##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION    FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934  Commission File Number: 001-13735   MIDWEST BANC HOLDINGS, INC. (Exact name of Registrant as specified in its charter.)
 Delaware
    
    36-3252484(State or other jurisdiction of
    
    (I.R.S. Employer Identification Number)incorporation or organization)501 W. North Ave.Melrose Park, Illinois
    
    60160(Address of principal executive offices)
    
    (ZIP code)
   (708) 865-1053(Registrants telephone number, including area code) Indicate by checkmark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [   ] Indicate by checkmark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No [   ] Indicate the number of shares outstanding of each of the issuers classes
of common stock, as of the latest practicable date. Class
    
    Outstanding at August 9, 2004Common, par value $.01
    
    17,898,132




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MIDWEST BANC HOLDINGS, INC. Form 10-Q Table of Contents Page NumberPART IItem 1.
    
    Financial Statements
    
    
    1Item 2.
    
    Management's Discussion and Analysis of Financial Condition and Results of Operations
    
    
    15Item 3.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    33Item 4.
    
    Controls and Procedures
    
    
    34PART IIItem 1.
    
    Legal Proceedings
    
    
    37Item 2.
    
    Changes in Securities, Use of Proceeds, and Issuer Purchases of Equity Securities
    
    
    37Item 3.
    
    Defaults Upon Senior Securities
    
    
    37Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    37Item 5.
    
    Other Information
    
    
    38Item 6.
    
    Exhibits and Reports on Form 8-K
    
    
    38Form 10-Q
    
    Signature Page
    
    
    39Certification of Chief Executive OfficerCertification of Chief Financial OfficerCertification of CEO and CFO
  i




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MIDWEST BANC HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS (Unaudited)
(In Thousands) June 30,
    
    December 31,2004
    
    2003ASSETSCash and cash equivalents
    
    $
    85,378
    
    
    $
    196,157Securities available-for-sale
    
    
    701,200
    
    
    
    796,140Securities held-to-maturity (fair value: $104,400 at
June 30, 2004 and $57,239 at December 31, 2003)
    
    
    105,409
    
    
    
    56,074Loans
    
    
    1,140,219
    
    
    
    1,081,296Allowance for loan losses
    
    
    (16,088
    )
    
    
    (15,714
    )Net loans
    
    
    1,124,131
    
    
    
    1,065,582Cash value of life insurance
    
    
    25,633
    
    
    
    24,906Premises and equipment, net
    
    
    28,028
    
    
    
    27,376Other real estate
    
    
    6,469
    
    
    
    6,942Core deposit and other intangibles, net
    
    
    2,431
    
    
    
    2,790Goodwill
    
    
    4,360
    
    
    
    4,360Due from broker
    
    
    149,543
    
    
    
    40,477Other assets
    
    
    50,501
    
    
    
    43,345Total assets
    
    $
    2,283,083
    
    
    $
    2,264,149LIABILITIES AND STOCKHOLDERS EQUITYLIABILITIESDepositsNon-interest-bearing
    
    $
    162,917
    
    
    $
    160,668Interest-bearing
    
    
    1,443,732
    
    
    
    1,425,743Total deposits
    
    
    1,606,649
    
    
    
    1,586,411Securities sold under agreements to repurchase
    
    
    199,386
    
    
    
    202,699Advances from the Federal Home Loan Bank
    
    
    250,031
    
    
    
    253,461Junior subordinated debt owed to unconsolidated trusts
    
    
    55,672
    
    
    
    54,000Note payable
    
    
    
    
    
    
    2,000Other liabilities
    
    
    31,379
    
    
    
    22,497Total liabilities
    
    
    2,143,117
    
    
    
    2,121,068STOCKHOLDERS EQUITYPreferred stock
    
    
    
    
    
    
    Common stock
    
    
    187
    
    
    
    187Surplus
    
    
    64,480
    
    
    
    64,330Retained earnings
    
    
    105,758
    
    
    
    102,041Accumulated other comprehensive loss
    
    
    (23,150
    )
    
    
    (15,824
    )Treasury stock, at cost (771,308 shares at June 30, 2004
and 806,934 shares at December 31, 2003)
    
    
    (7,309
    )
    
    
    (7,653
    )Total stockholders equity
    
    
    139,966
    
    
    
    143,081Total liabilities and stockholders equity
    
    $
    2,283,083
    
    
    $
    2,264,149
 See accompanying notes to unaudited consolidated financial statements. PAGE 1




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MIDWEST BANC HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
THREE MONTHS ENDED JUNE 30, 2004 AND 2003 (In Thousands, Except Per Share Data)
 2004
    
    2003Interest IncomeLoans
    
    $
    16,324
    
    
    $
    17,784SecuritiesTaxable
    
    
    7,692
    
    
    
    8,979Exempt from federal income taxes
    
    
    167
    
    
    
    795Trading securities
    
    
    352
    
    
    
    Federal funds sold and other short-term investments
    
    
    469
    
    
    
    18Total interest income
    
    
    25,004
    
    
    
    27,576Interest ExpenseDeposits
    
    
    7,243
    
    
    
    7,647Federal funds purchased
    
    
    16
    
    
    
    55Securities sold under agreements to repurchase
    
    
    1,305
    
    
    
    1,476Advances from the Federal Home Loan Bank
    
    
    2,491
    
    
    
    2,875Junior subordinated debt owed to unconsolidated trusts
    
    
    859
    
    
    
    658Note payable
    
    
    
    
    
    
    38Total interest expense
    
    
    11,914
    
    
    
    12,749Net interest income
    
    
    13,090
    
    
    
    14,827Provision for loan losses
    
    
    756
    
    
    
    755Net interest income after provision for loan losses
    
    
    12,334
    
    
    
    14,072Other IncomeService charges on deposits
    
    
    1,544
    
    
    
    1,434Net gains (losses) on securities transactions
    
    
    (750
    )
    
    
    2,701Net trading profits
    
    
    1,051
    
    
    
    2,305Gains on sales of loans
    
    
    169
    
    
    
    377Insurance and brokerage commissions
    
    
    484
    
    
    
    556Trust income
    
    
    158
    
    
    
    169Increase in cash surrender value of life insurance
    
    
    264
    
    
    
    234Other income
    
    
    208
    
    
    
    163Total other income
    
    
    3,128
    
    
    
    7,939Other ExpensesSalaries and employee benefits
    
    
    6,585
    
    
    
    5,999Occupancy and equipment
    
    
    1,677
    
    
    
    1,465Professional services
    
    
    1,101
    
    
    
    1,279Other expenses
    
    
    2,072
    
    
    
    1,929Total other expenses
    
    
    11,435
    
    
    
    10,672Income before income taxes
    
    
    4,027
    
    
    
    11,339Provision for income taxes
    
    
    843
    
    
    
    3,548Net Income
    
    $
    3,184
    
    
    $
    7,791Basic earnings per share
    
    $
    0.18
    
    
    $
    0.44Diluted earnings per share
    
    $
    0.17
    
    
    $
    0.43Cash dividend declared per common share
    
    $
    0.12
    
    
    $
    0.10
 See accompanying notes to unaudited consolidated financial statements. PAGE 2




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MIDWEST BANC HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
SIX MONTHS ENDED JUNE 30, 2004 AND 2003 (In Thousands, Except Per Share Data)
 2004
    
    2003Interest IncomeLoans
    
    $
    32,842
    
    
    $
    38,184SecuritiesTaxable
    
    
    16,508
    
    
    
    17,718Exempt from federal income taxes
    
    
    464
    
    
    
    1,589Trading securities
    
    
    352
    
    
    
    Federal funds sold and other short-term investments
    
    
    931
    
    
    
    67Total interest income
    
    
    51,097
    
    
    
    57,558Interest ExpenseDeposits
    
    
    14,400
    
    
    
    15,672Federal funds purchased
    
    
    18
    
    
    
    101Securities sold under agreements to repurchase
    
    
    2,705
    
    
    
    2,891Advances from the Federal Home Loan Bank
    
    
    4,985
    
    
    
    5,722Junior subordinated debt owed to unconsolidated trusts
    
    
    1,712
    
    
    
    1,305Notes payable
    
    
    20
    
    
    
    74Total interest expense
    
    
    23,840
    
    
    
    25,765Net interest income
    
    
    27,257
    
    
    
    31,793Provision for loan losses
    
    
    1,512
    
    
    
    1,745Net interest income after provision for loan losses
    
    
    25,745
    
    
    
    30,048Other IncomeService charges on deposits
    
    
    2,980
    
    
    
    2,901Net gains on securities transactions
    
    
    2,116
    
    
    
    2,803Net trading profits (losses)
    
    
    (781
    )
    
    
    3,459Gains on sales of loans
    
    
    322
    
    
    
    665Insurance and brokerage commissions
    
    
    969
    
    
    
    1,014Trust income
    
    
    307
    
    
    
    304Increase in cash surrender value of life insurance
    
    
    727
    
    
    
    491Other income
    
    
    431
    
    
    
    364Total other income
    
    
    7,071
    
    
    
    12,001Other ExpensesSalaries and employee benefits
    
    
    13,066
    
    
    
    12,051Occupancy expense and equipment
    
    
    3,369
    
    
    
    3,226Professional services
    
    
    1,982
    
    
    
    2,467Other expenses
    
    
    4,059
    
    
    
    3,711Total other expenses
    
    
    22,476
    
    
    
    21,455Income before income taxes
    
    
    10,340
    
    
    
    20,594Provision for income taxes
    
    
    2,331
    
    
    
    6,409Net Income
    
    $
    8,009
    
    
    $
    14,185Basic earnings per share
    
    $
    0.45
    
    
    $
    0.80Diluted earnings per share
    
    $
    0.44
    
    
    $
    0.78Cash dividends declared per common share
    
    $
    0.24
    
    
    $
    0.20
 See accompanying notes to unaudited consolidated financial statements. PAGE 3




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MIDWEST BANC HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (Unaudited)
SIX MONTHS ENDED JUNE 30, 2004 AND 2003 (In Thousands, Except Per Share Data)
 AccumulatedOther
    
    
    
    
    
    TotalCompre-
    
    
    
    
    
    Stock-Common
    
    
    
    
    
    Retained
    
    hensive
    
    Treasury
    
    holdersStock
    
    Surplus
    
    Earnings
    
    Income (Loss)
    
    Stock
    
    EquityBalance, January 1, 2003
    
    $
    171
    
    
    $
    29,366
    
    
    $
    87,105
    
    
    $
    7,145
    
    
    $
    (8,836
    )
    
    $
    114,951Cash dividends declared ($0.20
per share)
    
    
    
    
    
    
    
    
    
    
    (3,559
    )
    
    
    
    
    
    
    
    
    
    
    (3,559
    )Issuance of 1,599,088 shares of
common stock upon acquisition of
Big Foot Financial Corp.
    
    
    16
    
    
    
    30,448
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    30,464Issuance of common stock
upon exercise of 60,513
stock options, net of tax benefit
    
    
    
    
    
    
    231
    
    
    
    
    
    
    
    
    
    
    
    575
    
    
    
    806Capital contribution from loan
payoff by related parties
    
    
    
    
    
    
    4,033
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,033Comprehensive incomeNet income
    
    
    
    
    
    
    
    
    
    
    14,185
    
    
    
    
    
    
    
    
    
    
    
    14,185Net decrease in fair value of
securities classified as available-
for-sale, net of income taxes and
reclassification adjustments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,012
    )
    
    
    
    
    
    
    (1,012
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    13,173Balance, June 30, 2003
    
    $
    187
    
    
    $
    64,078
    
    
    $
    97,731
    
    
    $
    6,133
    
    
    $
    (8,261
    )
    
    $
    159,868Balance, January 1, 2004
    
    $
    187
    
    
    $
    64,330
    
    
    $
    102,041
    
    
    $
    (15,824
    )
    
    $
    (7,653
    )
    
    $
    143,081Cash dividends declared ($0.24
per share)
    
    
    
    
    
    
    
    
    
    
    (4,292
    )
    
    
    
    
    
    
    
    
    
    
    (4,292
    )Issuance of common stock
upon exercise of 35,626
stock options, net of tax benefit
    
    
    
    
    
    
    150
    
    
    
    
    
    
    
    
    
    
    
    344
    
    
    
    494Comprehensive incomeNet income
    
    
    
    
    
    
    
    
    
    
    8,009
    
    
    
    
    
    
    
    
    
    
    
    8,009Net decrease in fair value of
securities classified as available-
for-sale, net of income taxes and
reclassification adjustments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (7,326
    )
    
    
    
    
    
    
    (7,326
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    683Balance, June 30, 2004
    
    $
    187
    
    
    $
    64,480
    
    
    $
    105,758
    
    
    $
    (23,150
    )
    
    $
    (7,309
    )
    
    $
    139,966
 See accompanying notes to unaudited consolidated financial statements. PAGE 4




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MIDWEST BANC HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
SIX MONTHS ENDED JUNE 30, 2004 AND 2003 (In Thousands)
 2004
    
    2003Cash flows from operating activitiesNet income
    
    $
    8,009
    
    
    $
    14,185Adjustments to reconcile net income to net cash
provided by operating activitiesDepreciation
    
    
    1,275
    
    
    
    1,191Provision for loan losses
    
    
    1,512
    
    
    
    1,745Amortization of other intangibles
    
    
    148
    
    
    
    247Amortization of premiums and discounts on securities, net
    
    
    1,788
    
    
    
    5,556Net gain on sales of securities
    
    
    (2,116
    )
    
    
    (2,803
    )Net gain on sales of mortgage loans
    
    
    (330
    )
    
    
    (4,006
    )Federal Home Loan Bank stock dividend
    
    
    (555
    )
    
    
    (647
    )Net change in real estate loans originated held for sale
    
    
    (104
    )
    
    
    (186
    )Increase in cash surrender value of life insurance
    
    
    (727
    )
    
    
    (491
    )Deferred income taxes
    
    
    144
    
    
    
    (2,300
    )Loss on other real estate
    
    
    59
    
    
    
    Change in other assets
    
    
    (4,216
    )
    
    
    592Change in other liabilities
    
    
    8,962
    
    
    
    15,277Net cash from operating activities
    
    
    13,849
    
    
    
    28,360Cash flows from investing activitiesSales of securities available-for-sale
    
    
    433,266
    
    
    
    301,521Maturities of securities available-for-sale
    
    
    37,470
    
    
    
    Principal payments on securities available-for-sale
    
    
    46,684
    
    
    
    196,078Purchase of securities available-for-sale
    
    
    (525,406
    )
    
    
    (766,976
    )Purchase of securities held-to-maturity
    
    
    (66,669
    )
    
    
    (4,437
    )Maturities of securities held-to-maturity
    
    
    1,175
    
    
    
    1,900Futures contracts
    
    
    (450
    )
    
    
    Purchase of mortgage loans
    
    
    (31,215
    )
    
    
    Net (increase) decrease in loans
    
    
    (28,683
    )
    
    
    67,066Proceeds from sale of mortgage loans
    
    
    
    
    
    
    146,552Cash received, net of cash and cash equivalents in acquisition
and stock issuance
    
    
    
    
    
    
    17,783Proceeds from sale of other real estate
    
    
    584
    
    
    
    1,517Property and equipment expenditures, net
    
    
    (2,288
    )
    
    
    (706
    )Net cash used in investing activities
    
    
    (135,532
    )
    
    
    (39,832
    )Cash flows from financing activitiesNet increase in deposits
    
    
    20,238
    
    
    
    52,278Borrowings
    
    
    
    
    
    
    5,500Repayment of borrowings
    
    
    (2,000
    )
    
    
    Dividends paid
    
    
    (4,292
    )
    
    
    (3,396
    )Change in securities sold under agreements to repurchase
and federal funds purchased
    
    
    (3,313
    )
    
    
    (8,990
    )Proceeds from exercised stock options
    
    
    271
    
    
    
    554Net cash from financing activities
    
    
    10,904
    
    
    
    45,946Increase (decrease) in cash and cash equivalents
    
    
    (110,779
    )
    
    

    34,474Cash and cash equivalents at beginning of period
    
    
    196,157
    
    
    
    49,687Cash and cash equivalents at end of period
    
    $
    85,378
    
    
    $
    84,161
 See accompanying notes to unaudited consolidated financial statements. PAGE 5




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MIDWEST BANC HOLDINGS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
 (Continued)
 2004
    
    2003Supplemental disclosuresCash paid during the year forInterest
    
    $
    23,792
    
    
    $
    26,146Income Taxes
    
    
    3,731
    
    
    
    3,575Supplemental schedule of noncash investing activitiesAmount due to broker for purchases of securities
    
    $
    149,543
    
    
    $
    18,038Real estate acquired in settlement of loans
    
    
    170
    
    
    
    2,707AcquisitionsNoncash assets acquired:Investment securities available for sale
    
    $
    
    
    
    $
    17,065Loans, net
    
    
    
    
    
    
    157,477Premises and equipment, net
    
    
    
    
    
    
    9,257Goodwill, net
    
    
    
    
    
    
    1,852Other intangibles, net
    
    
    
    
    
    
    3,361Other assets
    
    
    
    
    
    
    5,930Total noncash assets acquired
    
    $
    
    
    
    $
    194,942Liabilities assumed:Deposits
    
    $
    
    
    
    $
    137,729FHLB advances
    
    
    
    
    
    
    36,727Accrued expenses and other liabilities
    
    
    
    
    
    
    8,188Total liabilities assumed
    
    
    
    
    
    
    182,644Net noncash assets acquired
    
    $
    
    
    
    $
    12,103Cash and cash equivalents acquired
    
    $
    
    
    
    $
    19,688
 See accompanying notes to unaudited consolidated financial statements. PAGE 6




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NOTE 1  BASIS OF PRESENTATION The consolidated financial information of Midwest Banc Holdings, Inc. (the
Company) included herein is unaudited; however, such information reflects all
adjustments (consisting only of normal recurring adjustments) which are, in the
opinion of management, necessary for a fair presentation for the interim
periods. The financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America for
interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. The annualized results of operations for the six months ended June 30,
2004 are not necessarily indicative of the results expected for the full year
ending December 31, 2004. NOTE 2  BUSINESS COMBINATION AND MERGER TERMINATION On January 3, 2003, the Company acquired Big Foot Financial Corp. (BFFC)
through the issuance of approximately 1,599,088 shares of common stock valued
at $18.81 per share and cash paid of $1.4 million, and incurred acquisition
costs of $557,000, resulting in total consideration of $32.0 million. BFFC was
merged into the Company, and its banking subsidiary was merged into and its
offices became branches of Midwest Bank and Trust Company. At closing, the
Company transferred $3.4 million of securities categorized as held-to-maturity
to available-for-sale under permissible provisions of FASB Statement No. 115.
During the first quarter of 2003, the Company sold the mortgage loans and
mortgage servicing rights of $141.9 million of the acquired loans on a
non-recourse basis. The business combination is accounted for under the purchase method of
accounting. Accordingly, the results of operations of BFFC have been included
in the Companys results of operations since January 3, 2003, the date of
acquisition. Under this method of accounting, the purchase price is allocated
to the respective assets acquired and liabilities assumed based on their
estimated fair values. The excess of purchase price over the net assets
acquired is recorded as goodwill. NOTE 3  GOODWILL AND INTANGIBLES On January 1, 2002, the Company implemented Statement of Financial
Accounting Standards No. 142, Goodwill and Other Intangible Assets.Under the
provisions of SFAS No. 142, goodwill is no longer subject to amortization over
its estimated useful life, but instead is subject to at least annual
assessments for impairment by applying a fair-value based test. SFAS No. 142
also requires that an acquired intangible asset be separately recognized if the
benefit of the intangible asset is obtained through contractual or other legal
rights, or if the asset can be sold, transferred, licensed, rented or
exchanged, regardless of the acquirers intent to do so. PAGE 7




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Intangible asset disclosures are as follows (in thousands): June 30, 2004
    
    December 31, 2003Gross Carrying
    
    Accumulated
    
    Gross Carrying
    
    AccumulatedAmount
    
    Amortization
    
    Amount
    
    AmortizationAmortized intangible assets:Core deposit and other intangibles
    
    $
    3,130
    
    
    $
    (699
    )
    
    $
    3,341
    
    
    $
    (551
    )Aggregate intangible amortization
expense:For the three months ending June 30, 2004
    
    $
    107For the six months ending June 30, 2004
    
    
    148Estimated intangible amortization
expense:For the year ending December 31, 2004
    
    $
    362For the year ending December 31, 2005
    
    
    429For the year ending December 31, 2006
    
    
    373For the year ending December 31, 2007
    
    
    354For the year ending December 31, 2008
    
    
    354
 The following tables present the changes in the carrying amount of
goodwill and other intangibles during the six months ended June 30, 2004 and
the year ended December 31, 2003 (in thousands): June 30, 2004Core Depositand OtherGoodwill
    
    IntangiblesBalance at beginning of period
    
    $
    4,360
    
    
    $
    2,790Amortization expense
    
    
    
    
    
    
    (148
    )Intangibles acquired
    
    
    
    
    
    
    (211
    )Balance at end of period
    
    $
    4,360
    
    
    $
    2,431
 December 31, 2003Core Depositand OtherGoodwill
    
    IntangiblesBalance at beginning of year
    
    $
    4,360
    
    
    $
    244Amortization expense
    
    
    
    
    
    
    (495
    )Intangibles acquired
    
    
    
    
    
    
    3,041Balance at end of year
    
    $
    4,360
    
    
    $
    2,790
 NOTE 4  EARNINGS PER SHARE For purposes of per share calculations, the Company had 17,896,832 and
17,799,968 shares of common stock outstanding at June 30, 2004 and 2003,
respectively. Basic earnings per share for the three months and six months
ended June 30, 2004 and 2003 were computed by dividing net income by the
weighted average number of shares outstanding. Diluted earnings per share for
the three and six months ended June 30, 2004 and 2003 were computed by dividing
net income by the weighted average number of shares outstanding, adjusted for
the dilutive effect of stock options. Computations for basic and diluted
earnings per share are provided below. PAGE 8




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##### Table of Contents



IN THOUSANDS
    
    2004 QTD
    
    2003 QTD
    
    2004 YTD
    
    2003 YTDBasicNet income
    
    $
    3,184
    
    
    $
    7,791
    
    
    $
    8,009
    
    
    $
    14,185Weighted average common shares outstanding
    
    
    17,880
    
    
    
    17,798
    
    
    
    17,873
    
    
    
    17,763Basic earnings per common share
    
    $
    0.18
    
    
    $
    0.44
    
    
    $
    0.45
    
    
    $
    0.80DilutedNet income
    
    $
    3,184
    
    
    $
    7,791
    
    
    $
    8,009
    
    
    $
    14,185Weighted average common shares outstanding
    
    
    17,880
    
    
    
    17,798
    
    
    
    17,873
    
    
    
    17,763Diluted effect of stock options
    
    
    447
    
    
    
    414
    
    
    
    455
    
    
    
    406Dilutive average common shares
    
    
    18,327
    
    
    
    18,212
    
    
    
    18,328
    
    
    
    18,169Diluted earnings per common share
    
    $
    0.17
    
    
    $
    0.43
    
    
    $
    0.44
    
    
    $
    0.78
 All outstanding options were included in the computation of diluted
earnings per share for the quarters and six months ended June 30, 2004 and
2003. NOTE 5  STOCK OPTIONS During the first six months of 2004, 35,626 stock options exercised. The
total stock options outstanding were 1,040,918 at June 30, 2004 with exercise
prices ranging between $5.42 and $18.34 and expiration dates between 2006 and
2013. Employee compensation expense under stock options is reported using the
intrinsic value method. No stock-based compensation cost is reflected in net
income, as all options granted had an exercise price equal to or greater than
the market price of the underlying common stock at date of grant. The
following table illustrates the effect on net income and earnings per share if
expense was measured using the fair value recognition provisions of FASB
Statement No. 123, Accounting for Stock-Based Compensation
for three and six months ended June 30, 2004 and 2003. IN THOUSANDS
    
    2004 QTD
    
    2003 QTD
    
    2004 YTD
    
    2003 YTDNet income as reported
    
    $
    3,184
    
    
    $
    7,791
    
    
    $
    8,009
    
    
    $
    14,185Deduct: stock-based compensation expense
determined under fair value base method
    
    
    89
    
    
    
    75
    
    
    
    178
    
    
    
    149Pro forma net income
    
    $
    3,095
    
    
    $
    7,716
    
    
    $
    7,831
    
    
    $
    14,036BASIC EARNINGS PER SHARE AS REPORTED
    
    $
    0.18
    
    
    $
    0.44
    
    
    $
    0.45
    
    
    $
    0.80Pro forma basic earnings per share
    
    
    0.17
    
    
    
    0.43
    
    
    
    0.44
    
    
    
    0.79DILUTED EARNINGS PER SHARE AS REPORTED
    
    $
    0.17
    
    
    $
    0.43
    
    
    $
    0.44
    
    
    $
    0.78Pro forma diluted earnings per share
    
    
    0.17
    
    
    
    0.42
    
    
    
    0.43
    
    
    
    0.77
 PAGE 9




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NOTE 6  ISSUANCE OF TRUST PREFERRED SECURITIES The following table details the four trusts formed by the Company: Mandatory
    
    OptionalIssuer
    
    Issue Date
    
    Amount
    
    Rate
    
    Redemption Date
    
    Redemption DateMBHI Capital Trust I
    
    June 7, 2000
    
    $
    20,000,000
    
    
    10.0%
    
    June 7, 2030
    
    June 7, 2005MBHI Capital Trust II
    
    October 29, 2002
    
    $
    15,000,000
    
    
    LIBOR+3.45%
    
    November 7, 2032
    
    November 7, 2007MBHI Capital Trust III
    
    December 19, 2003
    
    $
    9,000,000
    
    
    LIBOR+3.00%
    
    December 30, 2033
    
    December 30, 2008MBHI Capital Trust IV
    
    December 19, 2003
    
    $
    10,000,000
    
    
    LIBOR+2.85%
    
    January 23, 2034
    
    January 23, 2008
 In May 2000, the Company formed the MBHI Capital Trust I (Trust). The
Trust is a statutory business trust formed under the laws of the State of
Delaware and is wholly owned by the Company. In June 2000, the Trust issued
10.0% Company obligated mandatory redeemable trust preferred securities with an
aggregate liquidation amount of $20.0 million ($25 per preferred security) to
third-party investors in an underwritten public offering. The Company issued
10.0% junior subordinated debentures aggregating $20.0 million to the Trust.
The junior subordinated debentures are the sole assets of the Trust. The
Company obligated mandatory redeemable trust preferred securities and the
junior subordinated debentures pay distributions and dividends, respectively,
on a quarterly basis, which are included in interest expense. The Company
obligated mandatory redeemable trust preferred securities will mature on June
7, 2030, at which time the preferred securities must be redeemed. The Company
obligated mandatory redeemable trust preferred securities and junior
subordinated debentures can be redeemed contemporaneously, in whole or in part,
beginning June 7, 2005 at a redemption price of $25 per preferred security. The
Company has provided a full, irrevocable, and unconditional guarantee on a
subordinated basis of the obligations of the Trust under the preferred
securities in the event of the occurrence of an event of default, as defined in
such guarantee. FIN No. 46, Consolidation of Variable Interest Entities, an Interpretation
of Accounting Research Bulletin No. 51 (Revised December 2003) (FIN 46). FIN
46 establishes accounting guidance for consolidation of variable interest
entities (VIE) that function to support the activities of the primary
beneficiary. The primary beneficiary of a VIE entity is the entity that absorbs
a majority of the VIEs expected losses, receives a majority of the VIEs
expected residual returns, or both, as a result of ownership, controlling
interest, contractual relationship or other business relationship with the VIE.
Prior to the implementation of FIN 46, VIEs were generally consolidated by an
enterprise when the enterprise had a controlling financial interest through
ownership of a majority of voting interest in the entity. The provisions of FIN
46 were effective immediately for all arrangements entered into after January
31, 2003. If a VIE existed prior to February 1, 2003, FIN 46 was effective at
the beginning of the first interim period beginning after June 15, 2003.
However, subsequent revisions to the interpretation deferred the implementation
date of FIN 46 until the first period ending after December 15, 2003. The
Company adopted FIN 46, as revised, in connection with its consolidated
financial statements for the quarter ended March 31, 2004. The implementation
of FIN 46 required the Company to deconsolidate its investment in MBHI Capital
Trust I, II, III, and IV because the Company is not the primary beneficiary.
The Company owns $1.7 million of common securities that have been issued by the
four statutory trust previously formed. The deconsolidation did not have an
impact on stockholders equity or net income. The Federal Reserve Board issued a proposed rule on May 6, 2004 that would
retain trust preferred securities in the Tier 1 capital of bank holding
companies. After a three-year transition, the aggregate amount of trust
preferred securities and certain other capital elements would be limited to 25
percent of Tier 1 capital elements  net of goodwill. The amount of trust
preferred securities and certain other elements in excess of the limit could be
included in Tier 2 capital, subject to restrictions. Comments on the proposed
rule were due to the Federal Reserve by July 11, 2004. PAGE 10




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NOTE 7  DERIVATIVE INSTRUMENTS As of June 30, 2004, the Company has entered into various interest rate
swap transactions which result in the Company converting $137.5 million of its
Federal Home Loan Bank Advance fixed rate debt to floating rate debt. The swap
transactions require payment of interest by the Company at a rate equal to the
three-month LIBOR plus a spread and, in turn, the Company receives a fixed
rate. The Company has documented these to be fair value hedges that are
carried at their estimated fair value with the changes recorded as an other
asset or other liability as appropriate. Summary information about interest rate swaps at June 30 are as follows: 2004
    
    2003(Dollars in thousands)Notional amounts
    
    $
    137,500
    
    
    $
    67,500Weighted average fixed rates received
    
    
    5.46
    %
    
    
    5.91
    %Weighted average variable rates paid
    
    
    3.28
    
    
    
    3.68Weighted average maturity
    
    6.11 years
    
    7.00 yearsFair value
    
    $
    (4,877
    )
    
    $
    2,807
 The Company has also bought and sold various put and call options with
terms approximating 90 days on U.S. Treasury and government agency obligations,
mortgage-backed securities, and future contracts. These are stand-alone
derivatives that are carried at their estimated fair value with the
corresponding gain or loss recorded in net trading profits or losses. The
outstanding amounts at June 30 are as follows: 2004
    
    2003(Dollars in thousands)Notional amounts
    
    $
    50,000
    
    
    $
    Weighted average maturity
    
    92 Days
    
    
    Fair value
    
    $
    164
    
    
    $
    
 In 2004, the Company entered into 3,000 U.S. Treasury 10-year note futures
contracts with a notional value of $300.0 million and a delivery date of
September 2004. The Company sold these contracts in order to hedge certain U.S.
Agency notes held in its available-for-sale portfolio. The Companys objective
was to offset changes in the fair market value of the U.S. Agency notes with
changes in the fair market value of the futures contracts, thereby reducing
interest rate risk. The Company has documented these futures contracts as fair
value hedges with the changes in market value of the futures contracts as well
as the changes in the market value of the hedged items charged or credited to
earnings on a quarterly basis in net gains on securities transactions. For the
three and six months ending June 30, 2004, the change in the market values
resulted in a net loss of $1.1 million and $2.8 million, respectively, which
was recorded in net gains on securities transactions. Gains or losses for fair
value hedges occur when changes in the market value of the hedged items are not
identical to changes in the market value of hedge instruments during the
reporting period. The hedging relationship is assessed to be highly effective,
that is, there is a high correlation between the hedge instruments and hedged
items. PAGE 11




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NOTE 8  UNREALIZED LOSSES ON SECURITIES The following is a summary of the fair value of securities
held-to-maturity and available-for-sale with unrealized losses and an aging of
those unrealized losses: June 30, 2004Less Than 12 Months
    
    12 Months or More
    
    TotalFair
    
    Unrealized
    
    Fair
    
    Unrealized
    
    Fair
    
    UnrealizedValue
    
    Losses
    
    Value
    
    Losses
    
    Value
    
    Losses(In thousands)Obligations of U.S. government
agencies
    
    $
    323,383
    
    
    $
    (11,117
    )
    
    $
    175,137
    
    
    $
    (17,292
    )
    
    $
    498,520
    
    
    $
    (28,409
    )Mortgage-backed securities
    
    
    97,762
    
    
    
    (1,840
    )
    
    
    40,971
    
    
    
    (1,595
    )
    
    
    138,733
    
    
    
    (3,435
    )Equity securities
    
    
    19,026
    
    
    
    (184
    )
    
    
    57,732
    
    
    
    (7,204
    )
    
    
    76,758
    
    
    
    (7,388
    )Corporate and other debt securities
    
    
    6,520
    
    
    
    (425
    )
    
    
    12,608
    
    
    
    (1,011
    )
    
    
    19,128
    
    
    
    (1,436
    )Total temporarily impaired securities
    
    $
    446,691
    
    
    $
    (13,566
    )
    
    $
    286,448
    
    
    $
    (27,102
    )
    
    $
    733,139
    
    
    $
    (40,668
    )
 Management does not believe any individual unrealized loss as of June 30,
2004 represents other-than-temporary impairment. The unrealized loss for U.S.
government agencies and mortgage-backed securities relate primarily to
securities issued by FNMA and FHLMC. The unrealized losses for equity
securities relate primarily to callable preferred stock issued by FNMA and
FHLMC with a variable dividend. The unrealized losses reported for Corporate
and other debt securities relate to securities which were rated single A minus
or more by a nationally recognized rating agency. These unrealized losses are
primarily attributable to changes in interest rates. The Company has both the
intent and ability to hold the securities contained in the previous table for a
time necessary to recover its amortized cost. The majority of the above
temporary loss is reflected net of tax in other comprehensive loss which does
not impact regulatory capital. NOTE 9  OFF-BALANCE-SHEET RISK AND CONCENTRATIONS OF CREDIT RISK The Company is a party to financial instruments with off-balance-sheet
risk in the normal course of business to meet financing needs of customers.
Since many commitments to extend credit expire without being used, the amounts
below do not necessarily represent future cash commitments. These financial
instruments include lines of credit, letters of credit, and commitments to
extend credit. These are summarized as follows: Amount of Commitment Expiration Per PeriodWithin
    
    
    
    
    
    
    
    
    
    After1 Year
    
    1-3 Years
    
    4-5 Years
    
    5 Years
    
    Total(In Thousands)Lines of Credit:Commercial real estate
    
    $
    119,376
    
    
    $
    19,694
    
    
    $
    97
    
    
    $
    1,141
    
    
    $
    140,308Consumer real estate
    
    
    17,050
    
    
    
    2,708
    
    
    
    8,231
    
    
    
    26,631
    
    
    
    54,620Consumer
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,433
    
    
    
    3,433Commercial
    
    
    83,729
    
    
    
    17,710
    
    
    
    791
    
    
    
    1,284
    
    
    
    103,514Letters of credit
    
    
    19,325
    
    
    
    1,480
    
    
    
    4,302
    
    
    
    
    
    
    
    25,107Commitments to extend credit
    
    
    99,198
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    99,198Total commercial commitments
    
    $
    338,678
    
    
    $
    41,592
    
    
    $
    13,421
    
    
    $
    32,489
    
    
    $
    426,180
 At June 30, 2004 commitments to extend credit included $25,979,000 of
fixed rate loan commitments. These commitments are due to expire within 30 to
90 days of issuance and have rates ranging primarily from 3.99% to 6.79%.
Substantially all of the unused lines of credit are at adjustable rates of
interest. The credit risk amounts represent the maximum accounting loss that would
be recognized at the reporting date if counterparties failed completely to
perform as contracted and any collateral or security proved to be of no value.
The Company has experienced little difficulty in accessing collateral when
necessary. The amounts of credit risk shown therefore greatly exceed expected
losses. PAGE 12




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NOTE 10  CAPITAL CONTRIBUTION AND REGULATORY MATTERS On March 5, 2003 one of the Companys subsidiary banks, Midwest Bank and
Trust Company (Bank), received a joint letter from the Federal Reserve Bank
of Chicago (Federal Reserve) and the Illinois Office of Banks and Real Estate
(OBRE) regarding additional provisions for loan losses that the Federal
Reserve and OBRE determined were appropriate based on their review of a series
of loans to an individual borrower and certain affiliated companies. The total
relationship approximated $19.6 million. In response to the letter, the Company
obtained an independent valuation of the primary collateral for the largest
portion of the relationship which is two companies in bankruptcy (the
Affiliated Companies). As a result of further communication with the Federal
Reserve and OBRE, additional analysis completed by the Company, and the receipt
of a supplemental letter from the Federal Reserve and OBRE as of April 10,
2003, the Company determined it would provide an additional $14.7 million to
the allowance for loan losses, charge off approximately $5.6 million in loans,
and reverse out $1 million of interest. These changes caused the Company to
restate its September 30, 2002 financial statements. As previously reported by the Company, on March 26, 2003, the Bank
received proceeds from an entity indirectly owned by certain directors and
family members of directors of the Bank of approximately $13.3 million in
connection with the sale of previously classified loans, which consisted of
$12.5 million of the loan principal balance, $750,000 for the letter of credit
and $67,000 of accrued interest and late charges. As a result, the Bank
recognized a $4.0 million after-tax capital contribution as a result of the
sale of these loans to the related parties. As of December 31, 2002, $6.3
million of the $12.5 million outstanding principal amount of these loans was
considered impaired. On April 24, 2003, the Federal Reserve and the OBRE completed the on-site
portion of their regularly scheduled examination of the Companys banking
subsidiaries. The examination included, among other items, a review of the
Companys over-all risk management, lending and credit review practices. The
Company received the examination report, which was dated August 1, 2003, during
the third quarter of 2003. On December 29, 2003, the Company and Midwest Bank and Trust Company
received a proposed written agreement from the Federal Reserve and the OBRE
which detailed recommended corrective actions in the Companys over all risk
management, lending and credit review practices, including the engagement of
third party consultants. This agreement relates to the joint examination which
began on March 3, 2003 and ended on May 23, 2003. Following discussions with
the regulators in late January 2004, the Company and the Bank received on March
11, 2004 a revised written agreement from the Federal Reserve and the OBRE.
The written agreement was filed upon execution by the Company and the Bank on
March 15, 2004. The written agreement outlines a series of steps to address and strengthen
the Companys risk management practices. These steps include third-party
reviews and the submission of written plans in a number of areas. These areas
include the Companys and the Banks boards of directors and management,
corporate governance, internal controls, risk management, lending and credit,
including allowance for loan and lease losses and loan review, and loan
policies and procedures. The agreement does not relate to the financial
condition, capital, earnings or liquidity of the Company or the Bank. Management believes that compliance with the terms will not have a direct
material effect upon the Companys consolidated financial position or results
of operations. No restrictions have been proposed relating to the payment of
dividends. The agreement requires submission of written plans, programs and policies
and procedures to the regulators for review and approval within specified time
frames. PAGE 13




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##### Table of Contents



Failure to satisfy the terms of the agreement could result in further
regulatory actions against the Company, the Bank and their boards of directors
and management. Since the joint examination of March 2003, the Company and the Bank have
taken steps, and continue to take steps, to address the recommendations
proposed by the regulators in their report dated August 1, 2003, which are now
incorporated into the written agreement. On March 29, 2004, the regulators
began their regularly scheduled joint examination of the Company and the Bank,
which was completed in April 2004. A written report was received during the
quarter, and the Board and management noted that progress was noted in many of
the areas addressed in the previous examination. The Securities and Exchange Commission has opened an inquiry in connection
with the Companys restatement of its September 30, 2002 financial statements.
The Company is cooperating fully with the SEC on this matter. PAGE 14




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ITEM 2  MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis is intended as a review of
significant factors affecting the financial condition and results of operations
of the Company for the periods indicated. The discussion should be read in
conjunction with the unaudited Consolidated Financial Statements and the Notes
thereto presented herein. In addition to historical information, the following
Managements Discussion and Analysis of Financial Condition and Results of
Operations contains forward-looking statements that involve risks and
uncertainties. The Companys actual results could differ significantly from
those anticipated in these forward-looking statements as a result of certain
factors discussed in this report. Also, see Note 10  Capital Contribution
and Regulatory Matters to our unaudited consolidated financial statements for
a discussion of certain regulatory matters. Critical Accounting Policies and 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 reported amounts
of assets and liabilities and the disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. By their nature, changes in
these assumptions and estimates could significantly affect the Companys
financial position or results of operations. Actual results could differ from
those estimates. Discussed below are those critical accounting policies that
are of particular significance to the Company. Allowance for Loan Losses:The allowance for loan losses represents
managements estimate of probable credit losses inherent in the loan portfolio.
Estimating the amount of the allowance for loan losses requires significant
judgment and the use of estimates related to the amount and timing of expected
future cash flows on impaired loans, estimated losses on pools of homogeneous
loans based on historical loss experience, and consideration of current
economic trends and conditions, all of which may be susceptible to significant
change. The loan portfolio also represents the largest asset type on the
consolidated balance sheet. Loan losses are charged off against the allowance,
while recoveries of amounts previously charged off are credited to the
allowance. A provision for loan losses is charged to operations based on
managements periodic evaluation of the factors previously mentioned, as well
as other pertinent factors. The allowance for loan losses consists of an allocated component and an
unallocated component. The components of the allowance represent an estimation
pursuant to either Statement of Financial Accounting Standards No. (SFAS) 5,
Accounting for Contingencies, or SFAS 114, Accounting by Creditors for
Impairment of a Loan. The allocated component of the allowance for loan losses
reflects expected losses resulting from analyses developed through specific
credit allocations for individual loans and historical loss experience for each
loan category. The specific credit allocations are based on regular analyses of
all loans over a fixed-dollar amount where the internal credit rating is at or
below a predetermined classification. These analyses involve a high degree of
judgment in estimating the amount of loss associated with specific loans,
including estimating the amount and timing of future cash flows and collateral
values. The Companys historical loss experience is updated quarterly. The
allocated component of the allowance for loan losses also includes
consideration of concentrations and changes in portfolio mix and volume, and
other qualitative factors. PAGE 15




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There are many factors affecting the allowance for loan losses; some are
quantitative while others require qualitative judgment. The process for
determining the allowance (which management believes adequately considers all
of the potential factors which potentially result in credit losses) includes
subjective elements and, therefore, may be susceptible to significant change.
To the extent actual outcomes differ from management estimates, additional
provision for credit losses could be required that could adversely affect
earnings or financial position in future periods. Evaluation of Securities for Impairment:Securities are classified as
held-to-maturity when the Company has the ability and management has the
positive intent to hold those securities to maturity. Accordingly, they are
stated at cost adjusted for amortization of premiums and accretion of
discounts. Securities are classified as available-for-sale when the Company may
decide to sell those securities for changes in market interest rates, liquidity
needs, changes in yields or alternative investments, and for other reasons.
They are carried at fair value with unrealized gains and losses, net of taxes,
reported in other comprehensive income (loss). Interest income is reported net
of amortization of premium and accretion of discount. Realized gains and losses
on disposition of securities available-for-sale are based on the net proceeds
and the adjusted carrying amounts of the securities sold, using the specific
identification method. Declines in the fair value of held-to-maturity and
available-for-sale securities below their cost that are deemed to be other than
temporary are reflected in earnings as realized losses. In estimating other
than temporary losses, management considers (1) the length of time and extent
to which the fair value has been less than cost, (2) the financial condition
and near-term prospects of the issuer, and (3) the intent and ability of the
Company to retain its investment in the issuer for a period of time sufficient
to allow for any anticipated recovery in fair value. The evaluation also
considers the impact that impairment may have on future capital, earnings, and
liquidity. Fair Value of Financial Instruments and Derivatives:Fair values of
financial instruments, including derivatives, are estimated using relevant
market information and other assumptions. Fair value estimates involve
uncertainties and matters of significant judgment regarding interest rates,
credit risk, prepayments, and other factors, especially in the absence of broad
markets for the particular items. There is no ready market for a significant
portion of the Companys financial instruments. Accordingly, fair values are
based on various factors relative to expected loss experience, current economic
conditions, risk characteristics, and other factors. The assumptions and
estimates used in the fair value determination process are subjective in nature
and involve uncertainties and significant judgment. As a consequence, fair
values cannot be determined with precision. Changes in assumptions or in market
conditions could significantly affect these estimates. Results of Operations  Three Months and Six Months
Ended June 30, 2004 and 2003 Set forth below are some highlights of the second quarter 2004 results
compared to the second quarter of 2003.  
    
    Consolidated net income for the second quarter of 2004
was $3.2 million, a 59.1% decrease when compared to $7.8 million
for the second quarter of 2003.  
    
    Basic earnings per share for the three months ended
June 30, 2004 were $0.18 or 59.1% lower than for the comparable
period in 2003.  
    
    Diluted earnings per share for the three months ended
June 30, 2004 were $0.17 or 60.5% lower than for the comparable
period in 2003.  
    
    The return on average assets for the three months ended
June 30, 2004 was 0.56% PAGE 16




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##### Table of Contents



compared to 1.40% for the similar period in 2003.  
    
    The return on average equity for the three months ended
June 30, 2004 was 9.10% compared to 19.63% for the similar period
in 2003.  
    
    Net interest income decreased 11.7% to $13.1 million in
the second quarter of 2004 compared to $14.8 million in the
second quarter of 2003.  
    
    Excluding gains on securities, other income decreased
25.9% to $3.9 million in the second quarter of 2004 compared to
$5.2 million in the second quarter of 2003.  
    
    Other expenses increased 7.1% to $11.4 million in the
second quarter of 2004 compared to $10.7 million in the second
quarter of 2003. Set forth below are some highlights of the six months ended June 30, 2004
results compared to the six months ended June 30, 2003.  
    
    Consolidated net income for the six months ended June
30, 2004 was $8.0 million, a 43.5% decrease when compared to
$14.2 million for the second quarter of 2003.  
    
    Basic earnings per share for the six months ended June
30, 2004 were $0.45 or 43.8% lower than for the comparable period
in 2003.  
    
    Diluted earnings per share for the six months ended
June 30, 2004 were $0.44 or 43.6% lower than for the comparable
period in 2003.  
    
    The return on average assets for the six months ended
June 30, 2004 was 0.71% compared to 1.29% for the similar period
in 2003.  
    
    The return on average equity for the six months ended
June 30, 2004 was 11.30% compared to 18.71% for the similar
period in 2003.  
    
    Net interest income decreased 14.3% to $27.3 million in
the first half of 2004 compared to $31.8 million in the first
half of 2003.  
    
    Excluding gains on securities, other income decreased
46.1% to $5.0 million in the first half of 2004 compared to $9.2
million in the first half of 2003.  
    
    Other expenses increased 4.8% to $22.5 million in the
first six months of 2004 compared to $21.5 million in the first
six months of 2003. Net Interest Income Net interest income is the difference between interest income and fees on
earning assets and interest expense on deposits and borrowings. Net interest
margin represents net interest income on a tax equivalent basis as a percentage
of average earning assets during the period. Net interest margin reflects the
spread between average yields earned on interest earning assets and the average
rates paid on interest bearing deposits and borrowings. Net interest income was $13.1 million and $14.8 million during the three
months ended June 30, 2004 and 2003, respectively, a decrease of $1.7 million,
or 11.7%. During the six months ended June 30, PAGE 17




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2004, net interest income decreased $4.5 million or 14.3% to $27.3 million
compared to $31.8 million for the similar period in 2003. The Companys net
interest margin (tax equivalent net interest income as a percentage of earning
assets) was 2.61% for the three months ended June 30, 2004 compared to 3.03%
for the comparable period in 2003. Due to the timing of
repositioning its earning assets, the margin declined from 2.84% at March 31,
2004. During the period of April 1, 2004 through May 17,
2004, market yields on maturing terms preferred by the Company at
this juncture increased approximately 100 basis points.
Repositioning occurred after that increase. During the six months ended June 30, 2004, the net interest margin was
2.73% compared to 3.24% for the similar period in 2003. Yields on earning assets decreased 10.3% to 4.88% during the second
quarter of 2004 compared to 5.44% for the second quarter of 2003. During the
first six months of 2004, yields on earning assets decreased to 4.98%, or
12.6%, from 5.70% for the similar period in 2003. Average earning assets
decrease by $7.7 million for the three months ended June 30, 2004; however,
they increased $17.8 million for the six months ended June 30, 2004 from the
six months ended June 30, 2003. During the first half of 2004, the Company
held $157.0 million in cash equivalents, which earned, on average, 99 basis
points. During the second quarter of 2004, management elected to invest cash
equivalent holdings after the fixed income markets and the Federal Reserve
adjusted interest rates to levels more consistent with the generally rising
nominal interest rate environment that management expected. Had the market and
central bank adjustments occurred at the beginning of the quarter with cash
equivalents invested at levels consistent with the prior year, earning asset
yields would have been 5.07% and the net interest margin would have been 2.88%
for the quarter ended June 30, 2004. The Company did increase its loans and
securities by reducing its cash equivalents. However, a significant portion of
this activity was completed near quarter-end and the increase in net interest
income is expected to be realized in future quarters. The average loan yield was 6.00% during the second quarter of 2004, a
decrease of 8.0% from 6.52% during the comparable period in 2003. For the six
months ended June 30, 2004, the average loan yield was 6.08%, a decrease of
8.2% from 6.62% during the comparable period in 2003. Average loan balances
decreased $5.8 million, or 0.5%, to $1.1 billion during the second quarter of
2004 compared to the similar period in 2003. During the first six months of
2004, average loan balances decreased $74.3 million, or 6.4%, to $1.1 billion
compared to the similar period of 2003. The Company purchased $30.2 million in
fixed rate mortgages at an average yield of 4.61% in June 2004 to offset loans
paid off during the year. Previously, the Company discussed its more
aggressive loan pricing strategies which have aided the realized growth in
loans and unfunded commitments. These pricing strategies remain in place and
additional high-quality lending opportunities will be pursued. Yields on securities were 4.24% during the second quarter of 2004, a
slight decrease from 4.28% during the comparable period in 2003. During the six
months ended June 30, 2004, securities yields decreased 3.0% to 4.46% from
4.60% in the comparable period in 2003. Consistent with the investment
strategy adopted during 2003, the Company further reduced its holdings in
mortgage-backed securities by $49.7 million during the first and second
quarters of 2004. The decrease in yields on earning assets was partially offset by a
decrease in rates paid on deposits and borrowings. Average rates paid on
deposits decreased 10.7% to 2.00% for the three months ended June 30, 2004 from
2.24% for the comparable period in 2003. For the first six months of 2004,
average rates paid on deposits decreased 12.3% to 2.00% from 2.28% for the
similar period of 2003. Average rates paid on borrowings were 3.60% for the
second quarter of 2004 compared to 3.92% for the second quarter of 2003.
During the six months ended June 30, 2004, average rates paid on borrowings
were 3.66% compared to 3.92% for the similar period in 2003. The Company anticipates a moderate improvement in net interest margin as
the second half of the year progresses. Primary factors include the
redeployment of its short-term securities position, higher loan volumes, and
continued benefit of interest rate swaps related to high interest rate FHLB
advances. Rising interest rates would have a nominal but beneficial impact on
the net interest margin. PAGE 18




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The quarter-to-date net interest margin calculation for June 30, 2004 and
2003 is shown below (interest income and average rate on non-taxable securities
and loans are reflected on a tax equivalent basis, assuming a 35% federal tax
rate for 2004 and 2003 and adjusted for the dividend received deduction where
applicable): June 30, 2004
    
    June 30, 2003Average
    
    
    
    
    
    Average
    
    Average
    
    
    
    
    
    AverageBalance
    
    Interest
    
    Rate
    
    Balance
    
    Interest
    
    RateInterest-Earning AssetsFederal funds sold and
interest-bearing due from banks
    
    $
    183,238
    
    
    $
    469
    
    
    
    1.02
    %
    
    $
    6,257
    
    
    $
    18
    
    
    
    1.15
    %Securities taxable (1)
    
    
    806,546
    
    
    
    8,481
    
    
    
    4.21
    
    
    
    927,584
    
    
    
    9,528
    
    
    
    4.11Securities tax-exempt (1)
    
    
    14,847
    
    
    
    257
    
    
    
    6.92
    
    
    
    72,767
    
    
    
    1,222
    
    
    
    6.72Commercial loans (1) (3) (4)
    
    
    191,339
    
    
    
    2,599
    
    
    
    5.43
    
    
    
    225,593
    
    
    
    3,345
    
    
    
    5.93Commercial real estate loans (1) (3)(4)
    
    
    727,545
    
    
    
    11,210
    
    
    
    6.16
    
    
    
    699,522
    
    
    
    11,614
    
    
    
    6.64Agriculture loans (1) (3) (4)
    
    
    65,511
    
    
    
    969
    
    
    
    5.92
    
    
    
    55,790
    
    
    
    916
    
    
    
    6.57Consumer real estate loans (3) (4)
    
    
    100,898
    
    
    
    1,445
    
    
    
    5.73
    
    
    
    108,332
    
    
    
    1,799
    
    
    
    6.64Consumer installment loans (3) (4)
    
    
    11,382
    
    
    
    211
    
    
    
    7.42
    
    
    
    13,190
    
    
    

    261
    
    
    
    7.92$
    2,101,306
    
    
    $
    25,641
    
    
    
    4.88
    %
    
    $
    2,109,035
    
    
    $
    28,703
    
    
    
    5.44
    %Interest-Bearing LiabilitiesInterest-
bearing demand depositsr
    
    $
    229,128
    
    
    $
    676
    
    
    
    1.18
    %
    
    $
    174,932
    
    
    $
    527
    
    
    
    1.21
    %Money-market demand deposits
and savings deposits
    
    
    332,574
    
    
    
    1,069
    
    
    
    1.29
    
    
    
    328,843
    
    
    
    1,022
    
    
    
    1.24Time deposits less than $100,000
    
    
    772,066
    
    
    
    4,948
    
    
    
    2.56
    
    
    
    716,990
    
    
    
    5,110
    
    
    
    2.85Time deposits greater than $100,000
    
    
    88,078
    
    
    
    471
    
    
    
    2.14
    
    
    
    100,556
    
    
    
    643
    
    
    
    2.56Public funds
    
    
    15,098
    
    
    
    79
    
    
    
    2.09
    
    
    
    55,161
    
    
    
    345
    
    
    
    2.50Federal funds purchased
and repurchase agreements
    
    
    207,201
    
    
    
    1,321
    
    
    
    2.55
    
    
    
    224,830
    
    
    
    1,531
    
    
    
    2.72FHLB advances
    
    
    255,917
    
    
    
    2,491
    
    
    
    3.89
    
    
    
    255,905
    
    
    
    2,875
    
    
    
    4.49Notes payable and other borrowings
    
    
    55,672
    
    
    
    859
    
    
    
    6.17
    
    
    
    40,330
    
    
    
    696
    
    
    
    6.90$
    1,955,734
    
    
    $
    11,914
    
    
    
    2.44
    %
    
    $
    1,897,547
    
    
    $
    12,749
    
    
    
    2.68
    %Net Interest Income (1) (5)
    
    
    
    
    
    $
    13,727
    
    
    
    2.44
    %
    
    
    
    
    
    $
    15,954
    
    
    
    2.76
    %Net Interest Margin (1)
    
    
    
    
    
    
    
    
    
    
    2.61
    %
    
    
    
    
    
    
    
    
    
    
    3.03
    %Net Interest Income (2) (5)
    
    
    
    
    
    $
    13,090
    
    
    
    2.32
    %
    
    
    
    
    
    $
    14,827
    
    
    
    2.56
    %Net Interest Margin (2)
    
    
    
    
    
    
    
    
    
    
    2.49
    %
    
    
    
    
    
    
    
    
    
    
    2.81
    %
  (1)
    
    Adjusted for 35% tax rate in 2004 and 2003 and adjusted for the
dividends-received deduction where applicable.  (2)
    
    Not adjusted for 35% tax rate in 2004 and 2003 or for the
dividends-received deduction.  (3)
    
    Nonaccrual loans are included in the average balance, however these loans
are not earning any interest.  (4)
    
    Includes loan fees; these fees are immaterial.  (5)
    
    The following table reconciles reported net interest income on a tax
equivalent basis for the periods presented: 2Q04
    
    2Q03Net interest income
    
    $
    13,090
    
    
    $
    14,827Tax equivalent adjustment to net interest income
    
    
    637
    
    
    
    1,127Net interest income, tax equivalent basis
    
    $
    13,727
    
    
    $
    15,954
 PAGE 19




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The year-to-date net interest margin calculation for June 30, 2004 and
2003 is shown below (interest income and average rate on non-taxable securities
and loans are reflected on a tax equivalent basis, assuming a 35% federal tax
rate for 2004 and 2003 and adjusted for the dividend received deduction where
applicable): June 30, 2004
    
    June 30, 2003Average
    
    
    
    
    
    Average
    
    Average
    
    
    
    
    
    AverageBalance
    
    Interest
    
    Rate
    
    Balance
    
    Interest
    
    RateInterest-Earning AssetsFederal funds sold and
interest-bearing due from banks
    
    $
    190,107
    
    
    $
    931
    
    
    
    0.98
    %
    
    $
    11,957
    
    
    $
    67
    
    
    
    1.12
    %Securities taxable
    
    
    814,041
    
    
    
    17,924
    
    
    
    4.40
    
    
    
    848,427
    
    
    
    18,694
    
    
    
    4.41Securities tax-exempt (1)
    
    
    21,063
    
    
    
    714
    
    
    
    6.78
    
    
    
    72,658
    
    
    
    2,445
    
    
    
    6.73Commercial loans (1) (3)
    
    
    195,572
    
    
    
    5,300
    
    
    
    5.42
    
    
    
    230,256
    
    
    
    6,951
    
    
    
    6.04Commercial real estate loans (1) (3)(4)
    
    
    717,227
    
    
    
    22,559
    
    
    
    6.29
    
    
    
    712,405
    
    
    
    23,948
    
    
    
    6.72Agriculture loans (1) (3)
    
    
    64,098
    
    
    
    1,917
    
    
    
    5.98
    
    
    
    56,720
    
    
    
    1,819
    
    
    
    6.41Consumer real estate loans (1) (3) (4)
    
    
    98,945
    
    
    
    2,867
    
    
    
    5.80
    
    
    
    148,827
    
    
    
    5,194
    
    
    
    6.98Consumer installment loans (1) (3)
    
    
    11,530
    
    
    
    428
    
    
    
    7.42
    
    
    
    13,486
    
    
    
    540
    
    
    
    8.01$
    2,112,583
    
    
    $
    52,640
    
    
    
    4.98
    %
    
    $
    2,094,736
    
    
    $
    59,658
    
    
    
    5.70
    %Interest-Bearing LiabilitiesInterest-bearing demand deposits
    
    $
    223,588
    
    
    $
    1,315
    
    
    
    1.18
    %
    
    $
    166,461
    
    
    $
    1,008
    
    
    
    1.21
    %Money-market demand deposits
and savings deposits
    
    
    340,331
    
    
    
    2,144
    
    
    
    1.26
    
    
    
    323,278
    
    
    
    2,025
    
    
    
    1.25Time deposits less than $100,000
    
    
    762,269
    
    
    
    9,765
    
    
    
    2.56
    
    
    
    699,714
    
    
    
    10,255
    
    
    
    2.93Time deposits greater than $100,000
    
    
    85,810
    
    
    
    929
    
    
    
    2.17
    
    
    
    121,852
    
    
    
    1,553
    
    
    
    2.55Public funds
    
    
    28,850
    
    
    
    247
    
    
    
    1.71
    
    
    
    64,392
    
    
    
    831
    
    
    
    2.58Federal funds purchased
and repurchase agreements
    
    
    205,448
    
    
    
    2,723
    
    
    
    2.65
    
    
    
    218,858
    
    
    
    2,992
    
    
    
    2.73FHLB advances
    
    
    254,648
    
    
    
    4,985
    
    
    
    3.92
    
    
    
    255,603
    
    
    
    5,722
    
    
    
    4.48Notes payable and other borrowings
    
    
    56,408
    
    
    
    1,732
    
    
    
    6.14
    
    
    
    40,133
    
    
    
    1,379
    
    
    
    6.87$
    1,957,352
    
    
    $
    23,840
    
    
    
    2.44
    %
    
    $
    1,890,291
    
    
    $
    25,765
    
    
    
    2.72
    %Net Interest Income (1) (5)
    
    
    
    
    
    $
    28,800
    
    
    
    2.54
    %
    
    
    
    
    
    $
    33,893
    
    
    
    2.98
    %Net Interest Margin (1)
    
    
    
    
    
    
    
    
    
    
    2.73
    %
    
    
    
    
    
    
    
    
    
    
    3.24
    %Net Interest Income (2) (5)
    
    
    
    
    
    $
    27,257
    
    
    
    2.40
    %
    
    
    
    
    
    $
    31,793
    
    
    
    2.78
    %Net Interest Margin (2)
    
    
    
    
    
    
    
    
    
    
    2.58
    %
    
    
    
    
    
    
    
    
    
    
    3.04
    %
  (1)
    
    Adjusted for 35% tax rate in 2004 and 2003 and adjusted for the
dividends-received deduction where applicable.  (2)
    
    Not adjusted for 35% tax rate in 2004 and 2003 or for the
dividends-received deduction.  (3)
    
    Nonaccrual loans are included in the average balance, however these loans
are not earning any interest.  (4)
    
    Includes loan fees; these fees are immaterial.  (5)
    
    The following table reconciles reported net interest income on a tax
equivalent basis for the periods presented: 2Q04
    
    2Q03Net interest income
    
    $
    27,257
    
    
    $
    31,793Tax equivalent adjustment to net interest income
    
    
    1,543
    
    
    
    2,100Net interest income, tax equivalent basis
    
    $
    28,800
    
    
    $
    33,893
 Other Income Other income, excluding net gains on securities transactions, was $3.9
million for the three months ended June 30, 2004, a decrease of $1.4 million,
or 25.9% over the comparable period in 2003. For the six months ended June 30,
2004, other income, excluding net gains on securities transactions, was $5.0
million, a decrease of $4.2 million, or 46.1%, compared to $9.2 million for the
comparable period in 2003. Other income decreased mainly due to the decrease
in net trading profits and gains on sales of loans for both the three and six
months ended June 30, 2004 compared to 2003. The other income to average
assets ratio was 0.69% for the three months ended June 30, 2004 compared to
0.94% for the same period in 2003. For the six months ended June 30, 2004, the
other income to average assets ratio was 0.44% compared to 0.84% for the same
period in 2003. PAGE 20




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Service charges and fees increased 7.7%, or $110,000, in the second
quarter of 2004 from the second quarter of 2003. Year-to-date, service charges
and fees increased 2.7%, or $79,000, in 2004 compared to the comparable period
in 2003. Service charges and fees include service charges on deposit accounts,
which are expected to increase with future deposit growth within our existing
markets. Net gains on securities transactions were $2.7 million in the second
quarter of 2003 compared to net losses on securities transactions of $750,000
in the second quarter of 2004. Included in the net gains on securities
transactions for the three and six months ended June 30, 2004 were net losses
of $1.1 million and $2.8 million which resulted due to the difference in market
values for the futures contracts and hedged items. See Note 7 to the unaudited
consolidated financial statements. Periodically, the Company has bought or sold various covered put and call
options, with terms approximating 90 days, on mortgage-backed securities, U.S.
Treasury and government agency obligations, and futures contracts. These
covered options have either expired or have been exercised, except for one
outstanding call option at June 30, 2004, and the associated income or expense
was recognized in the corresponding period. Option fee income, included in
net trading profits or losses, decreased $856,000 to $1.1 million during the
second quarter of 2004 compared to $2.0 million in the second quarter of 2003.
Option fee income decrease $129,000 to $2.9 million during the six months ended
June 30, 2004 from $3.0 million during the similar period of 2003. Option fees
are part of managements ongoing strategy to manage risk in the securities
portfolio and take advantage of favorable market conditions. Management has
effectively used the proceeds from selling covered call and put options to
offset net interest margin compression and has administered such sales in a
coordinated process with the Companys overall asset/liability management.
Management is poised to adjust its option strategy when interest rates increase
or decrease. There is no assurance that the option fee income realized through
June 30, 2004 is sustainable in future periods. See Note 7 to the unaudited
consolidated financial statements. Gains on sales of loans decreased $208,000 or 55.2% to $169,000 during the
second quarter of 2004 compared to $377,000 for the similar period in 2003.
Year-to-date, gains on sales of loans decreased $335,000 or 50.4% to $330,000
in 2004 compared to $665,000 for the similar period in 2003. The decrease in
gains is due to a lower level of mortgage refinancing volume as a result of the
increase in rates. The Company places most mortgages originated into the
secondary market. Insurance and brokerage commissions decreased $72,000 from $556,000 in the
second quarter of 2003 to $484,000 for the second quarter of 2004. For the six
months ended June 30, 2004, insurance and brokerage commissions decreased
$45,000 to $969,000 compared to $1.0 million for the first six months of 2003.
Commissions are dependent upon favorable market conditions. During the second
quarter, market conditions were weaker than expected. Trust income decreased by 6.5% or $11,000 to $158,000 for the second
quarter of 2004 compared to $169,000 for the similar period in 2003. For the
six months ended June 30, 2004, trust income increased by $3,000 compared to
the six months ended June 30, 2004. Other Expenses Total other expenses increased 7.1%, or $763,000, to $11.4 million during
the second quarter of 2004 compared to $10.7 million for the comparable period
in 2003. For the six months ended June 30, 2004, total other expenses increased
4.8%, or $1.0 million, to $22.5 million from $21.5 million in the first six
months of 2003. Salary and benefit expenses increased 9.8% or $585,000 to $6.6 million for
the second quarter of 2004 compared to $6.0 million for the similar period in
2003. For the six months ended June 30, 2004, PAGE 21




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salary and benefit expenses increased $1.0 million or 8.4% to $13.1
million from $12.1 million for the comparable period in 2003. The full-time
equivalent number of employees was 447 as of June 30, 2004 compared to 433 as
of June 30, 2003. Increased full-time staff positions, enhanced benefit
programs, and increased health insurance costs have resulted in the increase in
salaries and employee benefits. Occupancy expenses increased $212,000 or 14.5% to $1.7 million during the
second quarter of 2004 compared to $1.5 million for the comparable period in
2003. For the six months ended June 30, 2004, occupancy expenses increased
$143,000 or 4.4% to $3.4 million from $3.2 million in the six months of 2003.
The increase in occupancy expense is a result of the increase in capital
investments and technology. Expenses, other than salary and employee benefits and occupancy, decreased
$34,000 to $3.2 million in the second quarter of 2004 compared to the similar
period in 2003. Other expenses decreased $137,000 to $6.0 million for the six
months ended June 30, 2004 compared to the similar period in 2003. The other expenses to average assets ratio was 2.03% for the three months
ended June 30, 2004 compared to 1.92% for the same period in 2003. For the six
months ended June 30, 2004, the other expenses to average assets ratio was
1.99% compared to 1.96% for the similar period in 2003. The net overhead
expenses to average assets ratio was 1.34% for the three months ended June 30,
2004 compared to 0.98% for the same period in 2003. For the six months ended
June 30, 2004, the net overhead expenses to average assets ratio was 1.55%
compared to 1.12% for the similar period in 2003. The efficiency ratio, which
is the total noninterest expense less amortization of intangibles and other
real estate owned expense as a percentage of net interest income on a fully
taxable equivalent basis plus noninterest income, was 63.19% for the three
months ended June 30, 2004 compared to 49.55% for the same period in 2003 and
66.97% for the three months ended March 31, 2004. The efficiency ratio was
65.00% for the six months ended June 30, 2004 compared to 49.00% for the
similar period in 2003. The efficiency ratio increased significantly as a
result of the decrease in noninterest income and net interest income. Overhead
expenses have also increased in part due to the two branch openings in Glenview
and Addison, Illinois. Income Taxes The Company recorded income tax expense of $843,000, or 20.9% of income,
and $3.5 million, or 31.3% of income, for the quarters ended June 30, 2004 and
2003, respectively. Year-to-date, the provision for income taxes decreased $4.1
million or 63.6%. Income tax expense was 22.5% of income for the six months
ended June 30, 2004 compared to 31.1% of income for the similar period of 2003.
The decrease in the tax rate was due in part to the large increase in U.S.
government agencies securities the Company held during 2004 compared to similar
period in 2003. PAGE 22




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Financial Condition Loans The following table sets forth the composition of the Companys loan
portfolio as of the indicated dates. June 30, 2004
    
    December 31, 2003(In thousands)Loan
    
    
    
    
    
    LoanCategory
    
    
    
    
    
    Categoryto Gross
    
    
    
    
    
    to GrossAmount
    
    Loans
    
    Amount
    
    LoansCommercial
    
    $
    185,967
    
    
    
    16.3
    %
    
    $
    203,920
    
    
    
    18.8
    %Commercial real estate
    
    
    746,687
    
    
    
    65.5
    
    
    
    711,891
    
    
    
    65.8Agricultural
    
    
    63,210
    
    
    
    5.5
    
    
    
    58,144
    
    
    
    5.4Consumer real estate (1)
    
    
    133,302
    
    
    
    11.7
    
    
    
    96,107
    
    
    
    8.9Consumer installment
    
    
    11,780
    
    
    
    1.0
    
    
    
    12,124
    
    
    
    1.1Total loans, gross
    
    
    1,140,946
    
    
    
    100.0
    %
    
    
    1,082,186
    
    
    
    100.0
    %Net deferred fees
    
    
    (727
    )
    
    
    
    
    
    
    (890
    )Total loans
    
    
    1,140,219
    
    
    
    
    
    
    
    1,081,296Allowance for loan losses
    
    
    (16,088
    )
    
    
    
    
    
    
    (15,714
    )Net loans
    
    $
    1,124,131
    
    
    
    
    
    
    $
    1,065,582Loans held for sale:Consumer real estate
    
    $
    1,467
    
    
    
    0.1
    %
    
    $
    1,571
    
    
    
    0.1
    %
  (1)
    
    Includes loans held for sale. Total loans increased $58.9 million, or 5.4%, to $1.1 billion at June 30,
2004 from December 31, 2003. The increase in loans was due to an increase in
commercial real estate loans and mortgage loans purchased during June 2004.
During the first quarter of 2004, management has implemented a more aggressive
loan pricing structure in efforts to increase loan volume. Set forth below are
other highlights of the loan portfolio.  
    
    Commercial loans decreased $18.0 million to $186.0 million as of
June 30, 2004 from $203.9 million as of December 31, 2003, a decrease
of 8.8%.
    
    Commercial real estate loans increased $34.8 million, or 4.9%, from
December 31, 2003 compared to June 30, 2004. The Company has added
lending personnel to assist in the growth in this category on which the
Company maintains a primary focus.
    
    Agricultural loans increased $5.1 million, or 8.7% as of June 30,
2004 compared to December 31, 2003.
    
    Consumer real estate loans increased $37.2 million as of June 30,
2004 compared to December 31, 2003. PAGE 23




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##### Table of Contents




    
    Most consumer residential mortgage loans the Company originates are
sold in the secondary market. At any point in time, loans will be at
various stages of the mortgage banking process. Included as part of
consumer real estate loans are loans held for sale. The carrying value
of these loans approximated their market value at that time. The Company attempts to balance the types of loans in its portfolio with
the objective of reducing risk. Some of the risks the Company attempts to
reduce include:  
    
    The primary risks associated with commercial loans are the quality
of the borrowers management, financial strength and cash flow
resources, and the impact of local economic factors.
    
    Risks associated with real estate loans include concentrations of
loans in a certain loan type, such as commercial or residential, and
fluctuating land and property values.
    
    Consumer loans also have risks associated with concentrations of
loans in a single type of loan, as well as the risk a borrower may
become unemployed as a result of deteriorating economic conditions. Allowance for Loan Losses Allowance for loan losses has been established to provide for those loans
that may not be repaid in their entirety for a variety of reasons. The
allowance is maintained at a level considered by management to be adequate to
provide for probable incurred losses. The allowance is increased by provisions
charged to earnings and is reduced by chargeoffs, net of recoveries. The
provision for loan losses is based upon past loan loss experience and
managements evaluation of the loan portfolio under current economic
conditions. Loans are charged to the allowance for loan losses when, and to
the extent, they are deemed by management to be uncollectible. The allowance
for loan losses is composed of allocations for specific loans and a historical
portion for all other loans. Following is a summary of changes in the allowance for loan losses for the
six months ended June 30: 2004
    
    2003(In thousands)Balance, January 1
    
    $
    15,714
    
    
    $
    20,754Balance from acquisition
    
    
    
    
    
    
    300Adjustment for loan payoff by
related parties (1)
    
    
    
    
    
    
    (6,685
    )Provision charged to operations
    
    
    1,512
    
    
    
    1,745Loans charged off
    
    
    (1,277
    )
    
    
    (4,177
    )Recoveries
    
    
    139
    
    
    
    107Balance, June 30
    
    $
    16,088
    
    
    $
    12,044
 (1) Adjustment made following the March 26, 2003 receipt of $13.3 million
of proceeds relating to the sale of certain loans, of which $12.5 million
was applied to outstanding principal, $750,000 to the letter of credit,
and $67,000 applied to interest income and late charges. See Note 10 to
the unaudited consolidated financial statements. PAGE 24




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The Company recognizes that credit losses will be experienced and the risk
of loss will vary with, among other things, general economic conditions; the
type of loan being made; the creditworthiness of the borrower over the term of
the loan; and, in the case of a collateralized loan, the quality of the
collateral for such loan. The allowance for loan losses represents the
Companys estimate of the amount needed necessary to provide for probable
incurred losses in the portfolio. In making this determination, the Company
analyzes the ultimate collectibility of the loans in its portfolio by
incorporating feedback provided by internal loan staff, an independent loan
review personnel, and information provided by examinations performed by
regulatory agencies. The Company makes an ongoing evaluation as to the adequacy
of the allowance for loan losses. On a quarterly basis, management of the Banks meets to review the adequacy
of the allowance for loan losses. Each loan officer grades these individual
commercial credits. The Companys independent loan review personnel review the
officers grades. In the event that the loan is downgraded during this review,
the loan is included in the allowance analysis at the lower grade. The grading
system is in compliance with the regulatory classifications, and the allowance
is allocated to the loans based on the regulatory grading, except in instances
where there are known differences (e.g. collateral value is nominal). The allowance for loan losses represents managements estimate of probable
credit losses in the loan portfolio. Estimating the amount of the allowance for
loan losses requires significant judgment and the use of estimates related to
the amount and timing of expected future cash flows on impaired loans,
estimated losses on pools of homogeneous loans based on historical loss
experience, and consideration of current economic trends and conditions, all of
which may be susceptible to significant change. The loan portfolio also
represents the largest asset type on the consolidated balance sheet. Loan
losses are charged off against the allowance, while recoveries of amounts
previously charged off are credited to the allowance. A provision for loan
losses is charged to operations based on managements periodic evaluation of
the factors previously mentioned, as well as other pertinent factors. The allowance for loan losses consists of an allocated component and an
unallocated component. The components of the allowance represent an estimation
pursuant to either Statement of Financial Accounting Standards No. (SFAS) 5,
Accounting for Contingencies, or SFAS 114, Accounting by Creditors for
Impairment of a Loan. The allocated component of the allowance for loan losses
reflects expected losses resulting from analyses developed through specific
credit allocations for individual loans and historical loss experience for each
loan category. The specific credit allocations are based on regular analyses of
all loans over a fixed-dollar amount where the internal credit rating is at or
below a predetermined classification. These analyses involve a high degree of
judgment in estimating the amount of loss associated with specific loans,
including estimating the amount and timing of future cash flows and collateral
values. The Companys historical loss experience is updated quarterly. The
allocated component of the allowance for loan losses also includes
consideration of concentrations and changes in portfolio mix and volume, and
other qualitative factors. There are many factors affecting the allowance for loan losses; some are
quantitative while others require qualitative judgment. The process for
determining the allowance (which management believes adequately considers all
of the potential factors which potentially result in credit losses) includes
subjective elements and, therefore, may be susceptible to significant change.
To the extent actual outcomes differ from management estimates, additional
provision for credit losses could be required that could adversely affect
earnings or financial position in future periods. PAGE 25




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The Companys provision for loan losses was $756,000 for the second
quarter of 2004 compared to $755,000 for the similar period in 2003. For the
six months ended June 30, 2004, the provision for loan losses was $1.5 million
compared to $1.7 million for the similar period in 2003. The allowance for loan losses as a percentage of total loans was 1.41% as
of June 30, 2004 and 1.45% at December 31, 2003. Nonaccrual and Nonperforming Loans Nonaccrual loans decreased $3.0 million to $12.7 million at June 30, 2004
from $15.7 million at December 31, 2003. Nonperforming loans include nonaccrual loans and accruing loans which are
90 days or more delinquent. Typically, these loans have adequate collateral
protection or personal guaranties to provide a source of repayment to the Bank.
Nonperforming loans were $12.7 million at June 30, 2004 compared to $15.7
million at December 31, 2003. Since June 30, 2004, the
nonperforming loans have been reduced by $3.0 million or 23.6%. The following table sets forth information on the Companys nonperforming
loans and other nonperforming assets as of the indicated dates. June 30, 2004
    
    December 31, 2003(In thousands)Nonaccrual and impaired loans
not accruing
    
    $
    12,692
    
    
    $
    15,665Impaired and other loans 90 days
past due and accruing
    
    
    37
    
    
    
    18Total nonperforming loans
    
    
    12,729
    
    
    
    15,683Other real estate
    
    
    6,469
    
    
    
    6,942Total nonperforming assets
    
    $
    19,198
    
    
    $
    22,625Total nonperforming loans to
total loans
    
    
    1.12
    %
    
    
    1.45
    %Total nonperforming assets to
total loans and other real estate
    
    
    1.67
    
    
    
    2.08Total nonperforming assets to
total assets
    
    
    0.84
    
    
    
    1.00Allowance to nonperforming loans
    
    
    1.26
    x
    
    
    1.00
    x
 The Company utilizes an internal asset classification system as a means of
reporting problem and potential problem assets. At each scheduled Bank Board
of Directors meeting, a watch list is presented, showing significant loan
relationships listed as Special Mention, Substandard, and Doubtful. An asset
is classified Substandard if it is inadequately protected by the current net
worth and paying capacity of the obligor or the collateral pledged, if any.
Assets classified as Doubtful have all the weaknesses inherent in those
classified Substandard with the added characteristic that the weaknesses
present make collection or liquidation in full, on the basis of currently
existing facts, conditions and values, highly questionable and improbable.
Assets classified as Loss are those considered uncollectible and viewed as
non-bankable assets and have been charged off. Assets that do not currently
expose the Company to sufficient risk to warrant classification in one of the
aforementioned categories, but possess weaknesses that may or may not be within
the control of the customer, are deemed to be Special Mention. PAGE 26




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The Companys determination as to the classification of its assets and the
amount of its valuation allowances is subject to review by the Banks primary
regulators in the course of their regulatory examinations, which can order the
establishment of additional general or specific loss allowances. There can be
no assurance that regulators, in reviewing the Companys loan portfolio, will
not request the Company to materially increase its allowance for loan losses.
Although management believes that adequate specific and general loan loss
allowances have been established, actual losses are dependent upon future
events and, as a consequence, further additions to the level of specific and
general loan loss allowances may become necessary. Other real estate owned was $6.5 million at June 30, 2004, a decrease of
$473,000 compared to $6.9 million at December 31, 2003. Included in other real
estate owned is one property totaling $6.2 million. The fair market value of
this property was determined by a recent appraisal of the real property. This
property is a townhouse development for which the borrower ceased construction
activities on the project and a construction manager has been appointed. The
Company will continue the development and has engaged a well established
construction contractor to complete the development in the next two years.
There are 101 townhouse units to be built, and the Company expects full
retirement of its outstanding other real estate owned amount. Potential problem loans are loans included on the watch list presented to
the Board of Directors that do not meet the definition of a nonperforming loan,
but where known information about possible credit problems of borrowers causes
management to have serious doubts as to the ability of such borrowers to comply
with present loan repayment terms. At June 30, 2004, Special Mention,
Substandard, and Doubtful classifications were $25.3 million, $46.5 million,
and $2.5 million, respectively, compared to $12.7 million, $48.6 million, and
$2.7 million, respectively, at December 31, 2003. Total classifications
include those loans that have been adversely classified by bank examiners and
the Companys internal loan review department. Since June 30, 2004, classified
loans have been reduced by $8.9 million or 11.9% . The Companys allowance for loan
losses is considered by management to be adequate at June 30, 2004. Securities The Company manages, via a centralized portfolio management department,
its securities portfolio to provide a source of both liquidity and earnings.
Each Bank has its own asset/liability committee, which develops current
investment policies based upon its operating needs and market circumstances.
The investment policy of each Bank is reviewed by senior financial management
of the Company in terms of its objectives, investment guidelines and
consistency with overall Company performance and risk management goals. Each
Banks investment policy is formally reviewed and approved annually by its
board of directors. The asset/liability committee of each Bank is responsible
for reporting and monitoring compliance with the investment policy. Reports are
provided to each Banks board of directors and the Board of Directors of the
Company on a regular basis. The following tables set forth the composition of the Companys securities
portfolio by major category as of June 30, 2004. June 30, 2004Held-to-Maturity
    
    Available-for-Sale
    
    TotalAmortized
    
    Fair
    
    Amortized
    
    
    
    
    
    Amortized
    
    
    
    
    
    % ofCost
    
    Value
    
    Cost
    
    Fair Value
    
    Cost
    
    Fair Value
    
    Portfolio(Dollars in thousands)U.S. Treasury and obligations of
U.S. government agencies
    
    $
    
    
    
    $
    
    
    
    $
    526,930
    
    
    $
    498,520
    
    
    $
    526,930
    
    
    $
    498,520
    
    
    
    62.33
    %Obligations of states and
political subdivisions
    
    
    11,633
    
    
    
    12,032
    
    
    
    3,115
    
    
    
    3,209
    
    
    
    14,748
    
    
    
    15,241
    
    
    
    1.74Mortgage-backed securities
    
    
    93,776
    
    
    
    92,368
    
    
    
    74,951
    
    
    
    73,275
    
    
    
    168,727
    
    
    
    165,643
    
    
    
    19.96Equity securities
    
    
    
    
    
    
    
    
    
    
    114,396
    
    
    
    107,068
    
    
    
    114,396
    
    
    
    107,068
    
    
    
    13.53Other bonds
    
    
    
    
    
    
    
    
    
    
    20,564
    
    
    
    19,128
    
    
    
    20,564
    
    
    
    19,128
    
    
    
    2.43Total
    
    $
    105,409
    
    
    $
    104,400
    
    
    $
    739,956
    
    
    $
    701,200
    
    
    $
    845,365
    
    
    $
    805,600
    
    
    
    100.00
    %
 PAGE 27




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Securities available-for-sale are carried at fair value, with related
unrealized net gains or losses, net of deferred income taxes, recorded as an
adjustment to equity capital. At June 30, 2004, unrealized losses, net of
taxes on securities available-for-sale, were $23.2 million compared to $15.8
million at December 31, 2003. The increase in net unrealized losses on
securities available-for-sale resulted in a $7.3 million decrease in book
equity. The Company has entered into futures contracts as a means to reduce
market risk and partially offset further declines in book equity attributable
to increases in interest rates. In 2004, the Company entered into 3,000 U.S.
Treasury 10 year note futures contracts with a notional value of $300.0 million
and a delivery date of September 2004. The Company sold these contracts in
order to hedge a group of U.S. Agency notes held in its available-for-sale
portfolio. The Companys objective was to offset changes in the market value
of the U.S. Agency notes with changes in the fair market value of the future
contracts, thereby reducing interest rate risk. The hedging relationship is
assessed to be highly effective, that is, there is a high correlation between
the hedge instrument and hedged items. See Note 7 to the unaudited
consolidated financial statements. During
the first half of 2004, the Company held $157.0 million on
average in cash
equivalents, which earned 99 basis points. Consistent with the
investment strategy adopted during 2003, the Company further reduced its
holdings in mortgage-backed securities by $49.7 million during the first and
second quarters of 2004. Securities available-for-sale decreased to $701.2 million at June 30, 2004
from $796.1 million at December 31, 2003. Set forth below is a summary of the
change in the available-for-sale securities:  
    
    U.S. government agency mortgage-backed securities decreased 57.8%,
or $100.2 million, from $173.5 million at December 31, 2003 to $73.3
million at June 30, 2004.
    
    Equity securities decreased $47.7 million from $154.8 million at
December 31, 2003 to $107.1 million at June 30, 2004. Equity securities
included capital securities of United States Agencies and the Federal
Home Loan Bank as well as Federal Reserve Bank stock at June 30, 2004.
    
    Obligations of state and political subdivisions decreased $34.0
million to $3.2 million at June 30, 2004 from $37.2 million at December
31, 2003.
    
    Other bonds decreased $74.9 million to $19.1 million at June 30,
2004 compared to $94.1 million at December 31, 2003. Other bonds
include high grade corporate bonds primarily issued by financial
institutions.
    
    U.S. government agency notes increased $161.9 million to $498.5
million at June 30, 2004 compared to $336.6 million at December 31,
2003. Securities held-to-maturity increased $49.3 million, or 88.0%, from $56.1
million at December 31, 2003 to $105.4 million at June 30, 2004. There were no trading account securities held at June 30, 2004 or December
31, 2003. The Company holds trading account securities and derivatives on a
short-term basis based on market and liquidity conditions. Other Assets The Companys investment in bank-owned life insurance (BOLI) increased
by $727,000 due to PAGE 28




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##### Table of Contents



the increase in the cash surrender value of the insurance. The BOLI is
intended to provide funding for future employee benefit expense. Deposits and Borrowed Funds Total deposits of $1.6 billion at June 30, 2004 represented an increase of
$20.2 million, or 1.3%, from December 31, 2003. Non-interest-bearing deposits
were $162.9 million at June 30, 2004, approximately $2.2 million higher than
the level at December 31, 2003. Over the same period, interest-bearing
deposits increased 1.3%, or $18.0 million to $1.4 billion at June 30, 2004
compared to December 31, 2003. Core deposits, excluding certificates of deposits under $100,000,
increased $18.4 million to $726.5 million at June 30, 2004 compared to December
31, 2003. Certificates of deposit under $100,000 increased $37.0 million from
December 31, 2003 to $776.3 million at June 30, 2004. Certificates of deposit
over $100,000 and public funds certificates of deposit decreased $35.2 million from December 31, 2003
to $103.8 million at June 30, 2004. The majority of the decrease was a result
of maturities of retail certificates of deposit and public funds certificates of deposit, which were not
core deposits and were allowed to run-off. The Companys marketing efforts
focused on core and time deposit account growth in its retail markets, reducing
the need to rely on public funds and brokered certificates of deposit. The Companys membership in the Federal Home Loan Bank System gives it the
ability to borrow funds from the Federal Home Loan Bank of Chicago for short-
or long-term purposes under a variety of programs. The advances were used to
fund growth and permit the Companys bank subsidiaries to extend term
maturities, reduce funding costs and manage interest rate risk exposures more
effectively. Federal Home Loan Bank advances were $250.0 million at June 30, 2004 and
$253.5 million at December 31, 2003. The Company has converted $137.5 million
of its FHLB advances from fixed rate debt to floating rate through interest
rate swap transactions in 2003. These swap transactions resulted in a $764,000
and $1.5 million decrease in interest expense for the three and six months
ended June 30, 2004, respectively. The weighted average rate for FHLB advances
was 3.92% at June 30, 2004, with a range of maturities on such advances between
one and ten years. Borrowed funds at June 30, 2004 and December 31, 2003 are listed below: 2004
    
    2003(in thousands)Securities sold under agreements to repurchase
    
    $
    199,386
    
    
    $
    202,699Federal Home Loan Bank advances to bank subsidiaries
    
    
    250,031
    
    
    
    253,461Junior subordinated debt owed to unconsolidated trusts
    
    
    55,672
    
    
    
    54,000Revolving line of credit
    
    
    
    
    
    
    2,000Total
    
    $
    505,089
    
    
    $
    512,160
 The Company entered into a new credit agreement on April 8, 2004 with a
correspondent bank, which provides the Company with a revolving line of credit
with a maximum availability of $25.0 million. The Company has not yet drawn on
this line of credit. This revolving line of credit matures on April 7, 2005. The Company also utilizes securities sold under repurchase agreements as a
source of funds. Most local municipalities and some other organizations must
have funds insured or collateralized as a PAGE 29




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##### Table of Contents



matter of their own policies. Repurchase agreements provide a source of funds
and do not increase the Companys reserve requirement. Although the balance of
repurchase agreements is subject to variation, particularly seasonal variation,
the account relationships represented by these balances are principally local
and have been maintained for relatively long periods of time. The Company had
$199.4 million in securities sold under repurchase agreements at June 30, 2004
compared to $202.7 at December 31, 2003. The Company had no federal funds
purchased at June 30, 2004 and December 31, 2003. The vast majority of the
repurchase agreements are with primary dealers and have maturities of two to
three years. Capital Resources Stockholders equity decreased $3.1 million or 2.2% to $140.0 million at
June 30, 2004 from $143.1 million at December 31, 2003 as a result of the
increase in the unrealized loss on available-for-sale securities net of tax.
Total capital to average risk based capital decreased to 14.0% on June 30, 2004
from 14.7% on December 31, 2003. The Company and its two subsidiary banks are subject to regulatory capital
requirements administered by federal banking agencies. Capital adequacy
guidelines and prompt corrective action regulations involve quantitative
measures of assets, liabilities, and certain off-balance-sheet items calculated
under regulatory accounting practices. Capital amounts and classifications are
also subject to qualitative judgments by regulators about components, risk
weightings and other factors, and the regulators can lower classifications in
certain areas. Failure to meet various capital requirements can initiate
regulatory action that could have a direct material effect on the financial
statements. The prompt corrective action regulations provide five classifications,
including well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized, and critically undercapitalized, although these
terms are not used to represent overall financial condition. If adequately
capitalized, regulatory approval is required to accept brokered deposits. If
undercapitalized, capital distributions are limited, as is asset growth and
expansion, and plans for capital restoration are required. Each of the Banks were categorized as well capitalized as of June 30,
2004. Management is not aware of any conditions or events since the most
recent regulatory notification that would change the Companys or the Banks
categories. Capital levels and minimum required levels (dollars in thousands): At June 30, 2004Minimum Required
    
    Minimum RequiredActual
    
    for Capital Adequacy
    
    to be Well CapitalizedAmount
    
    Ratio
    
    Amount
    
    Ratio
    
    Amount
    
    Ratio(In thousands)Total
capital to risk-weighted assetsCompany
    
    $
    219,085
    
    
    
    14.0
    %
    
    $
    124,982
    
    
    
    8.0
    %
    
    
    n/a
    
    
    
    n/aMidwest Bank and Trust Company
    
    
    185,486
    
    
    
    13.5
    
    
    
    109,814
    
    
    
    8.0
    
    
    
    137,268
    
    
    
    10.0
    %Midwest Bank of Western Illinois
    
    
    23,144
    
    
    
    12.2
    
    
    
    15,139
    
    
    
    8.0
    
    
    
    18,923
    
    
    
    10.0Tier I capital to risk-weighted assetsCompany
    
    
    200,926
    
    
    
    12.9
    
    
    
    62,491
    
    
    
    4.0
    
    
    
    n/a
    
    
    
    n/aMidwest Bank and Trust Company
    
    
    170,753
    
    
    
    12.4
    
    
    
    54,907
    
    
    
    4.0
    
    
    
    82,361
    
    
    
    6.0Midwest Bank of Western Illinois
    
    
    21,790
    
    
    
    11.5
    
    
    
    7,569
    
    
    
    4.0
    
    
    
    11,354
    
    
    
    6.0Tier I capital to average assetsCompany
    
    
    200,926
    
    
    
    8.9
    
    
    
    90,731
    
    
    
    4.0
    
    
    
    n/a
    
    
    
    n/aMidwest Bank and Trust Company
    
    
    170,753
    
    
    
    8.7
    
    
    
    78,262
    
    
    
    4.0
    
    
    
    97,828
    
    
    
    5.0Midwest Bank of Western Illinois
    
    
    21,790
    
    
    
    7.3
    
    
    
    11,930
    
    
    
    4.0
    
    
    
    14,913
    
    
    
    5.0
 PAGE 30




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At December 31, 2003Minimum Required
    
    Minimum RequiredActual
    
    for Capital Adequacy
    
    to be Well CapitalizedAmount
    
    Ratio
    
    Amount
    
    Ratio
    
    Amount
    
    Ratio(In thousands)Total capital to risk-weighted assetsCompany
    
    $
    216,819
    
    
    
    14.7
    %
    
    $
    117,647
    
    
    
    8.0
    %
    
    
    n/a
    
    
    
    n/aMidwest Bank and Trust Company
    
    
    180,973
    
    
    
    14.0
    
    
    
    103,635
    
    
    
    8.0
    
    
    $
    129,544
    
    
    
    10.0
    %Midwest Bank of Western Illinois
    
    
    23,129
    
    
    
    13.2
    
    
    
    14,065
    
    
    
    8.0
    
    
    
    17,581
    
    
    
    10.0Tier I capital to risk-weighted assetsCompany
    
    
    201,105
    
    
    
    13.7
    
    
    
    58,823
    
    
    
    4.0
    
    
    
    n/a
    
    
    
    n/aMidwest Bank and Trust Company
    
    
    166,514
    
    
    
    12.9
    
    
    
    51,818
    
    
    
    4.0
    
    
    
    77,726
    
    
    
    6.0Midwest Bank of Western Illinois
    
    
    21,874
    
    
    
    12.4
    
    
    
    7,033
    
    
    
    4.0
    
    
    
    10,549
    
    
    
    6.0Tier I capital to average assetsCompany
    
    
    201,105
    
    
    
    8.9
    
    
    
    89,967
    
    
    
    4.0
    
    
    
    n/a
    
    
    
    n/aMidwest Bank and Trust Company
    
    
    166,514
    
    
    
    8.5
    
    
    
    78,071
    
    
    
    4.0
    
    
    
    97,589
    
    
    
    5.0Midwest Bank of Western Illinois
    
    
    21,874
    
    
    
    7.7
    
    
    
    11,391
    
    
    
    4.0
    
    
    
    14,239
    
    
    
    5.0
 The trust preferred securities issued by MBHI Capital Trust I, II, III,
and IV are currently included in the Tier 1 capital of the Company for
regulatory capital purposes. The Federal Reserve Board may in the future
disallow inclusion of the trust preferred securities in Tier 1 capital for
regulatory capital purposes. See Note 6 to the unaudited consolidated
financial statements. As of June 30, 2004, assuming the Company was not
permitted to include the $54.0 million in trust preferred securities issued by
MBHI Capital Trust I, II, III, and IV in its Tier 1 capital, the Company would
still exceed the regulatory required minimums for capital adequacy purposes. If
the trust preferred securities were no longer permitted to be included in Tier
1 capital, the Company would also be permitted to redeem the capital securities
without penalty. Liquidity Liquidity measures the ability of the Company to meet maturing obligations
and its existing commitments, to withstand fluctuations in deposit levels, to
fund its operations and to provide for customers credit needs. The liquidity
of the Company principally depends on cash flows from operating activities,
investment in and maturity of assets, changes in balances of deposits and
borrowings and its ability to borrow funds in the money or capital markets. Net cash inflows provided by operations were $13.8 million for the six
months ended June 30, 2004 compared to $28.4 million a year earlier. Net cash
outflows from investing activities were $135.5 million in the first six months
of 2004 compared to a net cash outflow of $39.8 million a year earlier. Cash
inflows from financing activities for the six months ended June 30, 2004 were
$10.9 million compared to a net inflow of $45.9 million in 2003. In the event of short-term liquidity needs, the Banks may purchase federal
funds from correspondent banks. In addition, the Company has established
repurchase agreements and brokered certificates of deposit arrangements with
various financial sources. The Companys membership in the Federal Home Loan
Bank System gives it the ability to borrow funds from the Federal Home Loan
Bank of Chicago for short- or long-term purposes under a variety of programs.
The Company also has a $25.0 million revolving line of credit of which is
available. Interest received net of interest paid was a principal source of operating
cash inflows for the three and six months ended June 30, 2004 and June 30,
2003, respectively. Management of investing and financing activities and
market conditions determine the level and the stability of net interest cash
flows. PAGE 31




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##### Table of Contents



Managements policy is to mitigate the impact of changes in market interest
rates to the extent possible so that balance sheet growth is the principal
determinant of growth in net interest cash flows. PAGE 32




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ITEM 3  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Interest Rate Sensitivity Analysis The Companys overall interest rate sensitivity is demonstrated by net
interest income analysis. Net interest income analysis measures the change in
net interest income in the event of hypothetical changes in interest rates.
This analysis assesses the risk of change in net interest income in the event
of sudden and sustained 1.0% to 2.0% increases and 1.0% decrease in market
interest rates. The table below presents the Companys projected changes in net
interest income for the various rate shock levels at June 30, 2004. Change in Net Interest Income Over One Year HorizonAt June 30, 2004
    
    At December 31, 2003Change inLevels of
    
    Dollar
    
    Percentage
    
    Dollar
    
    PercentageInterest Rates
    
    Change
    
    Change
    
    Change
    
    Change+200 bp
    
    $
    (2,573
    )
    
    
    -4.20
    %
    
    $
    (329
    )
    
    
    -0.50
    %+100 bp
    
    
    (1,721
    )
    
    
    -2.81
    
    
    
    (1,008
    )
    
    
    -1.53Base
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    -100 bp
    
    
    2,634
    
    
    
    4.30
    
    
    
    9
    
    
    
    0.01
 As shown above, at June 30, 2004, the effect of an immediate 100 basis
point decrease in interest rates would increase the Companys net interest
income by 4.30% or $2.6 million. The effect of an immediate 200 basis point
increase in rates would decrease the Companys net interest income by 4.20% or
$2.6 million. Changes in the mix of earning assets and interest-bearing liabilities
increased the Companys liability sensitivity during the past twelve months. Computations of the prospective effects of hypothetical interest rate
changes are based on numerous assumptions, including relative levels of market
interest rates, loan prepayments, and deposit decay rates, and should not be
relied upon as indicative of actual results. Actual values may differ from
those projections set forth above, should market conditions vary from
assumptions used in preparing the analyses. Further, the computations do not
contemplate any actions the Company may undertake in response to changes in
interest rates. PAGE 33




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##### Table of Contents



ITEM 4  CONTROLS AND PROCEDURES As of the end of the period covered by this report, an evaluation was
performed under the supervision and with the participation of the Companys
Chief Executive Officer and Chief Financial Officer of the effectiveness of the
Companys disclosure controls and procedures (as defined in Securities Exchange
Act Rule 240.13a-15(e)). Based on that evaluation, the Chief Executive Officer
and the Chief Financial Officer have concluded that the Companys current
disclosure controls and procedures are effective to ensure that information
required to be disclosed by the Company in the reports that it files or submits
under the Securities Exchange Act of 1934 is recorded, processed, summarized
and reported, within the time periods specified in the Securities and Exchange
Commissions rules and forms. There were no changes in the Companys internal control over financial
reporting that occurred during the period covered by this report that have
materially affected, or are reasonably likely to materially affect, the
Companys internal control over financial reporting. PAGE 34




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SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES
LITIGATION REFORM ACT OF 1995 This report contains certain forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933, as amended, and Section 21E of
the Securities Exchange Act of 1934, as amended: Statement under the Safe
Harbor Provisions of the Private Securities Litigation Reform Act of 1995. The
Company and its representatives may, from time to time, make written or oral
statements that are forward-looking and provide information other than
historical information, including statements contained in the Form 10-K, the
Companys other filings with the Securities and Exchange Commission or in
communications to its stockholders. These statements involve known and unknown
risks, uncertainties and other factors that may cause actual results to be
materially different from any results, levels of activity, performance or
achievements expressed or implied by any forward-looking statement. These
factors include, among other things, the factors listed below. In some cases, the Company has identified forward-looking statements by
such words or phrases as will likely result, is confident that, expects,
should, could, may, will continue to, believes, anticipates,
predicts, forecasts, estimates, projects, potential, intends, or
similar expressions identifying forward-looking statements within the meaning
of the Private Securities Litigation Reform Act of 1995, including the negative
of those words and phrases. These forward-looking statements are based on
managements current views and assumptions regarding future events, future
business conditions, and the outlook for the Company based on currently
available information. These forward-looking statements are subject to certain
risks and uncertainties that could cause actual results to differ materially
from those expressed in, or implied by, these statements. The Company wishes to
caution readers not to place undue reliance on any such forward-looking
statements, which speak only as of the date made. In connection with the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995, the Company is hereby identifying important
factors that could affect the Companys financial performance and could cause
the Companys actual results for future periods to differ materially from any
opinions or statements expressed with respect to future periods in any
forward-looking statements. Among the factors that could have an impact on the Companys ability to
achieve operating results, growth plan goals, and the beliefs expressed or
implied in forward-looking statements are:  
    
    Managements ability to reduce and effectively manage interest rate
risk and the impact of interest rates in general on the volatility of
the Companys net interest income;
    
    Fluctuations in the value of the Companys investment securities;
    
    The ability to attract and retain senior management experienced in
banking and financial services;
    
    The sufficiency of allowances for loan losses to absorb the amount of
actual losses inherent in the existing portfolio of loans;
    
    The Companys ability to adapt successfully to technological changes
to compete effectively in the marketplace;
    
    Credit risks and risks from concentrations (by geographic area and by
industry) within the Banks loan portfolio;
    
    The effects of competition from other commercial banks, thrifts,
mortgage banking firms, consumer finance companies, credit unions,
securities brokerage firms, insurance companies, PAGE 35




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##### Table of Contents



money market and other mutual funds, and other financial institutions
operating in the Companys market or elsewhere or providing similar
services;
    
    The failure of assumptions underlying the establishment of allowances
for loan losses and estimation of values of collateral and various
financial assets and liabilities;
    
    Volatility of rate sensitive deposits;
    
    Operational risks, including data processing system failures or fraud;
    
    Asset/liability matching risks and liquidity risks;
    
    Changes in the economic environment, competition, or other factors
that may influence the anticipated growth rate of loans and deposits,
the quality of the loan portfolio and loan and deposit pricing, and the
Companys ability to successfully pursue acquisition and expansion
strategies and integrate any acquired companies;
    
    The impact from liabilities arising from legal or administrative
proceedings on the financial condition of the Company;
    
    Possible administrative or enforcement actions of banking regulators
in connection with any material failure of the Banks to comply with
banking laws, rules or regulations, including the failure of Midwest
Bank and Trust Company to comply with the written agreement it entered
into with the Federal Reserve and the OBRE;
    
    Governmental monetary and fiscal policies, as well as legislative and
regulatory changes, that may result in the imposition of costs and
constraints on the Company through higher FDIC insurance premiums,
significant fluctuations in market interest rates, increases in capital
requirements, and operational limitations;
    
    Changes in general economic or industry conditions, nationally or in
the communities in which the Company conducts business;
    
    Changes in accounting principles, policies, or guidelines affecting
the businesses conducted by the Company;
    
    Possible administrative or enforcement actions of the Securities and
Exchange Commission in connection with the Companys restatement of its
September 30, 2002 financial statements;
    
    Acts of war or terrorism; and
    
    Other economic, competitive, governmental, regulatory, and technical
factors affecting the Companys operations, products, services, and
prices. The Company wishes to caution that the foregoing list of important factors
may not be all-inclusive and specifically declines to undertake any obligation
to publicly revise any forward-looking statements that have been made to
reflect events or circumstances after the date of such statements or to reflect
the occurrence of anticipated or unanticipated events. With respect to forward-looking statements set forth in the notes to
consolidated financial statements, including those relating to contingent
liabilities and legal proceedings, some of the factors that could affect the
ultimate disposition of those contingencies are changes in applicable laws, the
development of facts in individual cases, settlement opportunities, and the
actions of plaintiffs, judges, and juries. PAGE 36




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##### Table of Contents



PART II 
 Item 1. Legal Proceedings There are no material pending legal proceedings to which the Company or
its subsidiaries are a party other than ordinary routine litigation
incidental to their respective businesses. 
 Item 2. Changes in Securities, Use of Proceeds, and Issuer Purchases of Equity
Securities Issuer Purchases of Equity Securities Maximum NumberTotal Number
    
    of Sharesof Shares Purchased
    
    that May Yet BeTotal Number
    
    Average
    
    as Part of Publicly
    
    Purchased Underof Shares
    
    Price Paid
    
    Announced Plans
    
    the PlansPeriod
    
    Purchased
    
    per Share
    
    or Programs
    
    or Programs1/1/04 - 1/31/04
    
    
    
    
    
    
    N/A
    
    
    
    
    
    
    
    73,0002/1/04 - 2/29/04
    
    
    
    
    
    
    N/A
    
    
    
    
    
    
    
    73,0003/1/04 - 3/31/04
    
    
    
    
    
    
    N/A
    
    
    
    
    
    
    
    73,0004/1/04 - 4/30/04
    
    
    
    
    
    
    N/A
    
    
    
    
    
    
    
    73,0005/1/04 - 5/31/04
    
    
    
    
    
    
    N/A
    
    
    
    
    
    
    
    73,0006/1/04 - 6/30/04
    
    
    
    
    
    
    N/A
    
    
    
    
    
    
    
    73,000Total
    
    
    
    
    
    
    N/A
    
    
    
    
    
    
    
    73,000
 
 Item 3. Defaults Upon Senior Securities None 
 Item 4. Submission of Matters to a Vote of Security Holders The annual meeting of stockholders of the Company was held on May 5,
2004. Three proposals were submitted to a vote of the stockholders as
described in the Companys proxy statement dated April 5, 2004. The
following is a brief description of the matters voted upon, as well as
the outcome of the vote:  1.
    
    To elect three members to serve on the Companys Board of
Directors for a term of three years: The nominees were Messrs. E.V.
Silveri, Daniel Nagle, and LeRoy Rosasco.To elect E.V. Silveri for a three year term: Votes For:
    
    
    14,843,366Abstain:
    
    
    163,536
  To elect Daniel Nagle for a three year term: Votes For:
    
    
    14,454,294Abstain:
    
    
    552,608
  To elect LeRoy Rosasco for a three year term: Votes For:
    
    
    14,851,637Abstain:
    
    
    155,265
 PAGE 37




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##### Table of Contents



Item 5. Other Information None 
 Item 6. Exhibits and Reports on Form 8-K  (a)
    
    Exhibits The following exhibits are either filed as part of this report or are
incorporated herein by reference: 3.1
    
    Restated Certificate of Incorporation, as amended
(incorporated by reference to Registrants Registration Statement on
Form S-1, Registration No. 333-42827).3.2
    
    Restated By-laws, as amended (incorporated by reference to
Registrants Quarterly Report on Form 10-Q for the quarter ended
June 30, 1998, File No. 0-29652).3.3
    
    Amendment of Restated By-laws (incorporated by reference to
Registrants Quarterly Report on Form 10-Q for the quarter ended
June 30, 2000, File No. 0-29598).3.4
    
    Certificate of Amendment of Restated By-laws (incorporated by
reference to Registrants Form 10-Q for the quarter ended September
30, 2002, File No. 001-13735).3.11
    
    Certificate of Amendment of Restated Certificate of
Incorporation (incorporated by reference to Registrants Form 10-Q
for the quarter ended June 30, 2002, File No. 001-13735).4.1
    
    Specimen Common Stock Certificate (incorporated by reference
to Registrants Registration Statement on Form S-1, Registration No.
333-42827).4.2
    
    Certain instruments defining the rights of the holders of
long-term debt of the Company and certain of its subsidiaries, none
of which authorize a total amount of indebtedness in excess of 10%
of the total assets of the Company and its subsidiaries on a
consolidated basis, have not been filed as Exhibits. The Company
hereby agrees to furnish a copy of any of these agreements to the
SEC upon request.31.1
    
    Certification of Chief Executive Officer31.2
    
    Certification of Chief Financial Officer32.1
    
    Certification of Chief Executive Officer and Chief Financial
Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
  (b)
    
    Reports on Form 8-K  Current Report on Form 8-K dated April 30, 2004, filed with the
SEC on April 30, 2004. PAGE 38




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##### Table of Contents



SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. Date: August 9, 2004 MIDWEST BANC HOLDINGS, INC.(Registrant)By: /s/ Brad A. LueckeBrad A. Luecke,President andChief Executive OfficerBy: /s/ Daniel R. KadolphDaniel R. Kadolph,Senior Vice Presidentand Chief Financial Officer
 PAGE 39




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##### Table of Contents



EXHIBITS 3.1
    
    Restated Certificate of Incorporation, as amended
(incorporated by reference to Registrants Registration Statement on
Form S-1, Registration No. 333-42827).3.2
    
    Restated By-laws, as amended (incorporated by reference to
Registrants Quarterly Report on Form 10-Q for the quarter ended
June 30, 1998, File No. 0-29652).3.3
    
    Amendment of Restated By-laws (incorporated by reference to
Registrants Quarterly Report on Form 10-Q for the quarter ended
June 30, 2000, File No. 0-29598).3.4
    
    Certificate of Amendment of Restated By-laws (incorporated by
reference to Registrants Form 10-Q for the quarter ended September
30, 2002, File No. 001-13735).3.11
    
    Certificate of Amendment of Restated Certificate of
Incorporation (incorporated by reference to Registrants Form 10-Q
for the quarter ended June 30, 2002, File No. 001-13735).4.3
    
    Specimen Common Stock Certificate (incorporated by reference
to Registrants Registration Statement on Form S-1, Registration No.
333-42827).4.4
    
    Certain instruments defining the rights of the holders of
long-term debt of the Company and certain of its subsidiaries, none
of which authorize a total amount of indebtedness in excess of 10%
of the total assets of the Company and its subsidiaries on a
consolidated basis, have not been filed as Exhibits. The Company
hereby agrees to furnish a copy of any of these agreements to the
SEC upon request.31.1
    
    Certification of Chief Executive Officer31.2
    
    Certification of Chief Financial Officer32.1
    
    Certification of Chief Executive Officer and Chief Financial
Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.