per annum. Interest on
      the
      Capital Securities and Common Securities is payable quarterly in arrears each
      December 15, March 15, June 15 and September 15, commencing December 15, 2006.
      The Company may redeem the Capital Securities and the Common Securities, in
      whole or in part, without penalty, on or after September 15, 2011, or earlier
      upon the occurrence of certain events described below with the payment of a
      premium upon redemption.





The
      Company, as Guarantor, entered into a Guarantee Agreement with LaSalle Bank
      National Association, as Guarantee Trustee, for the benefit of the holders
      of
      the Capital Securities. Pursuant to the Guarantee Agreement, the Company
      unconditionally agreed to pay to the holders of the Capital Securities all
      amounts becoming due and payable with respect to the Capital Securities, to
      the
      extent that the Trust has funds available for such payment at the time. The
      Company’s guarantee obligation under the Guarantee Agreement is a general
      unsecured obligation of the Company and is subordinate and junior in right
      of
      payment to all of the Company’s long term debt.





The
      Debentures bear interest at the same rate and on the same dates as interest
      is
      payable on the Capital Securities and the Common Securities. The Company has
      the
      option, as long as it is not in default under the Indenture, at any time and
      from time to time, to defer the payment of interest on the Debentures for up
      to
      twenty consecutive quarterly interest payment periods. During any such deferral
      period, or while an event of default exists under the Indenture, the Company
      may
      not declare or pay dividends or distributions on, redeem, purchase, or make
      a
      liquidation payment with respect to, any of its capital stock, or make payments
      of principal, interest or premium on, or repay or repurchase, any other debt
      securities that rank equal or junior to the Debentures, subject to certain
      limited exceptions.





The
      Debentures mature 30 years after their date of issuance, and can be redeemed
      in
      whole or in part by the Company, without penalty, at any time after September
      15, 2011. The Company may also redeem the Debentures upon the occurrence of
      a
“capital treatment event,” an “investment company event” or a “tax event” as
      defined in the Indenture, but if such redemption occurs prior to September
      15,
      2011, a premium will be payable to Debenture holders upon the redemption. The
      payment of principal and interest on the Debentures is subordinate and subject
      to the right of payment of all “Senior Indebtedness” of the Company as described
      in the Indenture.




**Long
      Term Debt**


The
      Company has a revolving note with LaSalle Bank N.A with an available balance
      of
      $17.5 million which matures February 15, 2009. The outstanding balance was
      zero
      at December 31, 2006 and $14.2 million at December 31, 2005. The note accrues
      interest at a variable rate based on the ninety-day LIBOR index, on the date
      of
      the draw, plus 140 basis points. Interest payments are due ninety days after
      the
      date of any principal draws made on the loan and every ninety days thereafter.
      The assets of the Company collateralized the borrowings under the note. Under
      terms of the agreement, the Company is bound by certain restrictive debt
      covenants relating to earnings, net worth and various financial
      ratios.




**Other
      Borrowings**


The
      Company has a $ 5.0 million
      overdraft line of credit with the Federal Home Loan Bank, none of which was
      used
      as of December 31, 2006
      or 2005.
      The Company also has a letter of credit for $278,000 and
      $225,000, as of December 31, 2006 and
      2005, respectively, none of which is used as of either year end. The Company
      has
      a contract with an official check overnight remittance service. The balance
      with
      the remittance service is zero as of December 31, 2006 and $166,000 as of
      December 31, 2005.





-
          42 -




**11.**
            **INCOME
                TAXES**


An
      analysis of the income tax provision is as follows: (dollars in
      thousands)





Year
                Ended
            
            Year
                Ended
            
            Year
                EndedDec
                2006
            
            Dec
                2005
            
            Dec
                2004Current:Federal
            
            $
            4,202
            
            $
            2,514
            
            $
            2,541State
            
            
            656
            
            
            281
            
            
            521Deferred:Federal
            
            
            (1,552
            )
            
            65
            
            
            (162
            )State
            
            
            (489
            )
            
            109
            
            
            (356
            )**Income
                Tax Provision**
            
            **$**
            **2,817**
            ****
            **$**
            **2,969**
            ****
            **$**
            **2,544**
            ****





The
      difference between the financial statement provision and amounts computed by
      using the statutory rate of 34% is reconciled as follows: (dollars in
      thousands)





Period
                Ended
            
            Dec
                2006
            
            Dec
                2005
            
            Dec
                2004Income
                tax provision at federal statutory rate
            
            $
            3,148
            
            $
            3,084
            
            $
            2,621State
                tax, net of federal tax benefit
            
            
            110
            
            
            256
            
            
            207Tax
                exempt interest
            
            
            (315
            )
            
            (206
            )
            
            (234
            )Increase
                in cash surrender value
              of
                life insurance
            
            
            (157
            )
            
            (152
            )
            
            (156
            )Other,
                net
            
            
            31
            
            
            (13
            )
            
            106**Income
                Tax Provision**
            
            **$**
            **2,817**
            
            $
            **2,969**
            
            $
            **2,544**





The
      Company is allowed to deduct an addition to a reserve for bad debts in
      determining taxable income. This addition differs from the provision for loan
      losses for financial reporting purposes. No deferred taxes have been provided
      on
      the income tax bad debt reserves which total $6.0 million, for years prior
      to
      1988. This tax reserve for bad debts is included in taxable income of later
      years only if the bad debt reserves are subsequently used for purposes other
      than to absorb bad debt losses. Because the Company does not intend to use
      the
      reserves for purposes other than to absorb losses, no deferred income taxes
      were
      provided at December 31, 2006
      and
      2005 respectively. Pursuant to Statement of Financial Accounting Standards No. 109
      (“SFAS 109”), ”Accounting for Income Taxes,” the Company has recognized the
      deferred tax consequences of differences between the financial statement and
      income tax treatment of allowances for loan losses arising after June 30,
      1987.





The
      Company’s deferred income tax assets and liabilities, included in other
      assets, are as follows: (dollars in thousands)





**As
                Of**
            
            Dec.
                2006
            
            Dec.
                2005Deferred
                tax assets:Bad
                debt reserves, net
            
            $
            2,602
            
            $
            2,687Unrealized
                loss on securities available for sale
            
            
            189
            
            
            970Capital
                loss on securities available for sale
            
            
            771
            
            
            -Other
            
            
            229
            
            
            67Deferred
                compensation
            
            
            2,170
            
            
            1,415Total
                deferred tax assets
            
            
            5,961
            
            
            5,139Deferred
                tax liabilities:Difference
                in basis of fixed assets
            
            
            387
            
            
            511FHLB
                dividend
            
            
            204
            
            
            169Deferred
                fees
            
            
            595
            
            
            325Originated
                mortgage servicing rights
            
            
            -
            
            
            843Total
                deferred tax liabilities
            
            
            1,186
            
            
            1,848**Net
                Deferred Tax Asset**
            
            $
            4,775
            
            $
            3,291




**12.**
            **REGULATORY
                MATTERS**


The
      Company and the Bank are subject to various regulatory capital requirements
      administered by the federal banking agencies. Failure to meet minimum capital
      requirements can initiate certain mandatory - and possible additional
      discretionary - actions by regulators that, if undertaken, could have a direct
      material effect on the Company’s and Bank’s financial statements. Under capital
      adequacy guidelines and the regulatory framework for prompt corrective action,
      the Company must meet specific capital guidelines that involve quantitative
      measures of the Company's assets, liabilities and certain off-balance sheet
      items as calculated under regulatory guidance. The capital amounts and
      classification are also subject to qualitative judgments by the regulators
      about
      components, risk weightings, and other factors.





Quantitative
      measures that have been established by regulation to ensure capital adequacy
      require the Company and the Bank to maintain minimum amounts and ratios (set
      forth in the following table), of total and Tier 1 capital (as defined in the
      regulations) to risk-weighted assets (as defined), and of Tier I capital (as
      defined) to average assets (as defined). As of December 31, 2006 ,
      the
      Company and the Bank met all capital adequacy requirements to which they were
      subject.





As
      of
      December 31, 2006, the
      most
      recent notifications from the Federal Reserve categorized the Company and the
      Bank as “well capitalized” under the regulatory framework for prompt corrective
      action. To be categorized as “well capitalized” the Company and the Bank must
      maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios
      as set forth in the table. There are no conditions or events since that
      notification that management believes have changed either entity’s
      category.


-
          43 -


A
      summary
      of capital amounts and ratios as of December 31, 2006 and
      2005:


(dollars
      in thousands)








Actual
            
            For
                Capital
              Adequacy
                Purposes
            
            To
                Be Categorized As
              “Well
                Capitalized”
              Under
                Prompt
              Corrective
                Action
              ProvisionsAmount
            
            Ratio
            
            Amount
            
            Ratio
            
            Amount
            
            Ratio**As
                of December 31, 2006**Total
                risk-based capital(to
                risk-weighted assets)HomeFederal
                Bank
            
            $
            89,811
            
            
            11.83
            %
            $
            60,759
            
            
            8.0
            %
            $
            75,948
            
            
            10.0
            %Home
                Federal Bancorp Consolidated
            
            $
            91,972
            
            
            12.09
            %
            $
            60,845
            
            
            8.0
            %
            $
            76,056
            
            
            10.0
            %Tier
                1 risk-based capital(to
                risk-weighted assets)HomeFederal
                Bank
            
            $
            83,213
            
            
            10.96
            %
            $
            30,379
            
            
            4.0
            %
            $
            45,569
            
            
            6.0
            %Home
                Federal Bancorp Consolidated
            
            $
            85,374
            
            
            11.23
            %
            $
            30,423
            
            
            4.0
            %
            $
            45,634
            
            
            6.0
            %Tier
                1 leverage capital(to
                average assets)HomeFederal
                Bank
            
            $
            83,213
            
            
            9.43
            %
            $
            35,308
            
            
            4.0
            %
            $
            44,135
            
            
            5.0
            %Home
                Federal Bancorp Consolidated
            
            $
            85,374
            
            
            9.66
            %
            $
            35,347
            
            
            4.0
            %
            $
            44,184
            
            
            5.0
            %







Actual
            
            For
                Capital
              Adequacy
                Purposes
            
            To
                Be Categorized As
              “Well
                Capitalized”
              *Under
                Prompt*
              Corrective
                Action
              **Provisions****Amount**
            
            **Ratio**
            
            **Amount**
            
            **Ratio**
            
            **Amount**
            
            **Ratio****As
                of December 31, 2005**Total
                risk-based capital(to
                risk-weighted assets)HomeFederal
                Bank
            
            $
            89,532
            
            
            13.58
            %
            $
            52,759
            
            
            8.0
            %
            $
            65,949
            
            
            10.0
            %Home
                Federal Bancorp Consolidated
            
            $
            79,734
            
            
            12.08
            %
            $
            52,822
            
            
            8.0
            %
            $
            66,028
            
            
            10.0
            %Tier
                1 risk-based capital(to
                risk-weighted assets)HomeFederal
                Bank
            
            $
            82,779
            
            
            12.55
            %
            $
            26,379
            
            
            4.0
            %
            $
            39,569
            
            
            6.0
            %Home
                Federal Bancorp Consolidated
            
            $
            72,981
            
            
            11.05
            %
            $
            26,411
            
            
            4.0
            %
            $
            39,617
            
            
            6.0
            %Tier
                1 leverage capital(to
                average assets)HomeFederal
                Bank
            
            $
            82,779
            
            
            9.82
            %
            $
            33,724
            
            
            4.0
            %
            $
            42,155
            
            
            5.0
            %Home
                Federal Bancorp Consolidated
            
            $
            72,981
            
            
            8.65
            %
            $
            33,760
            
            
            4.0
            %
            $
            42,201
            
            
            5.0
            %





**Dividend
      Restrictions**


The
      principal source of income and funds for the Company is dividends from the
      Bank.
      The Bank is subject to certain restrictions on the amount of dividends that
      it
      may declare without prior regulatory approval. The Bank requested and received
      regulatory approval to pay $7.5 million and $8.2 million in dividends to its
      sole shareholder Home Federal Bancorp for the years ended December 2006 and
      2005, respectively. In 2007, the Bank anticipates requesting regulatory approval
      to pay dividends to the Company.





Additionally
      eligible deposit accountholders at the time of conversion, January 14, 1988,
      were granted priority in the unlikely event of a future liquidation of the
      Bank.
      Consequently, a special reserve account was established equal to the Bank’s
      $9,435,000 equity at December 31, 1986. No dividends may be paid to shareholders
      or outstanding shares repurchased if such payments reduce the equity of the
      Bank
      below the amount required for the liquidation account.








**13.**
            **EMPLOYEE
                BENEFIT PLANS**


**Multi-employer
      Pension Plan**


The
      Company participates in a noncontributory multi-employer pension plan covering
      all qualified employees. The trustees of the Financial Institutions Retirement
      Fund administer the plan. There is no separate valuation of the plan benefits
      or
      segregation of plan assets specifically for the Company, because the plan is
      a
      multi-employer plan and separate actuarial valuations are not made with respect
      to each employer. However, as of June 30, 2006, the latest actuarial valuation,
      the total plan assets exceeded the actuarially determined value of accrued
      benefits. The Company had expenses of $1.3 million,
      $1.3 million and $1.2 million for the years ended December 2006 ,
      2005
      and 2004, respectively. Cash contributions to the multi-employer pension plan
      for these same periods were $ 1.1 million,
      $1.4 million and $2.1 million, respectively.


-
          44 -


**Supplemental
      Retirement Plan**


The
      Company has entered into supplemental retirement agreements for certain officers
      (“the Plan”). These agreements are unfunded. However, the Company has entered
      into life insurance contracts to offset the expense of these agreements.
      Benefits under these arrangements are generally paid over a 15 year period.
      The
      following table sets forth the Plan's funded status and amount recognized in
      the
      Company's consolidated statements of income for the years ended December
      31 , 2006 ,
      2005
      and 2004, as well as the projected benefit cost for 2007: (dollars in
      thousands)





Dec
                2007
            
            Dec
                2006
            
            Dec
                2005
            
            Dec
                2004Economic
                assumptions:Discount
                rate
            
            
            
            
            
            5.8
            %
            
            5.8
            %
            
            6.5
            %Salary
                rate
            
            
            
            
            
            4.0
            %
            
            4.0
            %
            
            4.0
            %Components
                of net periodic pension expense:Interest
                cost on projected benefit obligation
            
            $
            203
            
            $
            197
            
            $
            197
            
            $
            183Service
                cost
            
            
            106
            
            
            100
            
            
            91
            
            
            68Prior
                service cost
            
            
            64
            
            
            61
            
            
            53
            
            
            217**Net
                Periodic Benefit Cost**
            
            $
            373
            
            $
            358
            
            $
            341
            
            $
            468





A
      reconciliation of the prior and ending balances of the Projected Benefit
      Obligation ("PBO") for 2006
      and 2005 is
      as follows: (dollars in thousands)





Dec
                2006
            
            Dec
                2005Projected
                benefit obligation at beginning of year
            
            $
            3,522
            
            $
            3,112Interest
                cost
            
            
            197
            
            
            197Service
                cost
            
            
            100
            
            
            91Amendments
            
            
            -
            
            
            11Change
                in discount rate
            
            
            -
            
            
            248Actuarial
                loss
            
            
            47
            
            
            53Benefits
                paid during year
            
            
            (219
            )
            
            (190
            )**Projected
                Benefit Obligation at End of Year (unfunded
                status)**
            
            $
            3,647
            
            $
            3,522





In
      September 2006, the FASB issued SFAS No. 158. This Statement requires an
      employer to recognize the overfunded or underfunded status of a defined benefit
      postretirement plan (other than a multiemployer plan) as an asset or liability
      in its statement of financial position and to recognize changes in that funded
      status in the year in which the changes occur through comprehensive income.
      A
      summary of the Plan's funded status at December 31, 2005 and the transition
      of
      SFAS No. 158 is as follows: (dollars in thousands)





Projected
                benefit obligation at December 31, 2005
            
            $
            3,522Unrecognized
                prior service cost
            
            
            (562
            )Unrecognized
                net actuarial loss
            
            
            (432
            )Accrued
                benefit cost at December 31, 2005
            
            
            2,528Benefit
                cost for fiscal year ended December 31, 2006
            
            
            358Benefits
                paid during fiscal year ended December 31, 2006
            
            
            (219
            )**Accrued
                benefit cost at December 31, 2006**
            
            $
            2,667Unfunded
                status at December 31, 2006
            
            $
            3,647Balance
                sheet adjustment at December 31, 2006
            
            
            980Accumulated
                other comprehensive income at December 31, 2006, net of
                tax
            
            
            592





Other
      changes in plan assets and benefit obligations recognized in other comprehensive
      income are as follows: (dollars in thousands)


Net
                loss
            
            $
            472Unrecognized
                prior service cost
            
            
            508Total
                recognized in other comprehensive income
            
            $
            980Total
                recognized in net periodic benefit cost and other comprehensive
                income
            
            $
            1,337





The
      estimated net loss and prior service cost for the Plan that will be amortized
      from accumulated other comprehensive income into net periodic benefit cost
      over
      the next fiscal year are $9,000 and $54,000, respectively. As of December 31,
      2006, the projected benefit obligation and the accumulated benefit obligation
      are $3.6 million and $3.5 million, respectively.





Prior
      service cost is amortized over the estimated remaining employee service lives
      of
      approximately nine years. The Company expects to make contributions of $373,000 to the
      plan in 2007. The Company anticipates paying benefits over the next five
      years and in the aggregate for the five years thereafter as follows: 2007 -
      $219,000, 2008 - $226,000, 2009 - $212,000, 2010 - $212,000, 2011 - $212,000
      and
      2012 through 2016 - $1,778,000.





**401(k)
      Plan**


The
      Company has an employee thrift plan established for substantially all full-time
      employees. The Company has elected to make matching contributions equal to
      50%
      of the employee contributions up to a maximum of 1.5% of an individual's total
      eligible salary. The Company contributed $126,000 ,
      $121,000 and $130,000, during the years ended  December
      31, 2006, 2005
      and
      2004, respectively, to this plan .




-
          45 -




**14.**
            **STOCK
                OPTIONS**


The
      Company has stock option plans for the benefit of officers, other key employees
      and directors. As of December 31, 2006 ,
      the
      plans were authorized to grant additional options to purchase 177,131 shares
      of the Company's common stock. The option price is not to be less than the
      fair
      market value of the common stock on the date the option is granted, and the
      stock options are exercisable at any time within the maximum term of 10 years
      and one day from the grant date, limited by general vesting terms up to a
      maximum amount of $100,000 per year on incentive stock options. The options
      are
      nontransferable and are forfeited upon termination of employment, except in
      case
      of retirement, in which case the options are exercisable for three years after
      date of retirement. The Company issues new common shares to satisfy exercises
      of
      stock options.





As
      previously stated, effective January 1, 2006, the Company adopted the fair
      value
      recognition provisions of Statement of Financial Accounting Standards No. 123(R)
      “Share-Based Payment” (“SFAS 123(R)”). Under the modified prospective method of
      adoption selected by the Company, compensation expense related to stock options
      is recognized beginning January 1, 2006 for any new awards issued after this
      date, as well as for any previously-issued awards vesting on or after January
      1,
      2006. The pre-tax compensation cost charged against income and the related
      income tax benefit recognized in the December 31, 2006 income statement was
      $296,000 and $89,000, respectively.





The
      weighted average grant date fair value of options granted was $ 5.58 for the
      year ended December 31, 2006
      and was
      $5.00 for the year ended December 31, 2005 . No
      options were granted during the year ended December 31, 2004.The Company
      estimates the fair value of each option on the date of grant using the Black
      Scholes model. The Black Scholes model uses the following assumptions: 1.)
      expected life in years which is based on historical employee behavior; 2.)
      annualized volatility which is based on the price volatility of the Company’s
      stock over the expected life of the option; 3.) annual rate of quarterly
      dividends based on most recent historical rate; 4.) the discount rate based
      on
      the zero coupon bond with a term equal to the expected life of the option;
      and
      5.) assuming no forfeitures of options. The fair value of stock options granted
      in 2006 was
      calculated using the following assumptions: dividend yield of 2.81 %
      to
      3.08%; risk-free interest rates of 4.53 %
      to 4.90 %;
      expected volatility of 18.75 %
      to 21.07 %;
      and
      expected life of 5.91
      to
      6.03 years.
      The fair value of options granted in 2005 was
      calculated using the following assumptions: dividend yield of 2.97 %
      to 3.07 %;
      risk-free interest rates of 3.68 %
      to 4.11 %;
      expected volatility of 22.13 %
      to 22.38 %;
      and
      expected life of 5.91 years.





The
      following is the stock option activity for the years ended December 31, 2006 ,
      2005
      and 2004 and the stock options outstanding at the end of the respective
      periods:





Options
            
            Shares
            
            Weighted
                Average
              Exercise
                Price
            
            Weighted
                Average
              Life
              (in
                years)
            
            Aggregate
                Intrinsic Value**Outstanding
                December 31, 2003**
            
            
            **771,268**Forfeited
            
            
            (1,125
            )Exercised
            
            
            (83,485
            )**Outstanding
                December 31, 2004**
            
            
            **686,658**Granted
            
            
            50,000Forfeited
            
            
            (9,875
            )Exercised
            
            
            (109,066
            )**Outstanding
                December 31, 2005**
            
            
            **617,717**
            
            $
            21.86Granted
            
            
            97,500
            
            
            26.87Forfeited
            
            
            (3,000
            )
            
            26.90Exercised
            
            
            (104,724
            )
            
            18.74**Outstanding
                December 31,****2006**
            
            
            **607,493**
            
            $
            23.17
            
            
            4.6
            
            $
            2,997,000**Exercisable
                at December 31, 2006**
            
            
            **532,828**
            
            $
            22.74
            
            
            3.9
            
            $
            2,862,000







Options
      outstanding at December 31, 2006 include vested options and options expected
      to
      vest, assuming no forfeitures. As of December 31, 2006, there was approximately
      $300,000 of unrecognized compensation cost related to the unvested shares;
      that
      cost is expected to be recognized over the remaining vesting period, which
      approximates 4 years. The total intrinsic value of options exercised for the
      year ended December 31, 2006 was $885,000. During 2006, 2005 and 2004, the
      Company received $1,962,000, $1,846,000 and $1,293,000, respectively, from
      stock
      options exercised. Additionally, the Company received a tax benefit from options
      which had been exercised of $133,000, $270,000 and $154,000 in 2006, 2005,
      and
      2004, respectively.




**15.**
            **COMMITMENTS**


**Financial
      Instruments with Off-Balance Sheet Risk**


In
      the
      normal course of business, the Company makes various commitments to extend
      credit that are not reflected in the accompanying consolidated financial
      statements. Commitments, which are disbursed subject to certain limitations,
      extend over various periods of time. Generally, unused commitments are cancelled
      upon expiration of the commitment term as outlined in each individual contract.
      The follow table summarizes the Company’s significant commitments: (dollars in
      thousands)




**COMMITMENTS**Dec
                2006
            
            Dec
                2005**Commitments
                to extend credit:**Commercial
                mortgage loans and commercial loans
            
            $
            123,734
            
            $
            75,368Residential
                mortgage loans
            
            
            23,184
            
            
            19,159Revolving
                home equity lines of credit
            
            
            52,616
            
            
            58,818Other
            
            
            20,812
            
            
            1,754Standby
                letters of credit
            
            
            4,457
            
            
            3,991**Commitments
                to sell loans:**Residential
                mortgage loans
            
            
            8,976
            
            
            6,439Commercial
                mortgage loans and commercial loans
            
            
            6,262
            
            
            6,413





-
          46 -




Management
      believes that none of these arrangements exposes the Company to any greater
      risk
      of loss than already reflected on our balance sheet so accordingly no reserves
      have been established for these commitments.





The
      Company’s exposure to credit loss in the event of nonperformance by the other
      parties to the financial instruments for commitments to extend credit is
      represented by the contract amount of those instruments. The Company uses the
      same credit policies and collateral requirements in making commitments as it
      does for on-balance sheet instruments.





The
      Company also has exposure for a possible environmental contamination at the
      previous Operations Building in Seymour. A phase I environmental site assessment
      of the property showed two items that represent a potential for contamination.
      A
      photographic studio was operated on the site for approximately 50 years from
      1901 to 1950 and the proximity of the site to a former service station that
      began operations in 1924 with an unknown closing date. The environmental report
      concluded that further testing was recommended to determine the impact of the
      potential contamination. While it is reasonably possible that a liability may
      be
      incurred regarding possible environmental cleanup, Management is unable to
      reasonably estimate what that amount, if any, might be at this
      time.





**Employment
      Agreements**


The
      Company has entered into employment agreements with certain executive officers.
      Under certain circumstances provided in the agreements, the Company may be
      obligated to continue the officer's salary for a period of up to three
      years.




**16.**
            **FAIR
                VALUE OF FINANCIAL
                INSTRUMENTS**


The
      disclosure of the estimated fair value of financial instruments is as follows:
      (dollars in thousands)





Dec2006
            
            Dec
                2005Carrying
              Value
            
            Fair
              Value
            
            Carrying
              Value
            
            Fair
              Value**Assets:**Cash
                and due from banks
            
            $
            106,063
            
            $
            106,063
            
            $
            53,736
            
            $
            53,736Securities
                available for sale
            
            
            56,887
            
            
            56,887
            
            
            123,351
            
            
            123,351Securities
                held to maturity
            
            
            1,635
            
            
            1,628
            
            
            1,806
            
            
            1,796Loans
                held for sale
            
            
            6,925
            
            
            7,055
            
            
            4,795
            
            
            4,859Portfolio
                loans, net
            
            
            675,662
            
            
            667,573
            
            
            608,688
            
            
            607,867Accrued
                interest receivable
            
            
            4,679
            
            
            4,679
            
            
            3,942
            
            
            3,942Federal
                Home Loan Bank stock
            
            
            8,329
            
            
            8,329
            
            
            9,965
            
            
            9,965**Liabilities:**Deposits
            
            
            727,159
            
            
            726,300
            
            
            655,314
            
            
            654,589FHLB
                borrowings
            
            
            68,667
            
            
            68,723
            
            
            86,633
            
            
            96,329Junior
                subordinated debt
            
            
            15,464
            
            
            14,999
            
            
            -
            
            
            -Long
                term debt
            
            
            -
            
            
            -
            
            
            14,242
            
            
            14,237Short-term
                borrowings
            
            
            -
            
            
            -
            
            
            166
            
            
            166Advance
                payments by borrowers for taxes and insurance
            
            
            354
            
            
            354
            
            
            121
            
            
            121Accrued
                interest payable
            
            
            715
            
            
            715
            
            
            714
            
            
            714**Financial
                Instruments:**Commitments
                to extend credit
            
            
            25
            
            
            25
            
            
            8
            
            
            8Interest
                rate swaps
            
            
            (86
            )
            
            (86
            )
            
            (199
            )
            
            (199
            )





The
      Company, using available market information and appropriate valuation
      methodologies, has determined the estimated fair values of financial
      instruments. Considerable judgment is required in interpreting market data
      to
      develop the estimates of fair value. Accordingly, the estimates presented herein
      are not necessarily indicative of the amounts that the Company could realize
      in
      a current market exchange. The use of different market assumptions and/or
      estimation methodologies may have a material effect on the estimated fair value
      amounts.





-
          47 -




**Cash,
      Interest-bearing Deposits, Accrued Interest Receivable, Advance Payments by
      Borrowers for Taxes and Insurance, Accrued Interest Payable and Short-term
      Borrowings**


The
      carrying amount as reported in the Consolidated Balance Sheets is a reasonable
      estimate of fair value.





**Securities
      Held to Maturity and Available for Sale**


Fair
      values are based on quoted market prices and dealer quotes. If quoted market
      prices or dealer quotes are not available, fair value is determined based on
      quoted prices of similar instruments.


**Loans
      Held for Sale and Loans, net**


The
      fair
      value is estimated by discounting the future cash flows using the current rates
      for loans of similar credit risk and maturities. The estimate of credit losses
      is equal to the allowance for loan losses.





**Federal
      Home Loan Bank Stock**


The
      fair
      value is estimated to be the carrying value, which is par.





**Deposits**


The
      fair
      value of demand deposits, savings accounts and money market deposit accounts
      is
      the amount payable on demand at the reporting date. The fair value of
      fixed-maturity certificates of deposit is estimated, by discounting future
      cash
      flows, using rates currently offered for deposits of similar remaining
      maturities.





**FHLB
      Borrowings**


The
      fair
      value is estimated by discounting future cash flows using rates currently
      available to the Company for advances of similar maturities.





**Junior
      Subordinated Debt and Long Term Debt**


Rates
      currently available to the Company for debt with similar terms and remaining
      maturities are used to estimate fair value of existing debt.





**Interest
      Rate Swaps**


The
      fair
      value is derived from models based upon well-recognized financial principles
      which management believes provide a reasonable approximation of the fair value
      of the interest rate swap transactions.





**Commitments**


The
      commitments to originate and purchase loans have terms that are consistent
      with
      current market conditions. The carrying value of the commitments to extend
      credit represent the unamortized fee income assessed based on the credit quality
      of the borrower. Since the amount assessed represents the market rate that
      would
      be charged for similar agreements, management believes that the fair value
      approximates the carrying value of these instruments.





The
      fair
      value estimates presented herein are based on information available to
      management at December 31, 2006 and
      2005.
      Although management is not aware of any factors that would significantly affect
      the estimated fair value amounts, such amounts have not been comprehensively
      revalued for purposes of these financial statements since that date, and,
      therefore, current estimates of fair value may differ significantly from the
      amounts presented herein.


**17.**
            **PARENT
                COMPANY FINANCIAL
                STATEMENTS**


The
      condensed financial statements of Home Federal Bancorp are as follows:
      ( dollars in
      thousands)





As
                of
            
            Dec
                2006
            
            Dec
                2005**Condensed
                Balance Sheets***(Parent
                Company only*)**Assets:**Cash
            
            $
            1,406
            
            $
            4,366Investment
                in subsidiary
            
            
            84,958
            
            
            83,688Other
            
            
            578
            
            
            72**Total
                Assets**
            
            $
            86,942
            
            $
            88,126**Liabilities:**Junior
                subordinated debt
            
            $
            15,464
            
            $
            -Long
                term debt
            
            
            -
            
            
            14,242Other
            
            
            197
            
            
            846Total
                liabilities
            
            
            15,661
            
            
            15,088Shareholders'
                equity
            
            
            71,281
            
            
            73,038**Total
                Liabilities and Shareholders' Equity**
            
            $
            86,942
            
            $
            88,126




-
          48 -




Period
                Ended
            
            Dec
                2006
            
            Dec
                2005
            
            Dec
                2004**Condensed
                Statements of Income***(Parent
                Company only*)Dividends
                from subsidiary
            
            $
            7,548
            
            $
            8,172
            
            $
            11,152Interest
                on securities
            
            
            10
            
            
            -
            
            
            -Other
            
            
            39
            
            
            176
            
            
            89Total
                income
            
            
            7,597
            
            
            8,348
            
            
            11,241Interest
                on junior subordinated debt
            
            
            326
            
            
            -
            
            
            -Interest
                on long term debt
            
            
            650
            
            
            808
            
            
            698Non
                interest expenses
            
            
            902
            
            
            971
            
            
            1,163Total
                expenses
            
            
            1,878
            
            
            1,779
            
            
            1,861Income
                before taxes and change in undistributed earnings of
                subsidiary
            
            
            5,719
            
            
            6,569
            
            
            9,380Applicable
                income tax benefit
            
            
            (637
            )
            
            (507
            )
            
            (703
            )Income
                before change in undistributed earnings of subsidiary
            
            
            6,356
            
            
            7,076
            
            
            10,083Increase
                (decrease) in undistributed earnings of subsidiary
            
            
            85
            
            
            (974
            )
            
            (4,920
            )**Net
                Income**
            
            $
            6,441
            
            $
            6,102
            
            $
            5,163





Period
                Ended
            
            Dec
                2006
            
            Dec
                2005
            
            Dec
                2004**Condensed
                Statements of Cash Flows***(Parent
                Company only*)**Operating
                Activities:**Net
                income
            
            $
            6,441
            
            $
            6,102
            
            $
            5,163Adjustments
                to reconcile net income to net cash provided by operating
                activities:Benefit
                for deferred income taxes
            
            
            (7
            )
            
            -
            
            
            -(Increase)
                decrease in other assets
            
            
            (500
            )
            
            49
            
            
            163Increase
                in accrued expenses and other liabilities
            
            
            585
            
            
            480
            
            
            100(Increase)
                decrease in undistributed earnings of subsidiary
            
            
            (85
            )
            
            974
            
            
            4,920Net
                cash provided by operating activities
            
            
            6,434
            
            
            7,605
            
            
            10,346**Financing
                Activities:**Payment
                of dividends on common stock
            
            
            (2,913
            )
            
            (2,909
            )
            
            (3,057
            )Repurchase
                shares of common stock
            
            
            (8,576
            )
            
            (8,086
            )
            
            (9,953
            )Excess
                tax benefit related to stock based compensation
            
            
            133
            
            
            270
            
            
            154Exercise
                of stock options
            
            
            1,962
            
            
            1,846
            
            
            1,293Net
                cash used in financing activities
            
            
            (9,394
            )
            
            (8,879
            )
            
            (11,563
            )Net
                decrease in cash
            
            
            (2,960
            )
            
            (1,274
            )
            
            (1,217
            )Cash
                at beginning of period
            
            
            4,366
            
            
            5,640
            
            
            6,857**Cash
                at End of Period**
            
            $
            1,406
            
            $
            4,366
            
            $
            5,640




**18.
      Subsequent Event**




On
      February 16, 2007, the Bank **** entered
      into a separation agreement with an executive vice president of the Bank and
      the
      Company. Pursuant to the agreement, six months following the date of the
      agreement, the Bank will pay the executive vice president a lump sum payment
      in
      the amount of $753,431. The Bank also will reimburse the executive vice
      president for attorney fees and outplacement services up to a maximum aggregate
      amount of $35,000. As a result, the Company will record a pre-tax charge of
      $788,431 in operating expenses during the first quarter of 2007. In addition,
      on
      February 16, 2007, the Company paid the executive vice president a net cash
      payment of $548,167 for 78,744 shares of Company common stock which were
      acquired by the executive vice president on that date upon the exercise of
      vested stock options. The net cash payment represented $28.75 per share less
      the
      option exercise price. The net cash payment associated with the acquisition
      of 78,744 shares of the Company common stock will result in a net reduction
      of
      shareholders’ equity of $548,167 during the first quarter of 2007.




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          49 -











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