##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 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 o Indicate by checkmark whether the Registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes x No o 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 May 7, 2004Common, par value $.01
    
    17,869,929




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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
    
    
    32Item 4. Controls and Procedures
    
    
    33PART 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
    
    
    37Item 6. Exhibits and Reports on Form 8-K
    
    
    37Form 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) March 31,
    
    December 31,2004
    
    2003ASSETSCash and cash equivalents
    
    $
    248,440
    
    
    $
    196,157Securities available-for-sale
    
    
    589,194
    
    
    
    796,140Securities held-to-maturity (fair value: $101,642 at
March 31, 2004 and $57,239 at December 31, 2003)
    
    
    100,638
    
    
    
    56,074Loans
    
    
    1,075,530
    
    
    
    1,081,296Allowance for loan losses
    
    
    (15,879
    )
    
    
    (15,714
    )Net loans
    
    
    1,059,651
    
    
    
    1,065,582Cash value of life insurance
    
    
    25,369
    
    
    
    24,906Premises and equipment, net
    
    
    27,118
    
    
    
    27,376Other real estate

    
    
    6,976
    
    
    
    6,942Core deposit and other intangibles
    
    
    2,538
    
    
    
    2,790Goodwill
    
    
    4,360
    
    
    
    4,360Due from broker
    
    
    143,258
    
    
    
    40,477Other assets
    
    
    47,611
    
    
    
    43,345Total assets
    
    $
    2,255,153
    
    
    $
    2,264,149LIABILITIES AND STOCKHOLDERS EQUITYLiabilitiesDepositsNon-interest-bearing
    
    $
    155,087
    
    
    $
    160,668Interest-bearing
    
    
    1,418,833
    
    
    
    1,425,743Total deposits
    
    
    1,573,920
    
    
    
    1,586,411Securities sold under agreements to repurchase
    
    
    203,144
    
    
    
    202,699Advances from the Federal Home Loan Bank
    
    
    256,095
    
    
    
    253,461Junior subordinated debt owed to unconsolidated trusts
    
    
    55,672
    
    
    
    54,000Note payable
    
    
    
    
    
    
    2,000Other liabilities
    
    
    23,279
    
    
    
    22,497Total liabilities
    
    
    2,112,110
    
    
    
    2,121,068Stockholders EquityPreferred stock
    
    
    
    
    
    
    Common stock
    
    
    187
    
    
    
    187Surplus
    
    
    64,380
    
    
    
    64,330Retained earnings
    
    
    104,722
    
    
    
    102,041Accumulated other comprehensive loss
    
    
    (18,672
    )
    
    
    (15,824
    )Treasury stock, at cost, (798,774 shares at March 31,
2004 and 806,934 shares at December 31, 2003)
    
    
    (7,574
    )
    
    
    (7,653
    )Total stockholders equity
    
    
    143,043
    
    
    
    143,081Total liabilities and stockholders equity
    
    $
    2,255,153
    
    
    $
    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 March 31, 2004 and 2003
(In thousands, except per share data) 2004
    
    2003Interest IncomeLoans
    
    $
    16,518
    
    
    $
    20,400SecuritiesTaxable
    
    
    8,816
    
    
    
    8,738Exempt from federal income taxes
    
    
    297
    
    
    
    795Federal funds sold and other short term investments
    
    
    462
    
    
    
    49Total interest income
    
    
    26,093
    
    
    
    29,982Interest ExpenseDeposits
    
    
    7,157
    
    
    
    8,025Federal funds purchased
    
    
    2
    
    
    
    46Securities sold under agreements to repurchase
    
    
    1,400
    
    
    
    1,415Advances from the Federal Home Loan Bank
    
    
    2,494
    
    
    
    2,847Junior subordinated debt owed to unconsolidated trusts
    
    
    853
    
    
    
    647Note payable
    
    
    20
    
    
    
    36Total interest expense
    
    
    11,926
    
    
    
    13,016Net interest income
    
    
    14,167
    
    
    
    16,966Provision for loan losses
    
    
    756
    
    
    
    990Net interest income after provision for loan losses
    
    
    13,411
    
    
    
    15,976Other IncomeService charges on deposits
    
    
    1,436
    
    
    
    1,467Net gains on securities transactions
    
    
    2,866
    
    
    
    102Net trading profits (losses)
    
    
    (1,832
    )
    
    
    1,153Gains on sales of loans
    
    
    161
    
    
    
    288Insurance and brokerage commissions
    
    
    485
    
    
    
    458Trust
    
    
    149
    
    
    
    135Increase in cash surrender value of life insurance
    
    
    463
    
    
    
    257Other
    
    
    215
    
    
    
    358Total other income
    
    
    3,943
    
    
    
    4,062Other ExpensesSalaries and employee benefits
    
    
    6,481
    
    
    
    6,052Occupancy and equipment
    
    
    1,692
    
    
    
    1,761Professional services
    
    
    881
    
    
    
    1,188Other
    
    
    1,987
    
    
    
    1,782Total other expenses
    
    
    11,041
    
    
    
    10,783Income before income taxes
    
    
    6,313
    
    
    
    9,255Provision for income taxes
    
    
    1,488
    
    
    
    2,861Net Income
    
    $
    4,825
    
    
    $
    6,394Basic earnings per share
    
    $
    0.27
    
    
    $
    0.36Diluted earnings per share
    
    $
    0.26
    
    
    $
    0.35Cash dividends 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 STOCKHOLDERS EQUITY (Unaudited)
Three months ended March 31, 2004 and 2003
(In thousands, except share and per share data) AccumulatedOther
    
    
    
    
    
    TotalCommon
    
    
    
    
    
    Retained
    
    Comprehensive
    
    Treasury
    
    StockholdersStock
    
    Surplus
    
    Earnings
    
    Income (Loss)
    
    Stock
    
    EquityBalance, January 1, 2003
    
    $
    171
    
    
    $
    29,366
    
    
    $
    87,105
    
    
    $
    7,145
    
    
    $
    (8,836
    )
    
    $
    114,951Cash dividends declared ($0.10 per
share)
    
    
    
    
    
    
    
    
    
    
    (1,780
    )
    
    
    
    
    
    
    
    
    
    
    (1,780
    )Issuance of 1,599,088 shares of
common stock upon acquisition
of Big Foot Financial, Corp.
    
    
    16
    
    
    
    30,065
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    30,081Issuance of common stock upon
exercise of 45,000 stock options, net
of tax benefit
    
    
    
    
    
    
    301
    
    
    
    
    
    
    
    
    
    
    
    557
    
    
    
    858Capital contribution from loan payoff
by related parties
    
    
    
    
    
    
    4,033
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,033Comprehensive incomeNet income
    
    
    
    
    
    
    
    
    
    
    6,394
    
    
    
    
    
    
    
    
    
    
    
    6,394Net increase in fair value of
securities classified as available-
for-sale, net of income taxes and
reclassification adjustments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    424
    
    
    
    
    
    
    
    424Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,818Balance, March 31, 2003
    
    $
    187
    
    
    $
    63,765
    
    
    $
    91,719
    
    
    $
    7,569
    
    
    $
    (8,279
    )
    
    $
    154,961Balance, January 1, 2004
    
    $
    187
    
    
    $
    64,330
    
    
    $
    102,041
    
    
    $
    (15,824
    )
    
    $
    (7,653
    )
    
    $
    143,081Cash dividends declared ($0.12 per
share)
    
    
    
    
    
    
    
    
    
    
    (2,144
    )
    
    
    
    
    
    
    
    
    
    
    (2,144
    )Issuance of common stock upon
exercise of 8,160 stock options, net
of tax benefit
    
    
    
    
    
    
    50
    
    
    
    
    
    
    
    
    
    
    
    79
    
    
    
    129Comprehensive incomeNet income
    
    
    
    
    
    
    
    
    
    
    4,825
    
    
    
    
    
    
    
    
    
    
    
    4,825Net decrease in fair value of
securities classified as available-
for-sale, net of income taxes and
reclassification adjustments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,848
    )
    
    
    
    
    
    
    (2,848
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,977Balance, March 31, 2004
    
    $
    187
    
    
    $
    64,380
    
    
    $
    104,722
    
    
    $
    (18,672
    )
    
    $
    (7,574
    )
    
    $
    143,043
 See accompanying notes to unaudited consolidated financial statements. PAGE 3




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MIDWEST BANC HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Three Months Ended March 31, 2004 and 2003
(In thousands) 2004
    
    2003Cash flows from operating activitiesNet income
    
    $
    4,825
    
    
    $
    6,394Adjustments to reconcile net income to net cash provided by
operating activitiesDepreciation
    
    
    649
    
    
    
    499Provision for loan losses
    
    
    756
    
    
    
    990Amortization of other intangibles
    
    
    41
    
    
    
    20Amortization of premiums and discounts on securities, net
    
    
    1,000
    
    
    
    2,396Net gain on sale of securities
    
    
    (2,866
    )
    
    
    (102
    )Net gain on sales of mortgage loans
    
    
    (161
    )
    
    
    (4,006
    )Federal Home Loan Bank stock dividend
    
    
    (288
    )
    
    
    (395
    )Net change in real estate loans originated held for sale
    
    
    (821
    )
    
    
    426Increase in cash surrender value of life insurance
    
    
    (463
    )
    
    
    (257
    )Deferred income taxes
    
    
    (122
    )
    
    
    (1,307
    )Loss on other real estate
    
    
    51
    
    
    
    Change in other assets
    
    
    1,565
    
    
    
    4,307Change in other liabilities
    
    
    1,104
    
    
    
    (2,532
    )Net cash from operating activities
    
    
    5,270
    
    
    
    6,433Cash flows from investing activitiesSales and maturities of securities available-for-sale
    
    
    270,583
    
    
    
    37,589Principal payments on securities
    
    
    24,997
    
    
    
    74,715Purchase of securities available-for-sale
    
    
    (173,070
    )
    
    
    (304,052
    )Purchase of securities held-to-maturity
    
    
    (51,453
    )
    
    
    (4,437
    )Maturities of securities held-to-maturity
    
    
    880
    
    
    
    18,108Futures contracts
    
    
    (14,141
    )
    
    
    Net decrease in loans
    
    
    6,072
    
    
    
    14,913Proceeds 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
    
    
    
    
    
    
    (84
    )Property and equipment expenditures, net
    
    
    (752
    )
    
    
    (298
    )Net cash from investing activities
    
    
    63,116
    
    
    
    789Cash flows from financing activitiesNet increase (decrease) in deposits
    
    
    (12,491
    )
    
    
    8,670Borrowings
    
    
    
    
    
    
    3,000Repayment of borrowings
    
    
    (2,000
    )
    
    
    Dividends paid
    
    
    (2,143
    )
    
    
    (1,616
    )Change in securities sold under agreements to repurchase
and federal funds purchased
    
    
    445
    
    
    
    7,811Repurchase of common stock
    
    
    
    
    
    
    Proceeds from exercise of stock options
    
    
    86
    
    
    
    537Net cash from (used in) financing activities
    
    
    (16,103
    )
    
    
    18,402Increase in cash and cash equivalents
    
    
    52,283
    
    
    
    25,624Cash and cash equivalents at beginning of period
    
    
    196,157
    
    
    
    49,687Cash and cash equivalents at end of period
    
    $
    248,440
    
    
    $
    75,311
 See accompanying notes to unaudited consolidated financial statements. PAGE 4




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##### Table of Contents



MIDWEST BANC HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Continued) 2004
    
    2003Supplemental disclosuresCash paid for:Interest
    
    $
    11,872
    
    
    $
    12,537Income Taxes
    
    
    1,331
    
    
    
    Supplemental schedule of noncash investing activitiesAmount due from broker for sale of securities
    
    $
    143,258
    
    
    $
    Real estate acquired in settlement of loans
    
    
    85
    
    
    
    AcquisitionsNoncash 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 5




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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 three months ended March 31,
2004 are not necessarily indicative of the results expected for the full year
ending December 31, 2004. NOTE 2  BUSINESS COMBINATIONS 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 6




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Intangible asset disclosures are as follows (in thousands): March 31, 2004
    
    December 31, 2003Gross Carrying
    
    Accumulated
    
    Gross Carrying
    
    AccumulatedAmount
    
    Amortization
    
    Amount
    
    AmortizationAmortized intangible assets:Core deposit and other intangibles
    
    $
    3,130
    
    
    $
    (592
    )
    
    $
    3,341
    
    
    $
    (551
    )Aggregate intangible amortization
expense:For the three months ending March
31, 2004
    
    $
    41Estimated 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 three months ended March 31, 2004 and
the year ended December 31, 2003 (in thousands): March 31, 2004Core Depositand OtherGoodwill
    
    IntangiblesBalance at beginning of period
    
    $
    4,360
    
    
    $
    2,790Amortization expense
    
    
    
    
    
    
    (41
    )Intangibles acquired
    
    
    
    
    
    
    (211
    )Balance at end of period
    
    $
    4,360
    
    
    $
    2,538
 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
 PAGE 7




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NOTE 4  EARNINGS PER SHARE For purposes of per share calculations, the Company had 17,869,366 shares
of common stock outstanding at March 31, 2004, and 17,798,118 shares of common
stock outstanding at March 31, 2003. Basic earnings per share for the three
months ended March 31, 2004 and 2003 were computed by dividing net income by
the weighted average number of shares outstanding during the period. Diluted
earnings per share for the three months ended March 31, 2004 and 2003 were
computed by dividing net income by the weighted average number of shares
outstanding during the period, adjusted for the dilutive effect of the
outstanding stock options. Computations for basic and diluted earnings per
share are provided below. For the three monthsended March 31,2004
    
    2003(in thousands, except per share data)BasicNet income
    
    $
    4,825
    
    
    $
    6,394Weighted average common shares
outstanding
    
    
    17,865
    
    
    
    17,727Basic earnings per common share
    
    $
    0.27
    
    
    $
    0.36DilutedNet income
    
    $
    4,825
    
    
    $
    6,394Weighted average common shares
outstanding
    
    
    17,865
    
    
    
    17,727Diluted effect of stock options
    
    
    483
    
    
    
    461Dilutive average common shares
    
    
    18,348
    
    
    
    18,188Diluted earnings per common share
    
    $
    0.26
    
    
    $
    0.35
 All outstanding options were included in the computation of diluted
earnings per share for the three months ended March 31, 2004 and 2003. NOTE 5  STOCK OPTIONS AND COMPENSATION During the first quarter of 2004, 8,160 options were exercised. The total
stock options outstanding were 1,066,885 at March 31, 2004 with exercise prices
ranging between $5.42 and $18.34 and expiration dates between 2006 and 2013.
No stock options were granted in the three months ended March 31, 2004. 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. PAGE 8




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##### Table of Contents



2004
    
    2003Net income as reported
    
    $
    4,825
    
    
    $
    6,394Deduct: stock-based compensation expense
determined under fair value based method, net of tax
    
    
    89
    
    
    
    75Pro forma net income
    
    $
    4,736
    
    
    $
    6,319BASIC EARNINGS PER SHARE AS REPORTED
    
    $
    0.27
    
    
    $
    0.36Pro forma basic earnings per share
    
    
    0.27
    
    
    
    0.36DILUTED EARNINGS PER SHARE AS REPORTED
    
    $
    0.26
    
    
    $
    0.35Pro forma diluted earnings per share
    
    
    0.26
    
    
    
    0.35
 NOTE 6  TRUST PREFERRED SECURITIES 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. 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
 FIN No. 46, Consolidation of Variable Interest Entities, an Interpretation
of Accounting Research Bulletin No. 51 (Revised December 2003). 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 de-consolidated 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 trusts previously formed. There was
no impact on stockholders equity or net income. 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. In July 2003, the Federal Reserve Board issued a
supervisory letter instructing bank holding companies to continue to include
the trust preferred securities in their Tier 1 capital for regulatory capital
purposes until notice is given to the contrary. The Federal Reserve Board
intends to review the regulatory implications of the change in accounting
treatment of subsidiary trusts that issue trust preferred securities and, if
necessary or warranted, provide further appropriate guidance. There can be no
assurance that the Federal Reserve Board will continue to permit institutions
to include trust preferred securities in Tier I capital for regulatory capital
purposes. As of March 31, 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. The interpretations of FIN 46 and its application to various transaction
types and structures are continually evolving. Management continuously monitors
emerging issues related to FIN 46, some of which could potentially impact the
Companys financial statements. PAGE 9




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NOTE 7  DERIVATIVE INSTRUMENTS As of March 31, 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 March 31 are as follows: (Dollars in thousands)
    
    2004
    
    2003Notional amounts
    
    $
    137,500
    
    
    $
    67,500Weighted average fixed rates received
    
    
    5.46
    %
    
    
    5.91
    %Weighted average variable rates paid
    
    
    3.26
    
    
    
    3.74Weighted average maturity
    
    6.36 years
    
    7.00 yearsFair value
    
    $
    968
    
    
    $
    1,296
 PAGE 10




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The Company has also bought and sold various put and call options with
terms less than 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 March 31 are as follows: (Dollars
in thousands)
    
    2004
    
    2003Notional amounts
    
    $
    
    
    
    $
    120,000Weighted average maturity
    
    
    
    
    
    66 daysFair value
    
    $
    
    
    
    $
    2,019
 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 June
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 months ending March 31,
2004, the change in the market values resulted in a net loss of $1.7
million. 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: March 31, 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
    
    $
    351,225
    
    
    $
    (24,773
    )
    
    $
    
    
    
    $
    
    
    
    $
    351,225
    
    
    $
    (24,773
    )Mortgage-backed securities
    
    
    100,834
    
    
    
    (766
    )
    
    
    1,103
    
    
    
    (22
    )
    
    
    101,937
    
    
    
    (788
    )Equity securities
    
    
    37,309
    
    
    
    (6,649
    )
    
    
    20,911
    
    
    
    (67
    )
    
    
    58,220
    
    
    
    (6,716
    )Corporate and other debt securities
    
    
    20,310
    
    
    
    (296
    )
    
    
    
    
    
    
    
    
    
    
    20,310
    
    
    
    (296
    )Total temporarily impaired securities
    
    $
    509,678
    
    
    $
    (32,484
    )
    
    $
    22,014
    
    
    $
    (89
    )
    
    $
    531,692
    
    
    $
    (32,573
    )
 Management does not believe any individual unrealized loss as of March 31,
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, and due to the high quality of
the securities, the Company may also realize its amortized cost through the use
of options or interest rate derivatives in conjunction with these securities.
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(Dollars in Thousands)Lines of Credit:Commercial real estate
    
    $
    109,342
    
    
    $
    28,927
    
    
    $
    16
    
    
    $
    757
    
    
    $
    139,042Consumer real estate
    
    
    12,463
    
    
    
    2,961
    
    
    
    8,928
    
    
    
    20,881
    
    
    
    45,233Consumer
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,449
    
    
    
    3,449Commercial
    
    
    84,109
    
    
    
    16,742
    
    
    
    855
    
    
    
    1,234
    
    
    
    102,940Letters of credit
    
    
    20,638
    
    
    
    1,507
    
    
    
    4,272
    
    
    
    
    
    
    
    26,417Commitments to extend credit
    
    
    118,005
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    118,005Total commercial commitments
    
    $
    344,557
    
    
    $
    50,137
    
    
    $
    14,071
    
    
    $
    26,321
    
    
    $
    435,086
 At March 31, 2004, commitments to extend credit
included $21,720,000 of fixed rate loan commitments. These
commitments are due to expire within 30 to 90 days of issuance and have rates
ranging primarily from 4.00% to 6.85%. Substantially all of the unused lines of
credit are at adjustable rates of interest. PAGE 12




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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. 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 (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. 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 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 a
revised written agreement from the Federal Reserve and the OBRE on March 11,
2004. The regulators have requested the Company and the Bank take action on the
proposed written agreement by March 15, 2004. 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 PAGE 13




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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. 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. The Securities and Exchange Commission has opened an inquiry in connection with the Companys
September 30, 2002 restatement. 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. There are many factors affecting the allowance for loan losses; some are
quantitative while PAGE 15




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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 Ended
March 31, 2004 and 2003 Set forth below are some highlights of the first quarter 2004 results
compared to the first quarter of 2003.  
    
    Consolidated net income for the first quarter of 2004
was $4.8 million, a 24.5% decrease when compared to $6.4 million for
the first quarter of 2003.
    
    Basic earnings per share for the three
months ended March 31, 2004 were $0.27 or 25.0%, lower than for the comparable period in
2003.
    
    Diluted earning per share for the three months ended March 31, 2004 were $0.26 or 25.7% lower than for the comparable period in 2003.
    
    The return on average assets for the three months ended
March 31, 2004 was 0.85% compared to 1.19% for the similar period
in 2003. PAGE 16




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
    
    The return on average equity for the three months ended
March 31, 2004 was 13.45% compared to 17.70% for the similar
period in 2003.
    
    Net interest income decreased 16.5% to $14.2 million in
the first quarter of 2004 compared to $17.0 million in the first
quarter of 2003.
    
    Excluding gains on securities, other income decreased
72.8% to $1.1 million in the first quarter of 2004 compared to
$4.0 million in the first quarter of 2003.
    
    Other expenses increased 2.4% to $11.0 million in the
first quarter of 2004 compared to $10.8 million in the first
quarter 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 $14.2 million and $17.0 million during the three
months ended March 31, 2004 and 2003, respectively, a decrease of 16.5%. Net
interest income decreased because the decrease in the yields on earning assets
was greater than the decrease in average rates paid on deposits and borrowings.
Evidence of this is the reduction in the Companys net interest margin
(tax equivalent net interest income as a percentage of earning assets) to 2.84%
for the three months ended March 31, 2004 compared to 3.45% for the comparable
period in 2003. Yields on earning assets decreased 14.8% to 5.08% during the
first quarter of 2004 compared to 5.96% for the first quarter of 2003. Average
earning assets, however, increased $46.0 million for the three months ended
March 31, 2004 compared to the first quarter of 2003. The average loan yield was 6.16% during the first quarter of 2004, a
decrease of 8.3% from 6.72% during the comparable period in 2003. Average loan
balances decreased $141.7 million, or 11.6%, to $1.1 billion during the first
quarter of 2004 from $1.2 billion during the first quarter of 2003. In
February 2003, $141.9 million of mortgage loans were sold following the closing
of the BFFC acquisition. The sale of these loans completed a step to reduce the
Companys interest rate risk. The Company established a new loan program
which has attracted considerable attention. The more competitive pricing
structure of this program has resulted in a significant increase in the
Companys loan pipeline. Since March 31, 2004, the Companys loan pipeline has
grown with $44.1 million of additional loan commitments. This increase in loan commitments along with expanded loan origination activity may result
in higher average loan yields during the remainder of 2004.


The programs capacity will be expanded, and the Company expects to realize loan
growth ranging from 7% to 11% for the balance of 2004. Yields on securities were 4.68% during the first quarter of 2004, a
decrease of 5.6% from 4.96% during the comparable period in 2003. Average
securities balances increased $8.5 million while interest income on securities
decreased by $490,000. During the first quarter of 2004, the Company held $197.0 million in cash
equivalents, which earned, on average, 94 basis points. Consistent with the
investment strategy adopted during 2003, the Company further reduced its
holdings in mortgage-backed securities by $45.6 million PAGE 17




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during the first quarter of 2004. As yields remained at historic lows during
the quarter, the Company liquidated another $195.9 million of securities to
record gains at current market levels and planned on reinvesting in shorter
duration securities and higher yielding loans. The anticipated increase in
interest rates did not occur by quarter-end, and the Company decided to invest
cautiously under current market conditions to protect its longer-term
profitability and reduce any adverse impact of any mark-to-market adjustments
on its capital base in the future. The decrease in yields on earning assets was offset by a decrease of 11.6%
in average rates paid on deposits and borrowings. Average rates on deposits
decreased 13.8% to 2.00% for the three months ended March 31, 2004 from 2.32%
for the comparable period in 2003. Average rates on borrowings were 3.72% for
the first quarter of 2004 compared to 3.96% in the comparable period in 2003. The net interest margin calculation for the three months ended March 31,
2004 and 2003 is shown below (net interest income and average rate on
non-taxable securities and loans are reflected on a tax equivalent basis,
assuming a 35% tax rate for 2004 and 2003 and adjusted for the dividends
received deduction where applicable): 2004
    
    2003Average
    
    
    
    
    
    Average
    
    Average
    
    
    
    
    
    AverageBalance
    
    Interest
    
    Rate
    
    Balance
    
    Interest
    
    Rate(dollars in thousands)Interest-Earning AssetsFederal funds sold and interest-bearing
due from banks
    
    $
    196,977
    
    
    $
    462
    
    
    
    0.94
    %
    
    $
    17,833
    
    
    $
    49
    
    
    
    1.10
    %Securities taxable (1)
    
    
    785,766
    
    
    
    9,069
    
    
    
    4.62
    
    
    
    767,720
    
    
    
    9,166
    
    
    
    4.78Securities tax-exempt (1)
    
    
    63,048
    
    
    
    830
    
    
    
    5.27
    
    
    
    72,548
    
    
    
    1,223
    
    
    
    6.74Commercial loans (1) (3) (4)
    
    
    199,805
    
    
    
    2,701
    
    
    
    5.41
    
    
    
    235,157
    
    
    
    3,606
    
    
    
    6.13Commercial real estate loans (1) (3) (4)
    
    
    706,909
    
    
    
    11,350
    
    
    
    6.42
    
    
    
    725,461
    
    
    
    12,334
    
    
    
    6.80Agricultural loans (1) (3) (4)
    
    
    62,684
    
    
    
    947
    
    
    
    6.04
    
    
    
    57,661
    
    
    
    903
    
    
    
    6.26Consumer real estate loans (3) (4)
    
    
    96,991
    
    
    
    1,422
    
    
    
    5.86
    
    
    
    187,709
    
    
    
    3,395
    
    
    
    7.23Consumer installment loans (3) (4)
    
    
    11,678
    
    
    
    217
    
    
    
    7.43
    
    
    
    13,785
    
    
    
    279
    
    
    
    8.10Total interest-earning assets
    
    $
    2,123,858
    
    
    $
    26,998
    
    
    
    5.08
    %
    
    $
    2,077,874
    
    
    $
    30,955
    
    
    
    5.96
    %Interest-Bearing LiabilitiesInterest-bearing demand deposits
    
    $
    218,048
    
    
    $
    639
    
    
    
    1.17
    %
    
    $
    157,896
    
    
    $
    481
    
    
    
    1.22
    %Money-market demand deposits
and savings deposits
    
    
    348,088
    
    
    
    1,075
    
    
    
    1.24
    
    
    
    317,652
    
    
    
    1,003
    
    
    
    1.26Time deposits less than $100,000
    
    
    752,471
    
    
    
    4,818
    
    
    
    2.56
    
    
    
    682,247
    
    
    
    5,144
    
    
    
    3.02Time deposits greater than $100,000
    
    
    83,544
    
    
    
    458
    
    
    
    2.19
    
    
    
    143,384
    
    
    
    911
    
    
    
    2.54Public funds
    
    
    42,601
    
    
    
    167
    
    
    
    1.57
    
    
    
    73,726
    
    
    
    486
    
    
    
    2.64Federal funds purchased
and repurchase agreements
    
    
    203,697
    
    
    
    1,402
    
    
    
    2.75
    
    
    
    212,820
    
    
    
    1,461
    
    
    
    2.75FHLB advances
    
    
    253,378
    
    
    
    2,494
    
    
    
    3.94
    
    
    
    251,767
    
    
    
    2,847
    
    
    
    4.50Notes payable and other borrowings
    
    
    57,144
    
    
    
    873
    
    
    
    6.11
    
    
    
    39,933
    
    
    
    683
    
    
    
    6.84Total interest-bearing liabilities
    
    $
    1,957,300
    
    
    $
    11,926
    
    
    
    2.44
    %
    
    $
    1,879,425
    
    
    $
    13,016
    
    
    
    2.76
    %Net Interest Income(1)
    
    
    
    
    
    $
    15,072
    
    
    
    2.64
    %
    
    
    
    
    
    $
    17,939
    
    
    
    3.20
    %Net Interest Margin(1)
    
    
    
    
    
    
    
    
    
    
    2.84
    %
    
    
    
    
    
    
    
    
    
    
    3.45
    %Net Interest Income(2)
    
    
    
    
    
    $
    14,167
    
    
    
    
    
    
    
    
    
    
    $
    16,966Net Interest Margin(2)
    
    
    
    
    
    
    
    
    
    
    2.67
    %
    
    
    
    
    
    
    
    
    
    
    3.27
    %
   PAGE 18




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##### Table of Contents



(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: 1Q04
    
    1Q03Net interest income
    
    $
    14,167
    
    
    $
    16,966Tax equivalent adjustment to net interest income
    
    
    905
    
    
    
    973Net interest income, tax equivalent basis
    
    $
    15,072
    
    
    $
    17,939
 PAGE 19




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Other Income Other income, excluding net gains on securities transactions, was $1.1
million for the three months ended March 31, 2004, a decrease of $2.9 million,
or 72.8%, over the comparable period in 2003. The other income, excluding net
gains on securities transactions, to average assets ratio was 0.19% for the
three months ended March 31, 2004 compared to 0.73% for the same period in
2003. The increase in other income was due to the increases in insurance and
investment brokerage commissions and the increase in cash surrender value of
life insurance. Service charges and fees decreased 2.1%, or $31,000, to $1.4 million in
the first quarter of 2004 from $1.5 million in the first quarter of 2003.
Service charges and fees include service charges on deposit accounts, which are
expected to increase with future deposit growth within our existing markets. Insurance and investment brokerage commissions increased 5.9%, or $27,000,
from $458,000 for the first quarter of 2003 to $485,000 for the first quarter
of 2004. This increase is due to the increased investment brokerage activities
through Midwest Financial and Investment Services, Inc., the Companys
subsidiary, which provides securities brokerage services to both bank and
non-bank customers. The Company anticipates that investment brokerage
commissions will increase in the future through this subsidiary. Gains on sales of loans decreased 49.0% to $147,000 during the first
quarter of 2004 from $288,000 for the comparable period in 2003 due to a lower level of mortgage refinancing volume. The Company
places most mortgages originated into the secondary market. Trust income increased 10.4%, or $14,000, to $149,000 for the first
quarter of 2004 compared to $135,000 for the comparable period in 2003. Sales of securities available-for-sale resulted in net gains of $2.9
million in the first quarter of 2004 compared to $102,000 for the comparable
period in 2003. Included in the net gains on available-for-sale securities
transactions was a net loss of $1.7 million as a result of the difference in
market values for the futures contracts and hedged items. See Note 7 to the
notes to the unaudited consolidated financial statements. Periodically, the Company has bought or sold various covered put and call
options, with terms less than 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, and the associated
income or expense has been recognized in the corresponding period. Option fee
income, included in net trading profits or losses, increased $728,000 to $1.7 million during
the first quarter of 2004 compared to $997,000 in the first quarter 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 March 31, 2004 is sustainable in future periods. The Company
had no covered put or call options outstanding at March 31, 2004. See Note 7
to the notes to the unaudited consolidated financial statements. Also included in net trading profits or losses was a $3.6 million loss during the first
quarter of 2004. This PAGE 20




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loss resulted from a futures position used as a strategy designed to benefit
the Company for relatively constant or rising interest rates. The objectives
of this strategy were not realized. The sharp decline in long-term U.S.
Treasury yields during March 2004 unfavorably impacted the position resulting
in the above-mentioned loss. Other Expenses Total other expenses increased 2.4%, or $258,000, to $11.0 million during
the first quarter of 2004 compared to $10.8 million for the comparable period
in 2003. The other expenses to average assets ratio was 1.95% for the three
months ended March 31, 2004 compared to 2.00% for the same period in 2003. The
efficiency ratio was 66.97% for the three months ended March 31, 2004 compared
to 48.38% for the same period in 2003. The efficiency ratio is equal to other
expense less amortization and other real estate expense divided by the sum of
net interest income on a fully tax-equivalent basis plus other income excluding
security gains. The increase in the efficiency ratio was due primarily to the
decrease in net interest income on a fully tax-equivalent basis and in other
income during the quarter. Salary and benefit expenses increased 7.1%, or $429,000, to $6.5 million
for the first quarter of 2004 compared to $6.1 million for the comparable
period in 2003. The number of full-time equivalent employees was 442 at March
31, 2004 compared to 429 as of March 31, 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 decreased $69,000, or 3.9%, to $1.7 million during the
first quarter of 2004 compared to $1.8 million for the comparable period in
2003. Professional services expense decreased $307,000, or 25.8%, to $881,000
for the first quarter of 2004 compared to $1.2 million for the first quarter of
2003. Consulting and data processing fees decreased by $326,000 and $98,000,
respectively, for the first three months of 2004 compared to 2003. The
expenses reflected in the first quarter of 2003 were due to the BFFC
acquisition and problem loans (see Note 10 to the notes to the unaudited
consolidated financial statements). Expenses, other than salary and employee benefits, occupancy, and
professional services, increased $205,000, or 11.5%, to $2.0 million in the
first quarter of 2004 from $1.8 million for the comparable period in 2003. Income Taxes The Company recorded income tax expense of $1.5 million, or 23.6% of
income, and $2.9 million, or 30.9% of income, for the quarters ended March 31,
2004 and 2003, respectively. The decrease in the tax rate was due in
part to the large increase in U.S. Government Agencies securities the Company held during the first
quarter of 2004 compared to similar period in 2003. Financial Condition Loans The following table sets forth the composition of the Companys loan
portfolio as of the indicated dates. PAGE 21




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March 31, 2004
    
    December 31, 2003(In thousands)Loan
    
    
    
    
    
    LoanCategory
    
    
    
    
    
    Categoryto Gross
    
    
    
    
    
    to GrossAmount
    
    Loans
    
    Amount
    
    LoansCommercial
    
    $
    191,079
    
    
    
    17.8
    %
    
    
    203,920
    
    
    
    18.8
    %Commercial real estate
    
    
    710,574
    
    
    
    66.0
    
    
    
    711,891
    
    
    
    65.8Agricultural
    
    
    65,098
    
    
    
    6.0
    
    
    
    58,144
    
    
    
    5.4Consumer real estate (1)
    
    
    97,972
    
    
    
    9.1
    
    
    
    96,107
    
    
    
    8.9Consumer installment
    
    
    11,576
    
    
    
    1.1
    
    
    
    12,124
    
    
    
    1.1Total loans, gross
    
    
    1,076,299
    
    
    
    100.0
    
    
    
    1,082,186
    
    
    
    100.0Net deferred fees
    
    
    (769
    )
    
    
    
    
    
    
    (890
    )Total loans
    
    
    1,075,530
    
    
    
    
    
    
    
    1,081,296Allowance for loan losses
    
    
    (15,879
    )
    
    
    
    
    
    
    (15,714
    )Net loans
    
    $
    1,059,651
    
    
    
    
    
    
    $
    1,065,582Loans held for sale:Consumer real estate
    
    $
    749
    
    
    
    0.1
    %
    
    $
    1,571
    
    
    
    0.1
    %
  (1)
    
    Includes loans held for sale. Total loans decreased $5.8 million, or 0.5%, to $1.1 billion at March 31,
2004 from December 31, 2003. The decrease in loans was due to loan repayments resulting from the
successful completion of several large construction projects by existing
borrowers. In addition, the decrease in loans was due to a corporate commitment
to tighter credit standards and pricing disciplines applied to commercial and
commercial real estate loans to protect long-term profitability. 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 $12.8 million to $191.1 million as of
March 31, 2004 from $203.9 million as of December 31, 2003, a decrease
of 6.3% for the reasons indicated above.
    
    Commercial real estate loans decreased 0.2% from December 31, 2003
compared to March 31, 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 $7.0 million, or 12.0% as of March 31,
2004 compared to December 31, 2003.
    
    Consumer real estate loans increased $1.9 million as of March 31,
2004 compared to December 31, 2003.
    
    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 PAGE 22




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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
three months ended March 31: 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
    
    
    756
    
    
    
    990Loans charged off
    
    
    (671
    )
    
    
    (325
    )Recoveries
    
    
    80
    
    
    
    29Balance, March 31
    
    $
    15,879
    
    
    $
    15,063
  (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. 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 PAGE 23




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##### Table of Contents



Companys independent loan review personnel reviews the officers grades.
In the event that the loan 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. The Companys provision for loan losses was $756,000 for the first quarter
of 2004 compared to $990,000 for the similar period in 2003. The allowance for loan losses as a percentage of total loans was 1.48% as
of March 31, 2004 and 1.45% at December 31, 2003. Nonaccrual and Nonperforming Loans Nonaccrual loans decreased $935,000 to $14.7 million at March 31, 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 PAGE 24




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##### Table of Contents



provide a source of repayment to the bank. Nonperforming loans were $14.7
million at March 31, 2004 compared to $15.7 million at December 31, 2003. The following table sets forth information on the Companys nonperforming
loans and other nonperforming assets as of the indicated dates. March 31, 2004
    
    December 31, 2003(in thousands)Nonaccrual and impaired loans
not accruing
    
    $
    14,730
    
    
    $
    15,665Impaired and other loans 90 days
past due and accruing
    
    
    14
    
    
    
    18Total nonperforming loans
    
    
    14,744
    
    
    
    15,683Other real estate
    
    
    6,976
    
    
    
    6,942Total nonperforming assets
    
    $
    21,720
    
    
    $
    22,625Total nonperforming loans to
total loans
    
    
    1.37
    %
    
    
    1.45
    %Total nonperforming assets to
total loans and other real estate
    
    
    2.01
    
    
    
    2.08Total nonperforming assets to
total assets
    
    
    0.96
    
    
    
    1.00Allowance to nonperforming loans
    
    
    1.08
    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. 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 its 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 such, further additions to the level of specific and general
loan loss allowances may become necessary. Other real estate owned was $7.0 million at March 31, 2004, an increase of
$34,000 compared to $6.9 million at December 31, 2003. Included in other real
estate owned is one property totaling $6.5 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 PAGE 25




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##### Table of Contents



the development and has engaged a well established construction contractor to
complete the development in the next two years. The contractor has been
approved by the local village and has commenced marketing and construction.
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 March 31, 2004, special mention,
substandard, and doubtful classifications were $17.4 million, $41.9 million,
and $1.1 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. The Companys allowance for
loan losses is considered by management to be adequate at March 31, 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. 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 March 31, 2004, unrealized losses, net of
taxes on securities available-for-sale, were $18.7 million compared to $15.8
million at December 31, 2003. The increase in net unrealized losses on
securities available-for-sale resulted in a $2.8 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 June 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 futures contracts, thereby
reducing interest rate risk. See Note 7 to the notes to the unaudited consolidated financial
statements. During the first quarter of 2004, the Company held $197.0 million in cash
equivalents, which earned, on average, 94 basis points. Consistent with the
investment strategy adopted during 2003, the Company further reduced its
holdings in mortgage-backed securities by $45.6 million during the first
quarter of 2004. As yields remained at historic lows during the quarter, the
Company liquidated another $195.9 million of securities to record gains at
current market levels and planned on reinvesting in shorter duration securities
and higher yielding loans. The anticipated increase in interest rates did not
occur by quarter-end, and the Company decided to invest cautiously under
current market conditions to protect its longer-term profitability and reduce
any adverse impact of any mark-to-market adjustments on its capital base in the
future. Securities available-for-sale decreased to $589.2 million at March 31,
2004 from PAGE 26




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##### Table of Contents



$796.1 million at December 31, 2003:  
    
    U.S. government agency mortgage-backed securities decreased 52.2%,
or $90.0 million, from $172.4 million at December 31, 2003 to $82.4
million at March 31, 2004.
    
    Equity securities decreased $50.7 million from $159.4 million at
December 31, 2003 to $108.7 million at March 31, 2004. Equity
securities included capital securities of United States Agencies and the Federal Home
Loan Bank as well as Federal Reserve Bank stock at March 31, 2004.
    
    Obligations of state and political subdivisions decreased $32.0
million to $3.1 million at March 31, 2004 from $35.1 million at
December 31, 2003.
    
    Other bonds decreased $75.0 million to $20.6 million at March 31,
2004 compared to $95.6 million at December 31, 2003. Other bonds
include high grade corporate bonds primarily issued by financial
institutions. Securities held-to-maturity increased $44.6 million, or 79.5%, from $56.1
million at December 31, 2003 to $100.6 million at March 31, 2004. There were no trading account securities held at March 31, 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 $463,000 due to 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 March 31, 2004 represented a decrease of
$12.5 million, or 0.8%, from December 31, 2003. Non-interest-bearing deposits
were $155.1 million at March 31, 2004, approximately $5.6 million lower than
the $160.7 million level at December 31, 2003. Over the same period,
interest-bearing deposits decreased 0.5%, or $6.9 million. Core deposits, excluding certificates of deposits under $100,000,
increased $2.7 million to $710.8 million at March 31, 2004 from $708.1 million
at December 31, 2003. Certificates of deposit under $100,000 increased $26.1
million from December 31, 2003 to $765.5 million at March 31, 2004.
Certificates of deposit over $100,000 and public funds decreased $41.3 million
from December 31, 2003 to $97.6 million at March 31, 2004. The majority of the
decrease was a result of maturities of brokered certificates of deposit and public fund
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. PAGE 27




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##### Table of Contents



Federal Home Loan Bank advances were $256.1 million at March 31, 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 during 2003. These swap transactions resulted in a
$762,000 decrease in interest expense for the three months ended March 31,
2004. The weighted average rate for FHLB advances was 3.94% at March 31, 2004,
with a range of maturities on such advances between one and ten years. Borrowed funds at March 31, 2004 and December 31, 2003 are listed below: 2004
    
    2003(in thousands)Securities sold under agreements
to repurchase
    
    $
    203,144
    
    
    $
    202,699Federal Home Loan Bank advances
to bank subsidiaries
    
    
    256,095
    
    
    
    253,461Junior subordinated debt owed to
unconsolidated trusts
    
    
    55,672
    
    
    
    54,000Revolving line of credit
    
    
    
    
    
    
    2,000Total
    
    $
    514,911
    
    
    $
    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 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 $203.1 million
in securities sold under repurchase agreements at March 31, 2004 compared to
$202.7 at December 31, 2003. The Company had no federal funds purchased at
March 31, 2004 and December 31, 2003. PAGE 28




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Capital Resources Stockholders equity decreased $38,000 from December 31, 2003 to $143.0
million at March 31, 2004. Total capital to average risk-weighted assets
decreased to 14.4% on March 31, 2004 from 14.7% on December 31, 2003. The
Company issued 1,599,088 shares of common stock due to the acquisition of BFFC
in 2003. The purchase price for that acquisition totaled $32.0 million. 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 March 31,
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 March 31, 2004Minimum Required
    
    Minimum RequiredActual
    
    for Capital Adequacy
    
    to be Well CapitalizedAmount
    
    Ratio
    
    Amount
    
    Ratio
    
    Amount
    
    Ratio(in thousands)Total capital to risk-weighted assetsCompany
    
    $
    218,108
    
    
    
    14.4
    %
    
    $
    120,948
    
    
    
    8.0
    %
    
    
    n/a
    
    
    
    n/aMidwest Bank and Trust Company
    
    
    183,858
    
    
    
    13.8
    
    
    
    106,262
    
    
    
    8.0
    
    
    
    132,827
    
    
    
    10.0
    %Midwest Bank of Western Illinois
    
    
    22,708
    
    
    
    12.5
    
    
    
    14,522
    
    
    
    8.0
    
    
    
    18,152
    
    
    
    10.0Tier I capital to risk-weighted assetsCompany
    
    
    199,939
    
    
    
    13.2
    
    
    
    60,474
    
    
    
    4.0
    
    
    
    n/a
    
    
    
    n/aMidwest Bank and Trust Company
    
    
    169,177
    
    
    
    12.7
    
    
    
    53,131
    
    
    
    4.0
    
    
    
    79,696
    
    
    
    6.0Midwest Bank of Western Illinois
    
    
    21,510
    
    
    
    11.9
    
    
    
    7,261
    
    
    
    4.0
    
    
    
    10,891
    
    
    
    6.0Tier I capital to average assetsCompany
    
    
    199,939
    
    
    
    8.8
    
    
    
    91,045
    
    
    
    4.0
    
    
    
    n/a
    
    
    
    n/aMidwest Bank and Trust Company
    
    
    169,177
    
    
    
    8.6
    
    
    
    78,892
    
    
    
    4.0
    
    
    
    98,615
    
    
    
    5.0Midwest Bank of Western Illinois
    
    
    21,510
    
    
    
    7.4
    
    
    
    11,608
    
    
    
    4.0
    
    
    
    14,510
    
    
    
    5.0
 PAGE 29




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##### Table of Contents



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. As of March 31, 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. See Note 6 to the notes to the unaudited
consolidated financial statements. 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 $5.3 million for the three
months ended March 31, 2004 compared to inflows of $6.4 million for the
comparable period in 2003. Net cash inflows from investing activities were
$63.1 million in the first three months of 2004 compared to a net cash inflows
of $789,000 for the comparable period in 2003. Cash outflows from financing
activities for the three months ended March 31, 2004 were $16.1 million
compared to a net inflow of $18.4 million in the comparable period during 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. Interest received net of interest paid was a principal source of operating
cash inflows for the three months ended March 31, 2004 and March 31, 2003,
respectively. Management of investing and financing activities and market
conditions determines the level and the stability of net interest cash flows.
Managements policy is to mitigate the impact of changes in market interest
rates to the extent PAGE 30




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##### Table of Contents



possible so that balance sheet growth is the principal determinant of growth in
net interest cash flows. PAGE 31




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##### Table of Contents



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 decreases in market interest
rates. The table below presents the Companys projected changes in net
interest income for the various rate shock levels at March 31, 2004. Change in Net Interest Income Over One Year HorizonAt March 31, 2004
    
    At December 31, 2003Change inLevels of
    
    Dollar
    
    Percentage
    
    Dollar
    
    PercentageInterest Rates
    
    Change
    
    Change
    
    Change
    
    Change+200 bp
    
    
    (242
    )
    
    
    -0.43
    %
    
    
    (329
    )
    
    
    -0.50
    %+100 bp
    
    
    (1,835
    )
    
    
    -3.25
    %
    
    
    (1,008
    )
    
    
    -1.53
    %Base
    
    
    
    
    
    
    
    %
    
    
    
    
    
    
    
    %-100 bp
    
    
    1,516
    
    
    
    2.69
    %
    
    
    9
    
    
    
    0.01
    %
 As shown above, at March 31, 2004, the effect of an immediate 200 basis
point increase in interest rates would decrease the Companys net interest
income by 0.43%, or $242,000. The effect of an immediate 100 basis point
reduction in rates would increase the Companys net interest income by 2.69%,
or $1.5 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 32




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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 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 33




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##### Table of Contents



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; PAGE 34




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##### Table of Contents




    
    The effects of competition from other commercial banks, thrifts,
mortgage banking firms, consumer finance companies, credit unions,
securities brokerage firms, insurance companies, 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 any written agreement it may enter
into with the Federal Reserve and the Illinois Commissioner;
    
    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;
    
    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 PAGE 35




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##### Table of Contents



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 None 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
    
    
    
    
    
    
    
    73,000Total
    
    
    
    
    
    
    N/A
    
    
    
    
    
    
    
    73,000
 
 Item 3. Defaults Upon Senior Securities None 
 Item 4. Submission of Matters to a Vote of Security Holders None 
 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). PAGE 37




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##### Table of Contents



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 January
29, 2004, filed with the SEC on January 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: May 7, 2004 MIDWEST BANC HOLDINGS, INC.(Registrant)By:
    
    /s/ Brad A. LueckeBrad A. Luecke,President and Chief Executive OfficerBy:
    
    /s/ Daniel R. KadolphDaniel R. Kadolph,Senior Vice President andChief Financial Officer
 PAGE 39




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Exhibit Index  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
    
    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).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. PAGE 40