SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) of the

Securities Exchange Act of 1934

For the fiscal year ended December 31, ~~2008~~

2009

Commission file number 0-11487

LAKELAND FINANCIAL CORPORATION

Indiana	35-1559596
~~Indiana~~	~~35-1559596~~
(State of incorporation)	(I.R.S. Employer Identification No.)

202 East Center Street, P.O. Box 1387, Warsaw, Indiana 46581-1387

(Address of principal executive offices)

Telephone (574) 267-6144

Securities registered pursuant to Section 12(b) of the Act:


Common Stock, no par value	NASDAQ Global Select Market
(Title of class)	(Name of Each Exchange on which Registered)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes __No o No xX

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes __No o No xX

Indicate by check mark 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 twelve months (or for such other 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 xX No o__

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


Large accelerated filer o [ ]	Accelerated filer x [X]	Non-accelerated filer o [ ]	Smaller reporting company [ ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act) Yes o__ No xX

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, based on the last sales price quoted on the Nasdaq Global Select Market on June 30, ~~2008,~~2009, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately ~~$218,127,216.~~

$219,686,892.

Number of shares of common stock outstanding at February ~~25, 2009: 12,414,130~~

24, 2010: 16,096,861

DOCUMENTS INCORPORATED BY REFERENCE

Part III - - Portions of the Proxy Statement for the Annual Meeting of Shareholders to be held on April ~~14, 2009~~13, 2010 are incorporated by reference into Part III hereof.

LAKELAND~~LAKELAND~~ FINANCIAL CORPORATION

Annual Report on Form 10-K

Table of Contents

		Page Number
	PART I	~~Page Number~~

Item 1.	~~PART I~~Business	3

~~Item 1.~~	~~Business~~	3
	Forward – Looking Statements	5
	Supervision and Regulation	6 7
	Industry Segments	11 12
	Guide 3 Information	11 12
Item 1a.	Risk Factors	29 30
Item 1b.	Unresolved Staff Comments	34 37
Item 2.	Properties	35 38
Item 3.	Legal Proceedings	36 39
~~Item 4.~~	~~Submission of Matters to a Vote of Security Holders~~	36
	PART II
	~~PART II~~
Item 4.	Reserved
Item 5.	Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer
	Purchases of Equity Securities	37 39
Item 6.	Selected Financial Data	39 44
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	40 45
	Overview	40 45
	Results of Operations	40 45
	Financial Condition	43 48
	Critical Accounting Policies	46 52
	Newly Issued But Not Yet Effective Accounting Standards	49 54
	Liquidity	49 55
	Off-Balance Sheet Transactions	50 56
	Inflation	51 57
Item 7a.	Quantitative and Qualitative Disclosures About Market Risk	52 58
Item 8.	Financial Statements and Supplementary Data	54 60
	Financial Statements	54 60
	Notes to Financial Statements	58 65
	Report of Independent Registered Public Accounting Firm	89 102
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	90 103
Item 9a.	Controls and Procedures	90 103
Item 9b.	Other Information	91 104

	PART III

Item 10.	Directors, ~~and~~ Executive Officers ~~of the Registrant~~and corporate Governance	91 104
Item 11.	Executive Compensation	91 104
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related
	Shareholder Matters	91 104
Item 13.	Certain Relationships and Related Transactions, and Director Independence	92 105
Item 14.	Principal Accountant Fees and Services	92 105

	PART IV

Item 15.	Exhibits and Financial Statement Schedules	93 106

	Form 10-K Signature Page	S1

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PART I


ITEM 1. BUSINESS

The Company was incorporated under the laws of the State of Indiana on February 8, 1983. As used herein, the term “Company” refers to Lakeland Financial Corporation, or if the context dictates, Lakeland Financial Corporation and its wholly-owned subsidiary, Lake City Bank (the “Bank”), an Indiana state bank headquartered in Warsaw, Indiana. Also included in the consolidated financial statements prior to December 27, 2006 is LCB Investments, Limited, a wholly-owned subsidiary of Lake City Bank, which is a Bermuda corporation that managed a portion of the Bank’s investment portfolio. On December 27, 2006, all securities were transferred to Lake City Bank from LCB Investments, Limited, and LCB Investments, Limited was dissolved. On December 18, 2006, LCB Investments II, Inc. was formed as a wholly-owned subsidiary of Lake City Bank incorporated in Nevada and it began managing a portion of the Bank’s investment portfolio in January 2007. On December 21, 2006, LCB Funding, Inc., a real estate investment trust, incorporated in Maryland was formed as a wholly-owned subsidiary of LCB Investments II. All intercompany transactions and balances are eliminated in consolidation.

~~General~~

~~Company’s Business~~. The Company is a bank holding company as defined in the Bank Holding Company Act of 1956, as amended. The Company owns all of the outstanding stock of Lake City Bank, Warsaw, Indiana, a full-service commercial bank organized under Indiana law. The Bank recognizes a wholly-owned subsidiary, LCB Investments II, which manages a portion of the Bank’s investment portfolio. The Company conducts no business except that incident to its ownership of the outstanding stock of the Bank and the operation of the Bank.

The Bank’s deposits are insured by the Federal Deposit Insurance Corporation. The Bank’s activities cover all phases of commercial banking, including checking accounts, savings accounts, time deposits, the sale of securities under agreements to repurchase, commercial, real estate and agricultural lending, direct and indirect consumer lending, commercial and residential real estate mortgage lending, retail and merchant credit card services, corporate cash management services, retirement services, bond administration, safe deposit box service and trust and brokerage services.

~~The Bank’s main banking office is located at 202 East Center Street, Warsaw, Indiana. As of December 31, 2008, the Bank had 43 offices in twelve counties throughout northern Indiana.~~

~~Bank’s Business.~~ The Bank was originally organized in 1872 and has continuously operated under the laws of the State of Indiana since its organization. The Bank’s activities cover all phases of commercial banking, including checking accounts, savings accounts, time deposits, the sale of securities under agreements to repurchase, commercial, real estate and agricultural lending, direct and indirect consumer lending, commercial and residential real estate mortgage lending, retail and merchant credit card services, corporate cash management services, retirement services, bond administration, safe deposit box services and trust and brokerage services. The interest rates for both deposits and loans, as well as the range of services provided, are consistent with those of most banks competing within the Bank’s service area.

The Bank competes for loans principally through a high degree of customer contact, timely loan review and approval, market-driven competitive loan pricing and the Bank’s reputation throughout the region. The Bank believes that its convenience, quality service and high touch, responsive approach to banking enhances its ability to compete favorably in attracting and retaining individual and business customers. The Bank actively solicits deposit-related customers and competes for customers by offering personal attention, professional service and competitive interest rates.

~~Market Overview.~~ While the Company operates in twelve counties, it currently defines operations by four primary geographical markets. They are the South Region, which includes Kosciusko County and portions of contiguous counties; the North Region, which includes portions of Elkhart and St. Joseph Counties, the Central Region, which includes portions of Elkhart County and contiguous counties; and the East Region, which includes Allen and contiguous counties. The South Region includes the city of Warsaw, which is the location of the Company’s headquarters. The Company has had a presence in this region since 1872. It has been in the North and Central Regions, which includes the cities of Elkhart, South Bend and Goshen, since 1990. The Company opened its first office in the East Region, which includes the cities of Fort Wayne and Auburn, in 1999. The Company also operates a loan production office in Indianapolis, which is staffed with commercial lending officers and was opened in 2006.

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The Company believes that these are well-established and fairly diverse economic regions. The Company has sought to diversify expansion and industry throughout its markets, which include a mix of industrial and service companies with no business or industry concentrations within individual markets and combined. Furthermore, no single industry or employer dominates any of the markets. Fort Wayne represents the largest population center served by the Company’s full-service branch system with a population of 206,000, according to 2000 U.S. Census Bureau data. South Bend, with a 2000 population of 108,000, is the second largest city served by the Company. Elkhart, with a 2000 population of 52,000, is the third largest city that the Company currently serves. As a result of the presence of offices in twelve counties that are widely dispersed, no single city or industry represents an undue concentration. In addition, the Indianapolis market represents a substantial future opportunity given its position as the largest metropolitan market in the state.

~~Expansion Strategy.~~ The Company’s expansion strategy is driven primarily by the potential for increased penetration in existing markets where opportunities for market share growth exists. Additionally, management considers growth in new markets with a close geographic proximity to its current operations. These markets are considered when the Company believes they would be receptive to its strategic plan to deliver broad based financial services with a commitment to local communities. When entering new markets, the Company believes it is critical to attract experienced local management with a similar philosophy in order to provide a basis for success. Since the early 1990’s, the Company has focused on growth through de novo branching in locations that management believes have potential for creating new market opportunities or for further penetrating existing markets. The Company opened a new branch facility in Fort Wayne, Indiana in late 2007 to house the Company’s Fort Wayne based Wealth Advisory Services and to serve the southwestern market of Fort Wayne. The location is a full-service branch facility. As noted earlier, the Company entered the Indianapolis market in 2006 and anticipates that it will expand in the future with full-service banking locations, although no timetable has been established.

The Company also considers opportunities beyond current markets when the Company’s Board of Directors and management believes that the opportunity will provide a desirable strategic fit without posing undue risk. The Company does not currently have any definitive understandings or agreements for any acquisitions or de novo expansion.

~~Products and Services.~~ The Company is a full-service commercial bank and provides commercial, retail, wealth advisory and investment management services to its customers. Commercial products include commercial loans and technology-driven solutions to commercial customers’ treasury management needs such as internet business banking and on-line treasury management services in addition to retirement services, bond administration and health savings account services. Retail banking clients are provided a wide array of traditional retail banking services, including lending, deposit and investment services. Retail lending programs are focused on mortgage loans, home equity lines of credit and traditional retail installment loans, including indirect automotive financing. The Company provides credit card services to retail and commercial customers through an outsourced retail card program and merchant processing activity. The Company also has an Honors Private Banking program that is positioned to serve the more financially sophisticated customer with a menu including investment management and trust services, executive mortgage programs and access to financial planning seminars and programs. The Company provides wealth advisory clients with traditional personal and corporate trust and investment services. The Company also provides retail brokerage services, including an array of financial and investment products such as annuities and life insurance.

~~Competition~~

Within its four primary geographical markets, the Bank competes with other local and regional banks in addition to major banks for large commercial deposit and loan accounts. The Bank is presently subject to an aggregate maximum loan limit to any single account pursuant to Indiana law of $30.5 million. The Bank currently enforces an internal limit of $20.0 million, which is less than the amount permitted by law. This maximum might occasionally limit the Bank from providing loans to those businesses or personal accounts whose borrowings periodically exceed this amount. In the event this were to occur, the Bank maintains correspondent relationships with other financial institutions. The Bank may participate with other banks in the placement of large borrowings in excess of its lending limit, although the Bank typically does not participate in such arrangements. The Bank is also a member of the Federal Home Loan Bank of Indianapolis in order to broaden its mortgage lending and investment activities and to provide additional funding, as necessary, to support these activities.

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money market mutual funds and large retailers are not subject to the same regulations and laws that govern the operation of traditional depository institutions and accordingly may have an advantage in competing for funds.

~~Foreign Operations~~

The Company has no investments with any foreign entity other than one nominal demand deposit account, which is maintained with a Canadian bank in order to facilitate the clearing of checks drawn on banks located in other countries. There are no foreign loans.

~~Employees~~

At December 31, 2008, the Company, including its subsidiaries, had 446 full-time equivalent employees. Benefit programs include a 401(k) plan, group medical insurance, group life insurance and paid vacations. The Company also maintained a defined benefit pension plan which, effective April 1, 2000, was frozen and employees can no longer accrue new benefits under that plan. The Company also has an equity incentive plan under which stock-based incentives may be granted to employees and directors. The Company also has an employee deferred compensation plan available to certain employees. The Bank is not a party to any collective bargaining agreement, and employee relations are considered good.

~~Forward-looking Statements~~

This document (including information incorporated by reference) contains, and future oral and written statements of the Company and its management may contain, forward-looking statements, within the meaning of such term in the Private Securities Litigation Reform Act of 1995, with respect to the financial condition, results of operations, plans, objectives, future performance and business of the Company. Forward-looking statements, which may be based upon beliefs, expectations and assumptions of the Company’s management and on information currently available to management, are generally identifiable by the use of words such as “believe,” “expect,” “anticipate,” “plan,” “intend,” “estimate,” “may,” “will,” “would,” “could,” “should” or other similar expressions. Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and the Company undertakes no obligation to update any statement in light of new information or future events.

The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain. The factors, which could have a material adverse effect on the operations and future prospects of the Company and its subsidiaries are detailed in the “Risk Factors” section included under Item 1a. of Part I of this Form 10-K. In addition to the risk factors described in that section, there are other factors that may impact any public company, including ours, which could have a material adverse effect on the operations and future prospects of the Company and its subsidiaries. These additional factors include, but are not limited to, the following:

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~~Changes~~ in ~~accounting standards~~Warsaw, Indiana. Also included in the consolidated financial statements prior to December 27, 2006 is LCB Investments, Limited, a wholly-owned subsidiary of Lake City Bank, which was a Bermuda corporation that managed a portion of the Bank’s investment portfolio. On December 27, 2006, all securities were transferred to Lake City Bank from LCB Investments, Limited, and ~~practices,~~LCB Investments, Limited was dissolved. On December 18, 2006, LCB Investments II, Inc. was formed as a wholly-owned subsidiary of Lake City Bank incorporated in Nevada and it began managing a portion of the Bank’s investment portfolio in January 2007. On December 21, 2006, LCB Funding, Inc., a real estate investment trust, incorporated in Maryland, was formed as a wholly-owned subsidiary of LCB Investments II. All intercompany transactions and balances are eliminated in consolidation.

General

Company’s Business. The Company is a bank holding company as defined in the Bank Holding Company Act of 1956, as amended. The Company owns all of the outstanding stock of Lake City Bank, Warsaw, Indiana, a full-service commercial bank organized under Indiana law. The Bank recognizes a wholly-owned subsidiary, LCB Investments II, which manages a portion of the Bank’s investment portfolio. The Company conducts no business except that incident to its ownership of the outstanding stock of the Bank and the operation of the Bank.

The Bank’s deposits are insured by the Federal Deposit Insurance Corporation. The Bank’s activities cover all phases of commercial banking, including checking accounts, savings accounts, time deposits, the sale of securities under agreements to repurchase, commercial, real estate and agricultural lending, direct and indirect consumer lending, commercial and residential real estate mortgage lending, retail and merchant credit card services, corporate treasury management services, retirement services, bond administration, safe deposit box service and trust and brokerage services.

The Bank’s main banking office is located at 202 East Center Street, Warsaw, Indiana. As of December 31, 2009, the Bank had 43 offices in twelve counties throughout Northern Indiana, as well as a loan production office in Indianapolis.

Bank’s Business. The Bank was originally organized in 1872 and has continuously operated under the laws of the State of Indiana since its organization. The Bank’s business strategy is simply focused on maintaining our traditional community banking approach while concurrently leveraging the strength and size of our balance sheet to effectively compete with larger regional and national competitors. We are focused on serving clients in the state of Indiana, with the majority of our business in Northern Indiana. While our strategy encompasses all phases of traditional community banking, including consumer lending and wealth advisory and trust services, we focus on building expansive commercial relationships and developing retail and commercial deposit gathering strategies. Key components of our strategy include: relationship-based services and commercial focused client service. The interest rates for both deposits and loans, as well as the range of services provided, are consistent with those of most banks competing within the Bank’s service area.

The Bank competes for loans principally through a high degree of customer contact, timely loan review and approval, market-driven competitive loan pricing and the Bank’s reputation throughout the region. The Bank believes that its convenience, quality service and high-touch, responsive approach to banking enhances its ability to compete favorably in attracting and retaining individual and business customers. The Bank actively solicits deposit-related customers and competes for customers by offering personal attention, professional service and competitive interest rates.

Market Overview. While the Company operates in thirteen counties, it currently defines operations by four primary geographical markets. They are the South Region, which includes Kosciusko County and portions of contiguous counties; the North Region, which includes portions of Elkhart and St. Joseph Counties; the Central Region, which includes portions of Elkhart County and contiguous counties; and the East Region, which includes Allen and contiguous counties. The South Region includes the city of Warsaw, which is the location of the Company’s headquarters. The Company has had a presence in this region since 1872. It has been in the North and Central Regions, which includes the cities of Elkhart, South Bend and Goshen, since 1990. The Company opened its first office in the East Region, which includes the cities of Fort Wayne and Auburn, in 1999. The Company also operates a loan production office in Indianapolis, which is staffed with commercial lending officers and was opened in 2006.

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The Company believes that these are well-established and fairly diverse economic regions. The Company has sought to diversify expansion and industry throughout its markets, which include a mix of industrial and service companies, with no business or industry concentrations within individual markets and combined. Furthermore, no single industry or employer dominates any of the markets. Fort Wayne represents the largest population center served by the Company’s full-service branch system with a population of 206,000, according to 2000 U.S. Census Bureau data. South Bend, with a 2000 population of 108,000, is the second largest city served by the Company. Elkhart, with a 2000 population of 52,000, is the third largest city that the Company currently serves. As a result of the presence of offices in twelve counties that are widely dispersed, no single city or industry represents an undue concentration. In addition, the Indianapolis market represents a substantial future opportunity given its position as the largest metropolitan market in the state.

Expansion Strategy. The Company’s expansion strategy is driven primarily by the potential for increased penetration in existing markets where opportunities for market share growth exists. Additionally, management considers growth in new markets with a close geographic proximity to its current operations. These markets are considered when the Company believes they would be receptive to its strategic plan to deliver broad-based financial services with a commitment to local communities. When entering new markets, the Company believes it is critical to attract experienced local management with a similar philosophy in order to provide a basis for success.

The Company is an Indiana institution serving Indiana clients. Since 1990, the Company has expanded from 17 offices in four Indiana counties to 43 branches in twelve Indiana counties and one loan production office. During this period, the Company has grown assets from $286 million to $2.6 billion today, an increase of 797%. Mergers and acquisitions have not played a substantive role in this growth as the Company’s expansion strategy has been driven primarily by organic growth. Since the decision to expand outside of the four-county home market in 1990, the Company has targeted growth in larger cities located in the Northern Indiana market. In 1990, the Company began an expansion strategy that the Company believes has created a well-established presence in the region directly north of the Company’s home market. This expansion was focused on the cities of Elkhart, South Bend and Goshen. In 1999, the Company expanded to the east and opened the first office in the Fort Wayne market. Most recently in 2006, the Company established a loan production office in Indianapolis.

While this overall expansion strategy has been guided by a focus on larger communities in Indiana, it has also been influenced by the competitive landscape in these markets. As the historically prominent community banks in these markets were acquired, in most cases by large out-of-state institutions, the Company believes that Lake City Bank’s traditional community banking strategy became highly relevant and provides a competitive advantage to the Company.

The Company believes that another benefit of this geographic expansion strategy into larger population centers is that the Company now serves a more well-established and diverse economic region. While the Company operates within a relatively small geographic region of the state, the Company’s expansion strategy has provided borrower diversification within a fairly diverse economic region. Further, the geographical diversification ensures that no single industry or employer dominates the Company’s markets. In addition, the Indianapolis market represents a substantial future opportunity given its position as the largest metropolitan market in the state. Like previous market expansions, the Company believes the Indianapolis market will provide future business opportunities as the competitive landscape in the market changes to the Company’s advantage.

Products and Services. The Company is a full-service commercial bank and provides commercial, retail, wealth advisory and investment management services to its customers. Commercial products include commercial loans and technology-driven solutions to commercial customers’ treasury management needs such as internet business banking and on-line treasury management services in addition to retirement services, bond administration and health savings account services. Retail banking clients are provided a wide array of traditional retail banking services, including lending, deposit and investment services. Retail lending programs are focused on mortgage loans, home equity lines of credit and traditional retail installment loans, including indirect automotive financing. The Company provides credit card services to retail and commercial customers through an outsourced retail card program and merchant processing activity. The Company also has an Honors Private Banking program that is positioned to serve the more financially sophisticated customer with a menu including investment management and trust services, executive mortgage programs and access to financial planning seminars and programs. The Company provides wealth advisory clients with traditional personal and corporate trust and investment services. The Company

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also provides retail brokerage services, including an array of financial and investment products such as annuities and life insurance.

Competition

The Bank competes with other local and regional banks in addition to major banks for large commercial deposit and loan accounts. The Bank is presently subject to an aggregate maximum loan limit to any single account pursuant to Indiana law of $42.5 million. The Bank currently enforces an internal limit of $20.0 million, which is less than the amount permitted by law. This maximum might occasionally limit the Bank from providing loans to those businesses or personal accounts whose borrowings periodically exceed this amount. In the event this were to occur, the Bank maintains correspondent relationships with other financial institutions. The Bank may participate with other banks in the placement of large borrowings in excess of its lending limit, although the Bank typically does not participate in such arrangements. The Bank is also a member of the Federal Home Loan Bank of Indianapolis in order to provide additional funding, as necessary, to support funding requests and to broaden its mortgage lending and investment activities

In addition to the banks located within its service area, the Bank also competes with savings and loan associations, credit unions, farm credit services, finance companies, personal loan companies, insurance companies, money market funds, and other non-depository financial intermediaries. Also, financial intermediaries such as money market mutual funds and large retailers are not subject to the same regulations and laws that govern the operation of traditional depository institutions and accordingly may have an advantage in competing for funds.

Foreign Operations

Employees

At December 31, 2009, the Company, including its subsidiaries, had 461 full-time equivalent employees. Benefit programs include a 401(k) plan, group medical insurance, group life insurance and paid vacations. The Company also maintained a defined benefit pension plan which, effective April 1, 2000, was frozen and employees can no longer accrue new benefits under that plan. The Company also has an equity incentive plan under which stock-based incentives and compensation may be ~~adopted~~granted to employees and directors. The Company also has an employee deferred compensation plan available to certain employees. The Bank is not a party to any collective bargaining agreement, and employee relations are considered good.

Forward-looking Statements

This document (including information incorporated by ~~state~~reference) contains, and ~~federal regulatory agencies,~~future oral and written statements of the ~~Financial Accounting Standards Board~~Company and its management may contain, forward-looking statements, within the meaning of such term in the Private Securities Litigation Reform Act of 1995, with respect to the financial condition, results of operations, plans, objectives, future performance and business of the Company. Forward-looking statements, which may be based upon beliefs, expectations and assumptions of the Company’s management and on information currently available to management, are generally identifiable by the use of words such as “believe,” “expect,” “anticipate,” “plan,” “intend,” “estimate,” “may,” “will,” “would,” “could,” “should” or other similar expressions. Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and the Company undertakes no obligation to update any statement in light of new information or future events.

the effects of future economic, business and market conditions and changes, domestic and foreign, including seasonality;

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governmental monetary and fiscal policies;

legislative and regulatory changes, including changes in banking, securities and tax laws and regulations and their application by our regulators, and changes in the scope and cost of Federal Deposit Insurance Corporation, or FDIC, insurance and other coverages;

changes in accounting policies, rules and practices;

the risks of changes in interest rates on the levels, composition and costs of deposits, loan demand, and the values and liquidity of loan collateral, securities, and other interest sensitive assets and liabilities;

the failure of assumptions and estimates underlying the establishment of reserves for possible loan losses and other estimates;

changes in borrowers’ credit risks and payment behaviors;

changes in the availability and cost of credit and capital in the financial markets;

changes in the prices, values and sales volumes of residential and commercial real estate;

the effects of competition from a wide variety of local, regional, national and other providers of financial, investment and insurance services;

the risks of mergers, acquisitions and divestitures, including, without limitation, the related time and costs of implementing such transactions, integrating operations as part of these transactions and possible failures to achieve expected gains, revenue growth and/or expense savings from such transactions;

changes in technology or products that may be more difficult, costly, or less effective than anticipated;

the effects of war or other conflicts, acts of terrorism or other catastrophic events, including storms, droughts, tornados and flooding, that may affect general economic conditions, including agricultural production and demand and prices for agricultural goods and land used for agricultural purposes, generally and in our markets;

the failure of assumptions and estimates used in our reviews of our loan portfolio and our analysis of our capital position; and

other factors and risks described under “Risk Factors” herein.

These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. For additional information regarding these and other risks, uncertainties and other factors, please review the disclosure in this annual report under “Risk Factors.”

Internet Website

The Company maintains an internet site at www.lakecitybank.com. The Company makes available free of charge on this site its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and other reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after it electronically files such material with, or furnishes it to, the Securities and Exchange Commission.

•

~~Changes~~ The Company’s Articles of Incorporation, Bylaws, Code of Conduct and the charters of its various committees of the Board of Directors are also available on the website.

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SUPERVISION AND REGULATION

General

Financial institutions, their holding companies and their affiliates are extensively regulated under federal and state law. As a result, the growth and earnings performance of the Company may be affected not only by management decisions and general economic conditions, but also by the requirements of federal and state statutes and by the regulations and policies of various bank regulatory authorities, including the Indiana Department of Financial Institutions (the “DFI”), the Board of Governors of the Federal Reserve System (the “Federal Reserve”) and the Federal Deposit Insurance Corporation (the “FDIC”). Furthermore, taxation laws administered by the Internal Revenue Service and state taxing authorities and securities laws administered by the Securities and Exchange Commission (the “SEC”) and state securities authorities have an impact on the business of the Company. The effect of these statutes, regulations and regulatory policies may be significant, and cannot be predicted with a high degree of certainty.

Federal and state laws and regulations generally applicable to financial institutions regulate, among other things, the scope of business, the kinds and amounts of investments, reserve requirements, capital levels relative to operations, the nature and amount of collateral for loans, the establishment of branches, mergers and consolidations and the payment of dividends. This system of supervision and regulation establishes a comprehensive framework for the respective operations of the Company and its subsidiaries and is intended primarily for the protection of the FDIC-insured deposits and depositors of the Bank, rather than shareholders. In addition to this generally applicable regulatory framework, turmoil in the credit markets in recent years has prompted the enactment of unprecedented legislation that has allowed the U.S. Treasury to make equity capital available to qualifying financial institutions to help restore confidence and stability in the U.S. financial markets, which imposes additional requirements on institutions in which the U.S. Treasury Department invests.

The following is a summary of the material elements of the regulatory framework that currently applies to the Company and its subsidiaries. It does not describe all of the statutes, regulations and regulatory policies that apply, nor does it restate all of the requirements of those that are described. Additionally, in response to the global financial crisis that began in 2007, various legislative and regulatory proposals have been issued addressing, among other things, the restructuring of the federal bank regulatory system, more stringent regulation of consumer products such as mortgages and credit cards, and safe and sound compensation practices. At this time, the Company is unable to determine whether any of these proposals will be adopted as proposed. As such, the following is qualified in its entirety by reference to applicable law. Any change in statutes, regulations or regulatory policies may have a material effect on the business of the Company and its subsidiaries.

The Company

General. The Company, as the sole shareholder of the Bank, is a bank holding company. As a bank holding company, the Company is registered with, and is subject to regulation by, the Federal Reserve under the Bank Holding Company Act of 1956, as amended (the “BHCA”). In accordance with Federal Reserve policy, the Company is expected to act as a source of financial strength to the Bank and to commit resources to support the Bank in circumstances where the Company might not otherwise do so. Under the BHCA, the Company is subject to periodic examination by the Federal Reserve. The Company is required to file with the Federal Reserve periodic reports of the Company’s operations and such additional information regarding the Company and its subsidiaries as the Federal Reserve may require. The Company is also subject to regulation by the DFI under Indiana law.

Acquisitions, Activities and Change in Control. The primary purpose of a bank holding company is to control and manage banks. The BHCA generally requires the prior approval of the Federal Reserve for any merger involving a bank holding company or any acquisition by a bank holding company of another bank or bank holding company. Subject to certain conditions (including deposit concentration limits established by the BHCA), the Federal Reserve may allow a bank holding company to acquire banks located in any state of the United States. In approving interstate acquisitions, the Federal Reserve is required to give effect to applicable state law limitations on the aggregate amount of deposits that may be held by the acquiring bank holding company and its insured depository institution affiliates in the state in which the target bank is located (provided that those limits do not discriminate against out-of-state depository institutions or ~~federal tax laws.~~

•

their holding companies) and state laws that require that the target bank have been in existence for a minimum period of time (not to exceed five years) before being acquired by an out-of-state bank holding company.

The ~~costs, effects~~BHCA generally prohibits the Company from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company that is not a bank and ~~outcomes~~from engaging in any business other than that of ~~existing~~

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banking, managing and controlling banks or ~~future litigation.~~

•

furnishing services to banks and their subsidiaries. This general prohibition is subject to a number of exceptions. The ~~economic impact~~principal exception allows bank holding companies to engage in, and to own shares of ~~past~~companies engaged in, certain businesses found by the Federal Reserve to be “so closely related to banking ... as to be a proper incident thereto.” This authority would permit the Company to engage in a variety of banking-related businesses, including the ownership and operation of a thrift, or any entity engaged in consumer finance, equipment leasing, the operation of a computer service bureau (including software development), and mortgage banking and brokerage. The BHCA generally does not place territorial restrictions on the domestic activities of non-bank subsidiaries of bank holding companies.

Additionally, bank holding companies that meet certain eligibility requirements prescribed by the BHCA and elect to operate as financial holding companies may engage in, or own shares in companies engaged in, a wider range of nonbanking activities, including securities and insurance underwriting and sales, merchant banking and any ~~future terrorist attacks, acts~~other activity that the Federal Reserve, in consultation with the Secretary of ~~war~~the Treasury, determines by regulation or ~~threats thereof~~order is financial in nature, incidental to any such financial activity or complementary to any such financial activity and does not pose a substantial risk to the safety or soundness of depository institutions or the financial system generally. As of the date of this filing, the Company has not applied for approval to operate as a financial holding company.

Federal law also prohibits any person or company from acquiring “control” of an FDIC-insured depository institution or its holding company without prior notice to the appropriate federal bank regulator. “Control” is conclusively presumed to exist upon the acquisition of 25% or more of the outstanding voting securities of a bank or bank holding company, but may arise under certain circumstances between 10% and 24.99% ownership.

Capital Requirements. Bank holding companies are required to maintain minimum levels of capital in accordance with Federal Reserve capital adequacy guidelines. If capital levels fall below the minimum required levels, a bank holding company, among other things, may be denied approval to acquire or establish additional banks or non-bank businesses.

The Federal Reserve’s capital guidelines establish the following minimum regulatory capital requirements for bank holding companies: (i) a risk-based requirement expressed as a percentage of total assets weighted according to risk; and (ii) a leverage requirement expressed as a percentage of total assets. The risk-based requirement consists of a minimum ratio of total capital to total risk-weighted assets of 8% and a minimum ratio of Tier 1 capital to total risk-weighted assets of 4%. The leverage requirement consists of a minimum ratio of Tier 1 capital to total assets of 3% for the most highly rated companies, with a minimum requirement of 4% for all others. For purposes of these capital standards, Tier 1 capital consists primarily of permanent stockholders’ equity less intangible assets (other than certain loan servicing rights and purchased credit card relationships). Total capital consists primarily of Tier 1 capital plus Tier 2 capital which consists of other non-permanent capital items such as certain other debt and equity instruments that do not qualify as Tier 1 capital and a portion of the company’s allowance for loan and lease losses.

The risk-based and leverage standards described above are minimum requirements. Higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual banking organizations. For example, the Federal Reserve’s capital guidelines contemplate that additional capital may be required to take adequate account of, among other things, interest rate risk, or the risks posed by concentrations of credit, nontraditional activities or securities trading activities. Further, any banking organization experiencing or anticipating significant growth would be expected to maintain capital ratios, including tangible capital positions (i.e., Tier 1 capital less all intangible assets), well above the minimum levels. As of December 31, 2009, the Company had regulatory capital in excess of the Federal Reserve’s minimum requirements.

Emergency Economic Stabilization Act of 2008. Events in the U.S. and global financial markets over the past several years, including deterioration of the worldwide credit markets, have created significant challenges for financial institutions throughout the country. In response to this crisis affecting the U.S. banking system and financial markets, on October 3, 2008, the U.S. Congress passed, and the ~~response~~President signed into law, the Emergency Economic Stabilization Act of 2008 (the “EESA”). The EESA authorized the Secretary of the United States Department of Treasury (“Treasury”) to implement various temporary emergency programs designed to strengthen the capital positions of financial institutions and stimulate the availability of credit within the U.S. financial system. Financial institutions participating in certain of the programs established under the EESA are required to adopt Treasury’s standards for executive compensation and corporate governance.

The TARP Capital Purchase Program. On October 14, 2008, Treasury announced that it would provide Tier 1 capital (in the form of perpetual preferred stock) to eligible financial institutions. This program, known as the

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TARP Capital Purchase Program (the “CPP”), allocated $250 billion from the $700 billion authorized by the EESA to Treasury for the purchase of senior preferred shares from qualifying financial institutions (the “CPP Preferred Stock”). Under the program, eligible institutions were able to sell equity interests to the Treasury in amounts equal to between 1% and 3% of the institution’s risk-weighted assets. The CPP Preferred Stock is non-voting and pays dividends at the rate of 5% per annum for the first five years and thereafter at a rate of 9% per annum. In conjunction with the purchase of the CPP Preferred Stock, the Treasury received warrants to purchase common stock from the participating public institutions with an aggregate market price equal to 15% of the preferred stock investment. Participating financial institutions are required to adopt Treasury’s standards for executive compensation and corporate governance for the period during which Treasury holds equity issued under the CPP. These requirements are discussed in more detail in the Compensation Discussion and Analysis section in the Company’s proxy statement, which is incorporated by reference in this Form 10-K.

Pursuant to the CPP, on February 27, 2009, the Company entered into a Letter Agreement with Treasury, pursuant to which the Company issued (i) 56,044 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A and (ii) a warrant to purchase 396,538 shares of the Company’s common stock, no par value, for an aggregate purchase price of $56,044,000 in cash. Since the Company’s participation in the CPP, the Company has raised additional capital through a public offering of common stock and, as a result of that offering, the number of shares of common stock subject to the warrant have been reduced by 50% to 198,269. The Company’s federal regulators, the Treasury and the Treasury’s Office of the Inspector General maintains significant oversight over the Company as a participating institution, to evaluate how it is using the capital provided and to ensure that it strengthens its efforts to help its borrowers avoid foreclosure, which is one of the core aspects of the EESA.

Dividend Payments. The Company’s ability to pay dividends to its shareholders may be affected by both general corporate law considerations and policies of the Federal Reserve applicable to bank holding companies. As an Indiana corporation, the Company is subject to the limitations of the Indiana General Business Corporation Law, which prohibit the Company from paying dividends if the Company is, or by payment of the dividend would become, insolvent, or if the payment of dividends would render the Company unable to pay its debts as they become due in the usual course of business. Additionally, policies of the Federal Reserve caution that a bank holding company should not pay cash dividends unless its net income available to common shareholders over the past year has been sufficient to fully fund the dividends and the prospective rate of earnings retention appears consistent with its capital needs, asset quality, and overall financial condition. The Federal Reserve also possesses enforcement powers over bank holding companies and their non-bank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices or violations of applicable statutes and regulations. Among these powers is the ability to proscribe the payment of dividends by banks and bank holding companies. Further, with respect to the Company’s participation in the CPP, the terms of the CPP Preferred Stock provide that no dividends on any common or preferred stock that ranks equal to or junior to the CPP Preferred Stock may be paid unless and until all accrued and unpaid dividends for all past dividend periods on the CPP Preferred Stock have been fully paid.

Federal Securities Regulation. The Company’s common stock is registered with the SEC under the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Consequently, the Company is subject to the information, proxy solicitation, insider trading and other restrictions and requirements of the SEC under the Exchange Act.

The Bank

General. The Bank is an Indiana-chartered bank, the deposit accounts of which are insured by the FDIC’s Deposit Insurance Fund (“DIF”) to the maximum extent provided under federal law and FDIC regulations. The Bank is also a member of the Federal Reserve System (“member bank”). As an Indiana-chartered, FDIC-insured member bank, the Bank is presently subject to the examination, supervision, reporting and enforcement requirements of the DFI, the chartering authority for Indiana banks, the Federal Reserve, as the primary federal regulator of member banks, and the FDIC, as administrator of the DIF.

Deposit Insurance. As an FDIC-insured institution, the Bank is required to pay deposit insurance premium assessments to the FDIC. The FDIC has adopted a risk-based assessment system whereby FDIC-insured depository institutions pay insurance premiums at rates based on their risk classification. An institution’s risk classification is assigned based on its capital levels and the level of supervisory concern the institution poses to the regulators. Under the regulations of the FDIC, as presently in effect, insurance assessments range from 0.07% to 0.78% of total deposits, depending on an institution’s risk classification, its levels of unsecured debt and secured liabilities, and, in certain cases, its level of brokered deposits.

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Furthermore, as a result of the increased volume of bank failures in 2008 and 2009, on May 22, 2009, the FDIC approved a final rule imposing a special assessment on all depository institutions whose deposits are insured by the FDIC. This one-time special assessment was imposed on institutions in the second quarter, and was collected on September 30, 2009. Pursuant to the final rule, the FDIC imposed on the Bank a special assessment in the amount of $1.1 million, which was due and payable on September 30, 2009.

On November 12, 2009, the FDIC adopted a final rule that required insured depository institutions to prepay on December 30, 2009, their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011, and 2012. On December 31, 2009, the Bank paid the FDIC $10.1 million in prepaid assessments. An institution’s prepaid assessments were calculated based on the institution’s actual September 30, 2009 assessment base, adjusted quarterly by an estimated 5 percent annual growth rate through the end of 2012. The FDIC also used the institution’s total base assessment rate in effect on September 30, 2009, increasing it by an annualized 3 basis points beginning in 2011. The FDIC will begin to offset prepaid assessments on March 30, 2010, representing payment of the regular quarterly risk-based deposit insurance assessment for the fourth quarter of 2009. Any prepaid assessment not exhausted after collection of the amount due on June 30, 2013, will be returned to the institution.

FDIC Temporary Liquidity Guarantee Program. In conjunction with Treasury’s actions to address the credit and liquidity crisis in financial markets, on October 14, 2008, the FDIC announced the Temporary Liquidity Guarantee Program. One component of the Temporary Liquidity Guarantee Program is the Transaction Account Guarantee Program, which temporarily provides participating institutions with unlimited deposit insurance coverage for non-interest bearing and certain low-interest bearing transaction accounts maintained at FDIC insured institutions. All institutions that did not opt out of the Transaction Account Guarantee Program were subject to a 10 basis point per annum assessment on amounts in excess of $250,000 in covered transaction accounts through December 31, 2009. On August 26, 2009, the FDIC extended the Transaction Account Guarantee Program for an additional six months through June 30, 2010. Beginning January 1, 2010, the assessment levels increased to 15 basis points, 20 basis points or 25 basis points per annum, based on the risk category to which an institution is assigned for purposes of the risk-based premium system. The Bank did not opt out of the six-month extension of the Transaction Account Guarantee Program. As a result, the Bank, like every other FDIC-insured depository institution in the United States that did not opt out of the Transaction Account Guarantee Program, is incurring fees on amounts in excess of $250,000 in covered transaction accounts.

FICO Assessments. The Financing Corporation (“FICO”) is a mixed-ownership governmental corporation chartered by the former Federal Home Loan Bank Board pursuant to the Federal Savings and Loan Insurance Corporation Recapitalization Act of 1987 to function as a financing vehicle for the recapitalization of the former Federal Savings and Loan Insurance Corporation. FICO issued 30-year non-callable bonds of approximately $8.2 billion that mature by 2019. Since 1996, federal legislation has required that all FDIC-insured depository institutions pay assessments to cover interest payments on FICO’s outstanding obligations. These FICO assessments are in addition to amounts assessed by the FDIC for deposit insurance. During the year ended December 31, 2009, the FICO assessment rate was approximately 0.01% of deposits.

Supervisory Assessments. All Indiana banks are required to pay supervisory assessments to the DFI to fund the operations of the DFI. The amount of the assessment is calculated on the basis of the bank’s total assets. During the year ended December 31, 2009, the Bank paid supervisory assessments to the DFI totaling $204,000.

Capital Requirements. Banks are generally required to maintain capital levels in excess of other businesses. Under federal regulations, the Bank is subject to the following minimum capital standards: (i) a leverage requirement consisting of a minimum ratio of Tier 1 capital to total assets of 3% for the most highly-rated banks with a minimum requirement of at least 4% for all others; and (ii) a risk-based capital requirement consisting of a minimum ratio of total capital to total risk-weighted assets of 8% and a minimum ratio of Tier 1 capital to total risk-weighted assets of 4%. In general, the components of Tier 1 capital and total capital are the same as those for bank holding companies discussed above.

The capital requirements described above are minimum requirements. Higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual institutions. For example, federal regulations provide that additional capital may be required to take adequate account of, among other things, interest rate risk or the risks posed by concentrations of credit, nontraditional activities or securities trading activities.

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certain types of activities and may qualify for expedited processing of other required notices or applications. Additionally, one of the criteria that determines a bank holding company’s eligibility to operate as a financial holding company is a requirement that all of its financial institution subsidiaries be “well-capitalized.” Under the regulations of the Federal Reserve, in order to be “well-capitalized” a financial institution must maintain a ratio of total capital to total risk-weighted assets of 10% or greater, a ratio of Tier 1 capital to total risk-weighted assets of 6% or greater and a ratio of Tier 1 capital to total assets of 5% or greater.

Federal law also provides the federal banking regulators with broad power to take prompt corrective action to resolve the problems of undercapitalized institutions. The extent of the regulators’ powers depends on whether the institution in question is “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized,” in each case as defined by regulation. Depending upon the capital category to which an institution is assigned, the regulators’ corrective powers include: (i) requiring the institution to submit a capital restoration plan; (ii) limiting the institution’s asset growth and restricting its activities; (iii) requiring the institution to issue additional capital stock (including additional voting stock) or to be acquired; (iv) restricting transactions between the institution and its affiliates; (v) restricting the interest rate the institution may pay on deposits; (vi) ordering a new election of directors of the institution; (vii) requiring that senior executive officers or directors be dismissed; (viii) prohibiting the institution from accepting deposits from correspondent banks; (ix) requiring the institution to divest certain subsidiaries; (x) prohibiting the payment of principal or interest on subordinated debt; and (xi) ultimately, appointing a receiver for the institution.

As of December 31, 2009: (i) the Bank was not subject to a directive from the Federal Reserve to increase its capital to an amount in excess of the minimum regulatory capital requirements; (ii) the Bank exceeded its minimum regulatory capital requirements under Federal Reserve capital adequacy guidelines; and (iii) the Bank was “well-capitalized,” as defined by Federal Reserve regulations.

Dividend Payments. The primary source of funds for the Company is dividends from the Bank. Indiana law prohibits the Bank from paying dividends in an amount greater than its undivided profits. The Bank is required to obtain the approval of the DFI for the payment of any dividend if the total of all dividends declared by the Bank during the calendar year, including the proposed dividend, would exceed the sum of the Bank’s net income for the year to date combined with its retained net income for the previous two years. Indiana law defines “retained net income” to mean the net income of a specified period, calculated under the consolidated report of income instructions, less the total amount of all dividends declared for the specified period. The Federal Reserve Act also imposes limitations on the amount of dividends that may be paid by state member banks, such ~~threats~~as the Bank. Without Federal Reserve approval, a state member bank may not pay dividends in any calendar year that, in the aggregate, exceed the bank’s calendar year-to-date net income plus the bank’s retained net income for the two preceding calendar years.

The payment of dividends by any financial institution is affected by the requirement to maintain adequate capital pursuant to applicable capital adequacy guidelines and ~~attacks.~~

•

regulations, and a financial institution generally is prohibited from paying any dividends if, following payment thereof, the institution would be undercapitalized. As described above, the Bank exceeded its minimum capital requirements under applicable guidelines as of December 31, 2009. As of December 31, 2009, approximately $24.7 million was available to be paid as dividends by the Bank. Notwithstanding the availability of funds for dividends, however, the Federal Reserve may prohibit the payment of any dividends by the Bank if the Federal Reserve determines such payment would constitute an unsafe or unsound practice.

Insider Transactions.The ~~ability~~Bank is subject to certain restrictions imposed by federal law on extensions of credit to the Company, on investments in the stock or other securities of the Company and the acceptance of the stock or other securities of the Company as collateral for loans made by the Bank. Certain limitations and reporting requirements are also placed on extensions of credit by the Bank to its directors and officers, to directors and officers of the Company, to ~~manage~~principal shareholders of the ~~risks associated~~Company and to “related interests” of such directors, officers and principal shareholders. In addition, federal law and regulations may affect the terms upon which any person who is a director or officer of the Company or the Bank or a principal shareholder of the Company may obtain credit from banks with which the Bank maintains a correspondent relationship.

Safety and Soundness Standards. The federal banking agencies have adopted guidelines that establish operational and managerial standards to promote the safety and soundness of federally insured depository institutions. The guidelines set forth standards for internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, asset quality and earnings.

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In general, the safety and soundness guidelines prescribe the goals to be achieved in each area, and each institution is responsible for establishing its own procedures to achieve those goals. If an institution fails to comply with any of the standards set forth in the guidelines, the institution’s primary federal regulator may require the institution to submit a plan for achieving and maintaining compliance. If an institution fails to submit an acceptable compliance plan, or fails in any material respect to implement a compliance plan that has been accepted by its primary federal regulator, the regulator is required to issue an order directing the institution to cure the deficiency. Until the deficiency cited in the regulator’s order is cured, the regulator may restrict the institution’s rate of growth, require the institution to increase its capital, restrict the rates the institution pays on deposits or require the institution to take any action the regulator deems appropriate under the circumstances. Noncompliance with the standards established by the safety and soundness guidelines may also constitute grounds for other enforcement action by the federal banking regulators, including cease and desist orders and civil money penalty assessments.

Branching Authority. Indiana banks, such as the Bank, have the authority under Indiana law to establish branches anywhere in the State of Indiana, subject to receipt of all required regulatory approvals.

Federal law permits state and national banks to merge with banks in other states subject to: (i) regulatory approval; (ii) federal and state deposit concentration limits; and (iii) state law limitations requiring the merging bank to have been in existence for a minimum period of time (not to exceed five years) prior to the merger. The establishment of new interstate branches or the acquisition of individual branches of a bank in another state (rather than the acquisition of an out-of-state bank in its entirety) is permitted only in those states the laws of which expressly authorize such expansion.

State Bank Investments and Activities. The Bank generally is permitted to make investments and engage in activities directly or through subsidiaries as authorized by Indiana law. However, under federal law and FDIC regulations, FDIC-insured state banks are prohibited, subject to certain exceptions, from making or retaining equity investments of a type, or in an amount, that are not permissible for a national bank. Federal law and FDIC regulations also prohibit FDIC-insured state banks and their subsidiaries, subject to certain exceptions, from engaging as principal in any activity that is not permitted for a national bank unless the bank meets, and continues to meet, its minimum regulatory capital requirements and the FDIC determines the activity would not pose a significant risk to the deposit insurance fund of which the bank is a member. These restrictions have not had, and are not currently expected to have, a material impact on the operations of the Bank.

Federal Reserve System. Federal Reserve regulations, as presently in effect, require depository institutions to maintain reserves against their transaction accounts (primarily NOW and regular checking accounts), as follows: for transaction accounts aggregating $55.2 million or less, the reserve requirement is 3% of total transaction accounts; and for transaction accounts aggregating in excess of $55.2 million, the reserve requirement is $1.335 million plus 10% of the aggregate amount of total transaction accounts in excess of $55.2 million. The first $10.7 million of otherwise reservable balances are exempted from the reserve requirements. These reserve requirements are subject to annual adjustment by the Federal Reserve. We will believe the Bank will continue to maintain compliance with the foregoing requirements.

INDUSTRY SEGMENTS

The Company’s chief decision-makers monitor and evaluate financial performance on a Company-wide basis. All of the Company’s financial service operations are similar and considered by management to be aggregated into one reportable operating segment. While the Company has assigned certain management responsibilities by region and business-line, the Company's chief decision-makers monitor and evaluate financial performance on a Company-wide basis. The majority of the Company's revenue is from the business of banking and the Company's assigned regions have similar economic characteristics, products, services and customers. Accordingly, all of the Company’s operations are considered by management to be aggregated in one reportable operating segment.

GUIDE 3 INFORMATION

On the pages that follow are tables that set forth selected statistical information relative to the business of the Company. This data should be read in conjunction with the consolidated financial statements, related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” as ~~well as anticipated.~~

set forth in Items 7 & 8, below, herein incorporated by reference.

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DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY;

INTEREST RATES AND INTEREST DIFFERENTIAL

(in thousands of dollars)

				2009								2008
	Average			Interest					Average			Interest
	Balance			Income		Yield (1)			Balance			Income		Yield (1)
ASSETS
Earning assets:
Loans:
Taxable (2)(3)	$	1,897,544		$	96,151		5.07	%	$	1,662,355		$	99,538		5.99	%
Tax exempt (1)		4,202			199		4.74			2,669			147		5.51

Investments: (1)
Available for sale		399,342			21,179		5.30			368,578			19,731		5.35

Short-term investments		22,540			35		0.16			12,136			171		1.41

Interest bearing deposits		1,631			26		1.59			2,045			49		2.40

Total earning assets		2,325,259			117,590		5.06	%		2,047,783			119,636		5.84	%

Nonearning assets:
Cash and due from banks		39,616			0					41,302			0

Premises and equipment		30,208			0					28,200			0

Other nonearning assets		76,671			0					70,986			0

Less allowance for loan losses		(24,801	)		0					(17,597	)		0

Total assets	$	2,446,953		$	117,590				$	2,170,674		$	119,636

(1)	Tax exempt income was converted to a fully taxable equivalent basis at a 35 percent tax rate for 2009 and 2008. The tax equivalent rate for tax exempt loans and tax exempt securities acquired after January 1, 1983 included the TEFRA adjustment applicable to nondeductible interest expenses.

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~~Internet Website~~

~~SUPERVISION AND REGULATION~~

~~General~~

Financial institutions, their holding companies and their affiliates are extensively regulated under federal and state law. As a result, the growth and earnings performance of the Company may be affected not only by management decisions and general economic conditions, but also by the requirements of federal and state statutes and by the regulations and policies of various bank regulatory authorities, including the Indiana Department of Financial Institutions (the “DFI”), the Board of Governors of the Federal Reserve System (the ”Federal Reserve”) and the Federal Deposit Insurance Corporation (the “FDIC”). Furthermore, taxation laws administered by the Internal Revenue Service and state taxing authorities and securities laws administered by the Securities and Exchange Commission (the ”SEC”) and state securities authorities have an impact on the business of the Company. The effect of these statutes, regulations and regulatory policies may be significant, and cannot be predicted with a high degree of certainty.

Federal and state laws and regulations generally applicable to financial institutions regulate, among other things, the scope of business, the kinds and amounts of investments, reserve requirements, capital levels relative to operations, the nature and amount of collateral for loans, the establishment of branches, mergers and consolidations and the payment of dividends. This system of supervision and regulation establishes a comprehensive framework for the respective operations of the Company and its subsidiaries and is intended primarily for the protection of the FDIC-insured deposits and depositors of the Bank, rather than shareholders. In addition to this generally applicable regulatory framework, recent turmoil in the credit markets prompted the enactment of unprecedented legislation that has allowed the U.S. Treasury to make equity capital available to qualifying financial institutions to help restore confidence and stability in the U.S. financial markets, which imposes additional requirements on institutions in which the U.S. Treasury Department invests.

The following is a summary of the material elements of the regulatory framework that applies to the Company and its subsidiaries. It does not describe all of the statutes, regulations and regulatory policies that apply, nor does it restate all of the requirements of those that are described. As such, the following is qualified in its entirety by reference to applicable law. Any change in statutes, regulations or regulatory policies may have a material effect on the business of the Company and its subsidiaries.

~~The Company~~

~~General.~~ The Company, as the sole shareholder of the Bank, is a bank holding company. As a bank holding company, the Company is registered with, and is subject to regulation by, the Federal Reserve under the Bank Holding Company Act of 1956, as amended (the “BHCA”). In accordance with Federal Reserve policy, the Company is expected to act as a source of financial strength to the Bank and to commit resources to support the Bank in circumstances where the Company might not otherwise do so. Under the BHCA, the Company is subject to periodic examination by the Federal Reserve. The Company is required to file with the Federal Reserve periodic reports of the Company’s operations and such additional information regarding the Company and its subsidiaries as the Federal Reserve may require. The Company is also subject to regulation by the DFI under Indiana law.

~~Acquisitions, Activities and Change in Control.~~ The primary purpose of a bank holding company is to control and manage banks. The BHCA generally requires the prior approval of the Federal Reserve for any merger involving a bank holding company or any acquisition by a bank holding company of another bank or bank holding company. Subject to certain conditions (including deposit concentration limits established by the BHCA), the Federal Reserve may allow a bank holding company to acquire banks located in any state of the United States. In approving interstate acquisitions, the Federal Reserve is required to give effect to applicable state law limitations on the aggregate amount of deposits that may be held by the acquiring bank holding company and its insured depository institution affiliates in the state in which the target bank is located (provided that those limits do not discriminate against out-of-state depository institutions or their holding companies) and state laws that require that

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~~the target bank have been in existence for a minimum period of time (not to exceed five years) before being acquired by an out-of-state bank holding company.~~

The BHCA generally prohibits the Company from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company that is not a bank and from engaging in any business other than that of banking, managing and controlling banks or furnishing services to banks and their subsidiaries. This general prohibition is subject to a number of exceptions. The principal exception allows bank holding companies to engage in, and to own shares of companies engaged in, certain businesses found by the Federal Reserve to be “so closely related to banking ... as to be a proper incident thereto.” This authority would permit the Company to engage in a variety of banking-related businesses, including the ownership and operation of a thrift, or any entity engaged in consumer finance, equipment leasing, the operation of a computer service bureau (including software development), and mortgage banking and brokerage. The BHCA generally does not place territorial restrictions on the domestic activities of non-bank subsidiaries of bank holding companies.

Additionally, bank holding companies that meet certain eligibility requirements prescribed by the BHCA and elect to operate as financial holding companies may engage in, or own shares in companies engaged in, a wider range of nonbanking activities, including securities and insurance underwriting and sales, merchant banking and any other activity that the Federal Reserve, in consultation with the Secretary of the Treasury, determines by regulation or order is financial in nature, incidental to any such financial activity or complementary to any such financial activity and does not pose a substantial risk to the safety or soundness of depository institutions or the financial system generally. As of the date of this filing, the Company has not applied for approval to operate as a financial holding company.

~~Capital Requirements.~~ Bank holding companies are required to maintain minimum levels of capital in accordance with Federal Reserve capital adequacy guidelines. If capital levels fall below the minimum required levels, a bank holding company, among other things, may be denied approval to acquire or establish additional banks or non-bank businesses.

The Federal Reserve’s capital guidelines establish the following minimum regulatory capital requirements for bank holding companies: (i) a risk-based requirement expressed as a percentage of total assets weighted according to risk; and (ii) a leverage requirement expressed as a percentage of total assets. The risk-based requirement consists of a minimum ratio of total capital to total risk-weighted assets of 8% and a minimum ratio of Tier 1 capital to total risk-weighted assets of 4%. The leverage requirement consists of a minimum ratio of Tier 1 capital to total assets of 3% for the most highly rated companies, with a minimum requirement of 4% for all others. For purposes of these capital standards, Tier 1 capital consists primarily of permanent stockholders’ equity less intangible assets (other than certain loan servicing rights and purchased credit card relationships). Total capital consists primarily of Tier 1 capital plus certain other debt and equity instruments that do not qualify as Tier 1 capital and a portion of the company’s allowance for loan and lease losses.

The risk-based and leverage standards described above are minimum requirements. Higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual banking organizations. For example, the Federal Reserve’s capital guidelines contemplate that additional capital may be required to take adequate account of, among other things, interest rate risk, or the risks posed by concentrations of credit, nontraditional activities or securities trading activities. Further, any banking organization experiencing or anticipating significant growth would be expected to maintain capital ratios, including tangible capital positions (~~i.e.~~~~, Tier 1 capital less all intangible assets), well above the minimum levels. As of December 31, 2008, the Company had regulatory capital in excess of the Federal Reserve’s minimum requirements.~~

~~Emergency Economic Stabilization Act of 2008.~~ Recent events in the U.S. and global financial markets, including the deterioration of the worldwide credit markets, have created significant challenges for financial institutions throughout the country. Dramatic declines in the housing market during the past year, marked by falling home prices and increasing levels of mortgage foreclosures, have resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities and major commercial and investment banks. In addition, many lenders and institutional investors have reduced, and in some cases, ceased to provide funding to borrowers, including other financial institutions, as a result of concern about the stability of the financial markets and the strength of counterparties.

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In response to the crises affecting the U.S. banking system and financial markets and to bolster the distressed economy and improve consumer confidence in the financial system, on October 3, 2008, the U.S. Congress passed, and the President signed into law, the Emergency Economic Stabilization Act of 2008 (the “EESA”). The EESA authorizes the Secretary of the United States Department of Treasury (“Treasury”) to implement various temporary emergency programs designed to strengthen the capital positions of financial institutions and stimulate the availability of credit within the U.S. financial system. Financial institutions participating in certain of the programs established under the EESA will be required to adopt Treasury’s standards for executive compensation and corporate governance.

~~The TARP Capital Purchase Program.~~ On October 14, 2008, Treasury announced that it will provide Tier 1 capital (in the form of perpetual preferred stock) to eligible financial institutions. This program, known as the TARP Capital Purchase Program (the “CPP”), allocates $250 billion from the $700 billion authorized by the EESA to Treasury for the purchase of senior preferred shares from qualifying financial institutions (the “CPP Preferred Stock”). Under the program, eligible institutions are able to sell equity interests to the Treasury in amounts equal to between 1% and 3% of the institution’s risk-weighted assets. The CPP Preferred Stock will generally be non-voting and will pay dividends at the rate of 5% per annum for the first five years and thereafter at a rate of 9% per annum. In conjunction with the purchase of the CPP Preferred Stock, the Treasury will receive warrants to purchase common stock from the participating public institutions with an aggregate market price equal to 15% of the preferred stock investment. Participating financial institutions will be required to adopt Treasury’s standards for executive compensation and corporate governance for the period during which Treasury holds equity issued under the CPP.

Pursuant to the CPP, on February 27, 2009, The Company entered into a Letter Agreement with Treasury, pursuant to which the Company issued (i) 56,044 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A and (ii) a warrant to purchase 396,538 shares of the Company’s common stock, no par value, for an aggregate purchase price of $56,044,000 in cash. The Company also expects that its federal regulators and the Treasury will maintain significant oversight over the Company as a participating institution, to evaluate how it uses the capital provided and to ensure that it strengthens its efforts to help its borrowers avoid foreclosure, which is one of the core aspects of the EESA.

~~Dividend Payments.~~ ~~The Company’s ability to pay dividends to its shareholders may be affected by both general corporate law considerations and policies of the Federal Reserve applicable to bank holding companies~~. As an Indiana corporation, the Company is subject to the limitations of the Indiana General Business Corporation Law, which prohibit the Company from paying dividends if the Company is, or by payment of the dividend would become, insolvent, or if the payment of dividends would render the Company unable to pay its debts as they become due in the usual course of business. Additionally, policies of the Federal Reserve caution that a bank holding company should not pay cash dividends unless its net income available to common shareholders over the past year has been sufficient to fully fund the dividends and the prospective rate of earnings retention appears consistent with its capital needs, asset quality, and overall financial condition. The Federal Reserve also possesses enforcement powers over bank holding companies and their non-bank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices or violations of applicable statutes and regulations. Among these powers is the ability to proscribe the payment of dividends by banks and bank holding companies. Further, if the Company participates in the CPP, the Company anticipates that the terms of the CPP Preferred Stock will provide that no dividends on any common or preferred stock that ranks equal to or junior to the CPP Preferred Stock may be paid unless and until all accrued and unpaid dividends for all past dividend periods on the CPP Preferred Stock have been fully paid.

~~Federal Securities Regulation~~. The Company’s common stock is registered with the SEC under the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended (the ”Exchange Act”). Consequently, the Company is subject to the information, proxy solicitation, insider trading and other restrictions and requirements of the SEC under the Exchange Act.

~~The Bank~~

~~General.~~ The Bank is an Indiana-chartered bank, the deposit accounts of which are insured by the FDIC’s Deposit Insurance Fund (“DIF”) to the maximum extent provided under federal law and FDIC regulations. The Bank is also a member of the Federal Reserve System (“member bank”). As an Indiana-chartered, FDIC-insured member bank, the Bank is presently subject to the examination, supervision, reporting and enforcement requirements of the DFI, the chartering authority for Indiana banks, the Federal Reserve, as the primary federal regulator of member banks, and the FDIC, as administrator of the DIF.

~~Table of Contents~~

~~Deposit Insurance.~~ As an FDIC-insured institution, the Bank is required to pay deposit insurance premium assessments to the FDIC. The FDIC has adopted a risk-based assessment system whereby FDIC-insured depository institutions pay insurance premiums at rates based on their risk classification. An institution’s risk classification is assigned based on its capital levels and the level of supervisory concern the institution poses to the regulators. Under the regulations of the FDIC, as presently in effect, insurance assessments range from 0.12% to 0.50% of total deposits for the first quarter 2009 assessment period only (subject to the application of assessment credits, if any, issued by the FDIC in 2008). Effective April 1, 2009, insurance assessments will range from 0.07% to 0.78%, depending on an institution’s risk classification, as well as its unsecured debt, secured liability and brokered deposits. In addition, under an interim rule, the FDIC plans to impose a 20 basis point emergency special assessment on insured depository institutions on June 30, 2009. The emergency special assessment will be collected on September 30, 2009. The interim rule also authorizes the FDIC to impose an additional emergency special assessment after June 30, 2009, of up to 10 basis points, if necessary to maintain public confidence in federal deposit insurance.

~~FDIC Temporary Liquidity Guarantee Program~~. In connection with the recently enacted EESA and in conjunction with the Treasury’s actions to address the current credit and liquidity crisis in financial markets, the FDIC announced the Temporary Liquidity Guarantee Program, which will temporarily provide to participating institutions unlimited deposit insurance coverage for non-interest bearing transaction accounts maintained at FDIC insured institutions (the “transaction account guarantee program”), and provide a limited guarantee on certain newly-issued senior unsecured debt (the “debt guarantee program”). For an initial 30-day period, all eligible financial institutions were automatically covered under this program without incurring any fees. Institutions that did not opt out by December 5, 2008, will be subject to the following potential assessments for participation: (i) for the debt guarantee program, between 50 and 100 basis points per annum for eligible senior unsecured debt (depending on the maturity date) issued between October 14, 2008 and June 30, 2009; and (ii) for the transaction account guarantee program, 10 basis points per annum on amounts in excess of $250,000 in non-interest bearing transaction accounts from November 13, 2008 through and including December 31, 2009. The Bank decided to continue to participate in these programs and did not opt out. As a result, the Bank expects to incur fees associated with the programs.

~~FICO Assessments.~~ The Financing Corporation (“FICO”) is a mixed-ownership governmental corporation chartered by the former Federal Home Loan Bank Board pursuant to the Federal Savings and Loan Insurance Corporation Recapitalization Act of 1987 to function as a financing vehicle for the recapitalization of the former Federal Savings and Loan Insurance Corporation. FICO issued 30-year non-callable bonds of approximately $8.2 billion that mature by 2019. Since 1996, federal legislation has required that all FDIC-insured depository institutions pay assessments to cover interest payments on FICO’s outstanding obligations. These FICO assessments are in addition to amounts assessed by the FDIC for deposit insurance. During the year ended December 31, 2008, the FICO assessment rate was approximately 0.01% of deposits.

~~Supervisory Assessments.~~ All Indiana banks are required to pay supervisory assessments to the DFI to fund the operations of the DFI. The amount of the assessment is calculated on the basis of the bank’s total assets. During the year ended December 31, 2008, the Bank paid supervisory assessments to the DFI totaling $178,000.

~~Capital Requirements.~~ Banks are generally required to maintain capital levels in excess of other businesses. Under federal regulations, the Bank is subject to the following minimum capital standards: (i) a leverage requirement consisting of a minimum ratio of Tier 1 capital to total assets of 3% for the most highly-rated banks with a minimum requirement of at least 4% for all others; and (ii) a risk-based capital requirement consisting of a minimum ratio of total capital to total risk-weighted assets of 8% and a minimum ratio of Tier 1 capital to total risk-weighted assets of 4%. In general, the components of Tier 1 capital and total capital are the same as those for bank holding companies discussed above.

Further, federal law and regulations provide various incentives for financial institutions to maintain regulatory capital at levels in excess of minimum regulatory requirements. For example, a financial institution that is “well-capitalized” may qualify for exemptions from prior notice or application requirements otherwise applicable to certain types of activities and may qualify for expedited processing of other required notices or applications. Additionally, one of the criteria that determines a bank holding company’s eligibility to operate as a financial holding company is a requirement that all of its financial institution subsidiaries be “well-capitalized.” Under the

~~Table of Contents~~

regulations of the Federal Reserve, in order to be “well-capitalized” a financial institution must maintain a ratio of total capital to total risk-weighted assets of 10% or greater, a ratio of Tier 1 capital to total risk-weighted assets of 6% or greater and a ratio of Tier 1 capital to total assets of 5% or greater.

As of December 31, 2008: (i) the Bank was not subject to a directive from the Federal Reserve to increase its capital to an amount in excess of the minimum regulatory capital requirements; (ii) the Bank exceeded its minimum regulatory capital requirements under Federal Reserve capital adequacy guidelines; and (iii) the Bank was “well-capitalized,” as defined by Federal Reserve regulations.

~~Dividend Payments.~~ The primary source of funds for the Company is dividends from the Bank. Indiana law prohibits the Bank from paying dividends in an amount greater than its undivided profits. The Bank is required to obtain the approval of the DFI for the payment of any dividend if the total of all dividends declared by the Bank during the calendar year, including the proposed dividend, would exceed the sum of the Bank’s net income for the year to date combined with its retained net income for the previous two years. Indiana law defines “retained net income” to mean the net income of a specified period, calculated under the consolidated report of income instructions, less the total amount of all dividends declared for the specified period. The Federal Reserve Act also imposes limitations on the amount of dividends that may be paid by state member banks, such as the Bank. Without Federal Reserve approval, a state member bank may not pay dividends in any calendar year that, in the aggregate, exceed the bank’s calendar year-to-date net income plus the bank’s retained net income for the two preceding calendar years.

The payment of dividends by any financial institution is affected by the requirement to maintain adequate capital pursuant to applicable capital adequacy guidelines and regulations, and a financial institution generally is prohibited from paying any dividends if, following payment thereof, the institution would be undercapitalized. As described above, the Bank exceeded its minimum capital requirements under applicable guidelines as of December 31, 2008. As of December 31, 2008, approximately $2.0 million was available to be paid as dividends by the Bank. Notwithstanding the availability of funds for dividends, however, the Federal Reserve may prohibit the payment of any dividends by the Bank if the Federal Reserve determines such payment would constitute an unsafe or unsound practice.

~~Insider Transactions.~~ The Bank is subject to certain restrictions imposed by federal law on extensions of credit to the Company, on investments in the stock or other securities of the Company and the acceptance of the stock or other securities of the Company as collateral for loans made by the Bank. Certain limitations and reporting requirements are also placed on extensions of credit by the Bank to its directors and officers, to directors and officers of the Company, to principal shareholders of the Company and to “related interests” of such directors, officers and principal shareholders. In addition, federal law and regulations may affect the terms upon which any person who is a director or officer of the Company or the Bank or a principal shareholder of the Company may obtain credit from banks with which the Bank maintains a correspondent relationship.

~~Safety and Soundness Standards.~~ The federal banking agencies have adopted guidelines that establish operational and managerial standards to promote the safety and soundness of federally insured depository institutions. The guidelines set forth standards for internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, asset quality and earnings.

~~Table of Contents~~

institution to submit a plan for achieving and maintaining compliance. If an institution fails to submit an acceptable compliance plan, or fails in any material respect to implement a compliance plan that has been accepted by its primary federal regulator, the regulator is required to issue an order directing the institution to cure the deficiency. Until the deficiency cited in the regulator’s order is cured, the regulator may restrict the institution’s rate of growth, require the institution to increase its capital, restrict the rates the institution pays on deposits or require the institution to take any action the regulator deems appropriate under the circumstances. Noncompliance with the standards established by the safety and soundness guidelines may also constitute grounds for other enforcement action by the federal banking regulators, including cease and desist orders and civil money penalty assessments.

~~Branching Authority.~~ ~~Indiana banks, such as the Bank, have the authority under Indiana law to establish branches anywhere in the State of Indiana, subject to receipt of all required regulatory approvals.~~

~~State Bank Investments and Activities.~~ The Bank generally is permitted to make investments and engage in activities directly or through subsidiaries as authorized by Indiana law. However, under federal law and FDIC regulations, FDIC-insured state banks are prohibited, subject to certain exceptions, from making or retaining equity investments of a type, or in an amount, that are not permissible for a national bank. Federal law and FDIC regulations also prohibit FDIC-insured state banks and their subsidiaries, subject to certain exceptions, from engaging as principal in any activity that is not permitted for a national bank unless the bank meets, and continues to meet, its minimum regulatory capital requirements and the FDIC determines the activity would not pose a significant risk to the deposit insurance fund of which the bank is a member. These restrictions have not had, and are not currently expected to have, a material impact on the operations of the Bank.

~~Federal Reserve System.~~ Federal Reserve regulations, as presently in effect, require depository institutions to maintain reserves against their transaction accounts (primarily NOW and regular checking accounts), as follows: for transaction accounts aggregating $44.4 million or less, the reserve requirement is 3% of total transaction accounts; and for transaction accounts aggregating in excess of $44.4 million, the reserve requirement is $1.023 million plus 10% of the aggregate amount of total transaction accounts in excess of $44.4 million. The first $10.3 million of otherwise reservable balances are exempted from the reserve requirements. These reserve requirements are subject to annual adjustment by the Federal Reserve. The Bank is in compliance with the foregoing requirements.

~~INDUSTRY SEGMENTS~~

The Company’s chief decision-makers monitor and evaluate financial performance on a Company-wide basis. All of the Company’s financial service operations are similar and considered by management to be aggregated into one reportable operating segment. While the Company has assigned certain management responsibilities by region and business-line, the Company’s chief decision-makers monitor and evaluate financial performance on a Company-wide basis. The majority of the Company’s revenue is from the business of banking and the Company’s assigned regions have similar economic characteristics, products, services and customers. Accordingly, all of the Company’s operations are considered by management to be aggregated in one reportable operating segment.

~~GUIDE 3 INFORMATION~~

~~Table of Contents~~

~~DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS’ EQUITY;~~
~~INTEREST RATES AND INTEREST DIFFERENTIAL~~
~~(in thousands of dollars)~~

2008

2007

Average
Balance

Interest
Income

Yield (1)

Average
Balance

Interest
Income

Yield (1)

ASSETS

Earning assets:

Loans:

Taxable (2)(3)

$
1,662,355

$
99,538

5.99
%
$
1,401,480

$
102,840

7.34
%
Tax exempt (1)

2,669

147

5.51

2,588

166

6.41

Investments: (1)

Available for sale

368,578

19,731

5.35

306,293

15,140

4.94

Short-term investments

12,136

171

1.41

17,412

863

4.96

Interest bearing deposits

2,045

49

2.40

1,486

68

4.58

Total earning assets

2,047,783

119,636

5.84
%

1,729,259

119,077

6.89
%

Nonearning assets:

Cash and due from banks

41,302

0

44,565

0

Premises and equipment

28,200

0

26,042

0

Other nonearning assets

70,986

0

54,220

0

Less allowance for loan losses

(17,597
)

0

(15,045
)

0

Total assets

$
2,170,674

$
119,636

$
1,839,041

$
119,077



(2)
~~(1)~~	Tax exempt income was converted to a fully taxable equivalent basis at a 35 percent tax rate for 2008 and 2007. The tax equivalent rate for tax exempt loans and tax exempt securities acquired after January 1, 1983 included the TEFRA adjustment applicable to nondeductible interest expenses.

~~(2)~~	Loan fees, which are immaterial in relation to total taxable loan interest income for the years ended December 31, 2009 and 2008, are included as taxable loan interest income.

(3)	Nonaccrual loans are included in the average balance of taxable loans.

Table of Contents

DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY;

INTEREST RATES AND INTEREST DIFFERENTIAL (Cont.)

(in thousands of dollars)

				2008								2007
	Average			Interest					Average			Interest
	Balance			Income		Yield (1)			Balance			Income		Yield (1)
ASSETS
Earning assets:
Loans:
Taxable (2)(3)	$	1,662,355		$	99,538		5.99	%	$	1,401,480		$	102,840		7.34	%
Tax exempt (1)		2,669			147		5.51			2,588			166		6.41

Investments: (1)
Available for sale		368,578			19,731		5.35			306,293			15,140		4.94

Short-term investments		12,136			171		1.41			17,412			863		4.96

Interest bearing deposits		2,045			49		2.40			1,486			68		4.58

Total earning assets		2,047,783			119,636		5.84	%		1,729,259			119,077		6.89	%

Nonearning assets:
Cash and due from banks		41,302			0					44,565			0

Premises and equipment		28,200			0					26,042			0

Other nonearning assets		70,986			0					54,220			0

Less allowance for loan losses		(17,597	)		0					(15,045	)		0

Total assets	$	2,170,674		$	119,636				$	1,839,041		$	119,077

(1)	Tax exempt income was converted to a fully taxable equivalent basis at a 35 percent tax rate for 2008 and 2007. The tax equivalent rate for tax exempt loans and tax exempt securities acquired after January 1, 1983 included the TEFRA adjustment applicable to nondeductible interest expenses.

(2)	Loan fees, which are immaterial in relation to total taxable loan interest income for the years ended December 31, 2008 and 2007, are included as taxable loan interest income.

(3)	Nonaccrual loans are included in the average balance of taxable loans.

Table of Contents

DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY;

INTEREST RATES AND INTEREST DIFFERENTIAL (Cont.)

(in thousands of dollars)

			2009							2008
	Average		Interest					Average		Interest
	Balance		Expense		Yield			Balance		Expense		Yield
LIABILITIES AND STOCKHOLDERS'
EQUITY

Interest bearing liabilities:
Savings deposits	$	70,202	$	100		0.14	%	$	64,877	$	64		0.10	%

Interest bearing checking accounts		572,539		5,790		1.01			495,057		9,979		2.02

Time deposits:
In denominations under $100,000		359,526		15,356		4.27			329,783		13,924		4.22
In denominations over $100,000		638,956		11,001		1.72			528,316		20,613		3.90

Miscellaneous short-term borrowings		272,224		1,089		0.40			278,451		5,620		2.02

Long-term borrowings and
subordinated debentures		72,792		2,726		3.74			86,230		5,016		5.82

Total interest bearing liabilities		1,986,239		36,062		1.82	%		1,782,714		55,216		3.10	%

Noninterest bearing liabilities
and stockholders' equity:
Demand deposits		229,009		0					219,762		0

Other liabilities		19,354		0					17,138		0

Stockholders' equity		212,351		0					151,060		0

Total liabilities and stockholders'
equity	$	2,446,953	$	36,062				$	2,170,674	$	55,216

Net interest differential - yield on
average daily earning assets			$	81,528		3.51	%			$	64,420		3.14	%

Table of Contents

DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY;

INTEREST RATES AND INTEREST DIFFERENTIAL (Cont.)

(in thousands of dollars)

			2008							2007
	Average		Interest					Average		Interest
	Balance		Expense		Yield			Balance		Expense		Yield
LIABILITIES AND STOCKHOLDERS'
EQUITY

Interest bearing liabilities:
Savings deposits	$	64,877	$	64		0.10	%	$	67,104	$	133		0.20	%

Interest bearing checking accounts		495,057		9,979		2.02			425,753		14,854		3.49

Time deposits:
In denominations under $100,000		329,783		13,924		4.22			295,328		14,289		4.84
In denominations over $100,000		528,316		20,613		3.90			462,056		24,338		5.27

Miscellaneous short-term borrowings		278,451		5,620		2.02			177,343		7,239		4.08

Long-term borrowings and
subordinated debentures (1)		86,230		5,016		5.82			30,972		2,628		8.49

Total interest bearing liabilities		1,782,714		55,216		3.10	%		1,458,556		63,481		4.35	%

Noninterest bearing liabilities
and stockholders' equity:
Demand deposits		219,762		0					226,484		0

Other liabilities		17,138		0					16,234		0

Stockholders' equity		151,060		0					137,767		0

Total liabilities and stockholders'
equity	$	2,170,674	$	55,216				$	1,839,041	$	63,481

Net interest differential - yield on
average daily earning assets			$	64,420		3.14	%			$	55,596		3.22	%

(1)	Long-term borrowings and subordinated debentures interest expense was reduced by interest capitalized on construction in process for 2007.

Table of Contents

ANALYSIS OF CHANGES IN INTEREST DIFFERENTIALS

(fully taxable equivalent basis)

(in thousands of dollars)

YEAR ENDED DECEMBER 31,

	2009 Over (Under) 2008 (1)									2008 Over (Under) 2007 (1)
	Volume			Rate			Total			Volume			Rate			Total
INTEREST AND LOAN FEE INCOME (2)
Loans:
Taxable	$	13,045		$	(16,432	)	$	(3,387	)	$	17,372		$	(20,674	)	$	(3,302	)
Tax exempt		75			(23	)		52			5			(24	)		(19	)
Investments:
Available for sale		1,633			(185	)		1,448			3,260			1,331			4,591

Short-term investments		83			(219	)		(136	)		(206	)		(486	)		(692	)

Interest bearing deposits		(9	)		(14	)		(23	)		20			(39	)		(19	)

Total interest income		14,827			(16,873	)		(2,046	)		20,451			(19,892	)		559

INTEREST EXPENSE
Savings deposits		6			30			36			(4	)		(65	)		(69	)
Interest bearing checking accounts		1,376			(5,565	)		(4,189	)		2,134			(7,009	)		(4,875	)

Time deposits:
In denominations under $100,000		1,269			163			1,432			1,566			(1,931	)		(365	)
In denominations over $100,000		3,659			(13,271	)		(9,612	)		3,168			(6,893	)		(3,725	)

Miscellaneous short-term borrowings		(123	)		(4,408	)		(4,531	)		3,021			(4,640	)		(1,619	)

Long-term borrowings and
subordinated debentures		(697	)		(1,593	)		(2,290	)		3,435			(1,047	)		2,388

Total interest expense		5,490			(24,644	)		(19,154	)		13,320			(21,585	)		(8,265	)

INCREASE (DECREASE) IN
INTEREST DIFFERENTIALS	$	9,337		$	7,771		$	17,108		$	7,131		$	1,693		$	8,824

(1)	The earning assets and interest bearing liabilities used to calculate interest differentials are based on average daily balances for 2009, 2008 and 2007. The changes in volume represent "changes in volume times the old rate". The changes in rate represent "changes in rate times old volume". The changes in rate/volume were also calculated by "change in rate times change in volume" and allocated consistently based upon the relative absolute values of the changes in volume and changes in rate.

(2)	Tax exempt income was converted to a fully taxable equivalent basis at a 35 percent tax rate for 2009, 2008 and 2007. The tax equivalent rate for tax exempt loans and tax exempt securities acquired after January 1, 1983 included the TEFRA adjustment applicable to nondeductible interest expense.

Table of Contents

ANALYSIS OF SECURITIES

(in thousands of dollars)

The amortized cost and the fair value of securities as of December 31, 2009, 2008 and 2007 were as follows:

	2009				2008				2007
	Amortized		Fair		Amortized		Fair		Amortized		Fair
	Cost		Value		Cost		Value		Cost		Value
Securities available for sale:
U.S. Treasury securities	$	1,005	$	992	$	1,001	$	1,025	$	1,201	$	1,206
U.S. Government agencies		4,588		4,610		15,453		15,685		18,539		18,555
Mortgage-backed securities		264,276		270,796		225,892		229,571		205,335		205,202
Non-agency residential mortgage-backed securities		88,382		72,495		106,790		85,098		45,823		45,293
State and municipal securities		59,375		61,135		55,081		55,651		56,613		57,501

Total debt securities available for sale	$	417,626	$	410,028	$	404,217	$	387,030	$	327,511	$	327,757

At year-end 2009, there were no holdings of securities of any one issuer, other than the U.S. Government, government agencies and government sponsored agencies, in an amount greater than 10% of stockholders’ equity. At year-end 2008, there were no holdings of securities of any one issuer, other than the U.S. Government, government agencies and government sponsored agencies, in an amount greater than 10% of stockholders’ equity with the exception of Residential Accredit Loans, Inc., which had a book value of $21.3 million and a market value of $15.8 million, Countrywide Home Loans Alternative Loan Trust, which had a book value of $19.9 million and a market value of $15.1 million and Chase Mortgage Finance Trust, which had a book value of $17.4 million and a market value of $15.0 million. These are all Alt A or Whole Loan securities in the Super Senior tranches, which are the highest rated tranches with very high credit standards. In addition, the collateral of the Alt A or Whole Loan securities purchased must meet certain criteria set by the Company’s Asset Liability Management Committee including maximum loan-to-value and minimum FICO scores, consist of only fixed-rate mortgages and must be AAA rated at the time of purchase. See Note 2 for more information on these investments. At year-end 2007, there were no holdings of securities of any one issuer, other than the U.S. Government, government agencies and government sponsored agencies, in an amount greater than 10% of stockholders’ equity with the exception of Residential Accredit Loans, Inc., which had a book value of $22.6 million and a market value of $22.3 million.

Table of Contents

ANALYSIS OF SECURITIES (cont.)

(fully tax equivalent basis)

(in thousands of dollars)

The weighted average yields and maturity distribution for debt securities portfolio at December 31, 2009, were as follows:

				After One			After Five
	Within			Year			Years			Over
	One			Within			Within Ten			Ten
	Year			Five Years			Years			Years

Securities available for sale:

US Treasury securities
Fair value	$	0		$	992		$	0		$	0
Yield		0	%		2.38	%		0	%		0	%

U.S. Government agencies
Fair value		4,610			0			0			0
Yield		3.88	%		0	%		0	%		0	%

Mortgage-backed securities
Fair value		0			13,977			70,382			186,437
Yield		0	%		5.14	%		5.00	%		5.09	%

Non-agency residential mortgage-backed securities
Fair value		0			0			5,648			66,847
Yield		0	%		0	%		5.00	%		5.66	%

State and municipal securities
Fair value		216			5,341			37,107			18,471
Yield		4.90	%		4.08	%		4.47	%		4.28	%


Total debt securities available for sale:
Fair value	$	4,826		$	20,310		$	113,137		$	271,755
Yield		3.92	%		4.73	%		4.82	%		5.18	%

Table of Contents

ANALYSIS OF LOAN PORTFOLIO

Analysis of Loans Outstanding

(in thousands of dollars)

The Company segregates its loan portfolio into four basic segments: commercial (including agricultural loans), residential real estate mortgages, installment and personal line of credit loans (including credit card loans). The loan portfolio as of December 31, 2009, 2008, 2007, 2006 and 2005 was as follows:

	2009			2008			2007			2006			2005
Commercial loans:
Taxable	$	1,697,449		$	1,522,523		$	1,238,623		$	1,081,420		$	960,046
Tax exempt		2,085			10,493			1,971			4,991			4,512

Total commercial loans		1,699,534			1,533,016			1,240,594			1,086,411			964,558

Residential real estate mortgage loans		95,211			117,230			124,107			109,176			74,820

Installment loans		51,878			51,174			49,185			52,548			67,964

Line of credit and credit card loans		167,194			132,147			109,760			105,762			91,426

Subtotal loans		2,013,817			1,833,567			1,523,646			1,353,897			1,198,768

Less: Allowance for loan losses		(32,073	)		(18,860	)		(15,801	)		(14,463	)		(12,774	)
Net deferred loan (fees)/costs		(1,807	)		(233	)		74			(60	)		(38	)

Net loans	$	1,979,937		$	1,814,474		$	1,507,919		$	1,339,374		$	1,185,956

The residential real estate mortgage loan portfolio included construction loans totaling $5,790, $6,468, $5,252, $8,636 and $7,987 as of December 31, 2009, 2008, 2007, 2006 and 2005. The Bank generally sells conforming mortgage loans which it originates. These loans generally represent mortgage loans that are made to clients with long-term or substantial relationships with the Bank on terms consistent with secondary market requirements. The loan classifications are based on the nature of the loans as of the loan origination date. There were no foreign loans included in the loan portfolio for the periods presented.

Table of Contents

ANALYSIS OF LOAN PORTFOLIO (cont.)

Analysis of Loans Outstanding (cont.)

(in thousands of dollars)

Repricing opportunities of the loan portfolio occur either according to predetermined adjustable rate schedules included in the related loan agreements or upon maturity of each principal payment. The following table indicates the scheduled maturities of the loan portfolio as of December 31, 2009.

			Residential
			Real
			Estate				Line of
	Commercial		Mortgage		Installment		Credit		Total		Percent

Original maturity of one day	$	0	$	0	$	0	$	106,637	$	106,637		5.30	%

Other within one year		766,059		18,418		16,489		20,199	$	821,165		40.78

After one year, within five years		779,741		20,728		33,245		16,148	$	849,862		42.20

Over five years		124,589		54,692		2,144		24,210	$	205,635		10.21

Nonaccrual loans		29,145		1,373		0		0	$	30,518		1.52

Total loans	$	1,699,534	$	95,211	$	51,878	$	167,194	$	2,013,817		100.0	%

At maturity, credits are reviewed and, if renewed, are renewed at rates and conditions that prevail at the time of maturity.

Loans due after one year which have a predetermined interest rate and loans due after one year which have floating or adjustable interest rates as of December 31, 2009 amounted to $680,527 and $374,970.

Table of Contents

ANALYSIS OF LOAN PORTFOLIO (cont.)

Review of Nonperforming Loans

(in thousands of dollars)

The following is a summary of nonperforming loans as of December 31, 2009, 2008, 2007, 2006 and 2005.

	2009		2008		2007		2006		2005
PART A - PAST DUE ACCRUING LOANS (90 DAYS OR MORE)

Residential real estate mortgage loans	$	0	$	126	$	155	$	0	$	89

Commercial and industrial loans		0		81		65		154		0

Loans to individuals for household, family and
other personal expenditures		190		271		189		145		85

Loans to finance agriculture production and
other loans to farmers		0		0		0		0		0

Total past due loans		190		478		409		299		174


PART B - NONACCRUAL LOANS

Residential real estate mortgage loans		1,373		757		18		132		132

Commercial and industrial loans		28,373		20,053		7,021		13,688		7,189

Loans to individuals for household, family and
other personal expenditures		0		0		0		0		0

Loans to finance agriculture production and
other loans to farmers		772		0		0		0		0

Total nonaccrual loans		30,518		20,810		7,039		13,820		7,321

PART C - TROUBLED DEBT RESTRUCTURED LOANS		0		0		0		0		0

Total nonperforming loans	$	30,708	$	21,288	$	7,448	$	14,119	$	7,495

Nonearning assets of the Company include nonperforming loans (as indicated above), nonaccrual investments and other real estate and repossessions, the total of which amounted to $31,582 at December 31, 2009.

Table of Contents

ANALYSIS OF LOAN PORTFOLIO (cont.)

Comments Regarding Nonperforming Assets

PART A - CONSUMER LOANS

Consumer installment loans, except those loans that are secured by real estate, are not placed on nonaccrual status since these loans are charged-off when they have been delinquent from 90 to 180 days, and when the related collateral, if any, is not sufficient to offset the indebtedness. Advances under consumer line of credit programs are charged-off when collection appears doubtful.

PART B - NONPERFORMING LOANS

When a loan is classified as a nonaccrual loan, interest on the loan is no longer accrued and all accrued interest receivable is charged-off. It is the policy of the Bank that all loans for which the collateral is insufficient to cover all principal and accrued interest will be reclassified as nonperforming loans to the extent they are unsecured, on or before the date when the loan becomes 90 days delinquent. Thereafter, interest is recognized and included in income only when received. Interest not recorded on nonaccrual loans is referenced in Footnote 4 in Item 8 below.

As of December 31, 2009, there were $30.5 million of loans on nonaccrual status, some of which were also on impaired status. There were $31.8 million of loans classified as impaired.

PART C - TROUBLED DEBT RESTRUCTURED LOANS

Loans renegotiated as troubled debt restructurings are those loans for which either the contractual interest rate has been reduced and/or other concessions are granted to the borrower because of a deterioration in the financial condition of the borrower which results in the inability of the borrower to meet the terms of the loan.

As of December 31, 2009 there were $6.5 million of loans renegotiated as troubled debt restructurings. These loans were excluded from troubled debt restructured loans in the previous table because they were included in nonaccrual loans. As of December 31, 2008, there were no loans renegotiated as troubled debt restructurings.

PART D - OTHER NONPERFORMING ASSETS

Management is of the opinion that there are no significant foreseeable losses relating to nonperforming assets, as defined in the preceding table, or classified loans, except as discussed above in Part B – Nonperforming Loans and Part C – Troubled Debt Restructured Loans.

PART E - LOAN CONCENTRATIONS

There were no loan concentrations within industries not otherwise disclosed, which exceeded ten percent of total loans except commercial real estate. Commercial real estate was $544.3 million at December 31, 2009. Nearly all of the Bank’s commercial, industrial, agricultural real estate mortgage, real estate construction mortgage and consumer loans are made within its basic service area.

Table of Contents

Basis For Determining Allowance For Loan Losses:

The allowance is an amount that management believes will be adequate to absorb probable incurred credit losses relating to specifically identified loans based on an evaluation, as well as other probable incurred losses inherent in the loan portfolio. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, and current economic conditions that may affect the borrower’s ability to repay. Management also considers trends in adversely classified loans based upon a monthly review of those credits. An appropriate level of general allowance is determined after considering the following: application of historical loss percentages, emerging market risk, emerging concentrations, commercial loan focus and large credit concentration, new industry lending activity and general economic conditions. For a more thorough discussion of the allowance for loan losses methodology see the Critical Accounting Policies section of Item 7.

Based upon these policies and objectives, $21.2 million, $10.2 million and $4.3 million were charged to the provision for loan losses and added to the allowance for loan losses in 2009, 2008 and 2007.

The allocation of the allowance for loan losses to the various lending areas is performed by management in relation to perceived exposure to loss in the various loan portfolios. However, the allowance for loan losses is available in its entirety to absorb losses in any particular loan category. Although management believes that the allowance for loan losses is adequate to absorb probable incurred losses on any existing loans, management cannot predict loan losses with any certainty, and the Company cannot guarantee that the allowance for loan losses will prove sufficient to cover actual losses in the future.

Table of Contents

ANALYSIS OF LOAN PORTFOLIO (cont.)

Summary of Loan Loss

(in thousands of dollars)

The following is a summary of the loan loss experience for the years ended December 31, 2009, 2008, 2007, 2006 and 2005.

	2009			2008			2007			2006			2005

Amount of loans outstanding, December 31,	$	2,012,010		$	1,833,335		$	1,523,720		$	1,353,837		$	1,198,730

Average daily loans outstanding during the year
ended December 31,	$	1,901,746		$	1,665,024		$	1,404,068		$	1,270,484		$	1,088,788

Allowance for loan losses, January 1,	$	18,860		$	15,801		$	14,463		$	12,774		$	10,754

Loans charged-off:
Commercial		7,251			6,726			2,381			905			317
Residential real estate		337			72			16			0			8
Installment		674			805			537			145			164
Credit cards and personal credit lines		249			3			458			22			112

Total loans charged-off		8,511			7,606			3,392			1,072			601

Recoveries of loans previously charged-off:
Commercial		337			147			252			53			37
Residential real estate		0			16			27			0			0
Installment		173			200			124			52			89
Credit cards and personal credit lines		12			95			29			12			15

Total recoveries		522			458			432			117			141

Net loans charged-off		7,989			7,148			2,960			955			460
Provision for loan loss charged to expense		21,202			10,207			4,298			2,644			2,480

Balance, December 31,	$	32,073		$	18,860		$	15,801		$	14,463		$	12,774

Ratio of net charge-offs during the period to
average daily loans outstanding:
Commercial		0.36	%		0.40	%		0.15	%		0.07	%		0.02	%
Residential real estate		0.02			0.00			0.00			0.00			0.00
Installment		0.03			0.04			0.03			0.01			0.01
Credit cards and personal credit lines		0.01			(0.01	)		0.03			0.00			0.01

Total ratio of net charge-offs		0.42	%		0.43	%		0.21	%		0.08	%		0.04	%

Ratio of allowance for loan losses to
nonperforming assets		101.55	%		84.23	%		160.27	%		101.67	%		169.87	%

Table of Contents

ANALYSIS OF LOAN PORTFOLIO (cont.)

Allocation of Allowance for Loan Losses

(in thousands of dollars)

The following is a summary of the allocation for loan losses as of December 31, 2009, 2008, 2007, ~~are included as taxable loan interest income.~~

~~(3)~~

~~Nonaccrual loans are included~~ 2006 and 2005.

	2009					2008					2007
	Allowance		Loans as			Allowance		Loans as			Allowance		Loans as
	For		Percentage			For		Percentage			For		Percentage
	Loan		of Gross			Loan		of Gross			Loan		of Gross
	Losses		Loans			Losses		Loans			Losses		Loans
Allocated allowance for loan losses:
Commercial	$	28,014		84.39	%	$	15,738		83.61	%	$	13,659		81.42	%
Residential real estate		365		4.73			292		6.39			571		8.15
Installment		453		2.58			384		2.79			421		3.23
Credit cards and personal credit lines		538		8.30			996		7.21			828		7.20

Total allocated allowance for loan losses		29,370		100.00	%		17,410		100.00	%		15,479		100.00	%

Unallocated allowance for loan losses		2,703					1,450					322

Total allowance for loan losses	$	32,073				$	18,860				$	15,801

	2006					2005
	Allowance		Loans as			Allowance		Loans as
	For		Percentage			For		Percentage
	Loan		of Gross			Loan		of Gross
	Losses		Loans			Losses		Loans
Allocated allowance for loan losses:
Commercial	$	12,185		80.24	%	$	10,870		80.46	%
Residential real estate		389		8.07			187		6.24
Installment		690		6.20			509		5.67
Credit cards and personal credit lines		561		5.49			688		7.63

Total allocated allowance for loan losses		13,825		100.00	%		12,254		100.00	%

Unallocated allowance for loan losses		638					520

Total allowance for loan losses	$	14,463				$	12,774

Table of Contents

ANALYSIS OF DEPOSITS

(in ~~the~~thousands of dollars)

The average ~~balance of taxable loans.~~

~~Table of Contents~~

~~DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS’ EQUITY;~~
~~INTEREST RATES AND INTEREST DIFFERENTIAL (Cont.)~~
~~(in thousands of dollars)~~

2007

2006

Average
Balance

Interest
Income

Yield (1)

Average
Balance

Interest
Income

Yield (1)

ASSETS

Earning assets:

Loans:

Taxable (2)(3)

$
1,401,480

$
102,840

7.34
%
$
1,264,490

$
91,946

7.27
%
Tax exempt (1)

2,588

166

6.41

5,995

328

5.47

Investments: (1)

Available for sale

306,293

15,140

4.94

293,931

13,609

4.63

Short-term investments

17,412

863

4.96

12,896

647

5.02

Interest bearing deposits

1,486

68

4.58

3,269

151

4.62

Total earning assets

1,729,259

119,077

6.89
%

1,580,581

106,681

6.75
%

Nonearning assets:

Cash and due from banks

44,565

0

56,235

0

Premises and equipment

26,042

0

24,750

0

Other nonearning assets

54,220

0

50,597

0

Less allowance for loan losses

(15,045
)

0

(13,692
)

0

Total assets

$
1,839,041

$
119,077

$
1,698,471

$
106,681

~~(1)~~

Tax exempt income was converted to a fully taxable equivalent basis at a 35 percent tax rate for 2007 and 2006. The tax equivalent rate for tax exempt loans and tax exempt securities acquired after January 1, 1983 included the TEFRA adjustment applicable to nondeductible interest expenses.

~~(2)~~

~~Loan fees, which are immaterial in relation to total taxable loan interest income~~daily deposits for the years ended December 31, 2009, 2008 and 2007, and ~~2006,~~the average rates paid on those deposits are ~~included~~summarized in the following table:

	2009					2008					2007
	Average		Average			Average		Average			Average		Average
	Daily		Rate			Daily		Rate			Daily		Rate
	Balance		Paid			Balance		Paid			Balance		Paid

Demand deposits	$	229,009		0.00	%	$	219,762		0.00	%	$	226,484		0.00	%

Savings and transaction accounts:
Regular savings		70,202		0.14			64,877		0.10			67,104		0.20
Interest bearing checking		572,539		1.01			495,057		2.02			425,753		3.49

Time deposits:
Deposits of $100,000 or more		638,956		1.72			528,316		3.90			462,056		5.27
Other time deposits		359,526		4.27			329,783		4.22			295,328		4.84

Total deposits	$	1,870,232		1.72	%	$	1,637,795		2.72	%	$	1,476,725		3.63	%

As of December 31, 2009, time certificates of deposit will mature as ~~taxable loan~~follows:

	$100,000		% of					% of
	or more		Total			Other		Total

Within three months	$	147,136		27.31	%	$	61,639		18.80	%

Over three months, within six months		82,596		15.33			71,485		21.80

Over six months, within twelve months		206,038		38.24			119,928		36.56

Over twelve months		103,044		19.12			74,897		22.84

Total time certificates of deposit	$	538,814		100.00	%	$	327,949		100.00	%

Table of Contents

QUALITATIVE MARKET RISK DISCLOSURE

Management’s market risk disclosure appears under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7, below, and is incorporated herein by reference in response to this item. The Company’s primary market risk exposure is interest ~~income.~~

~~(3)~~

~~Nonaccrual loans are included~~ rate risk. The Company does not have a material exposure to foreign currency exchange rate risk, does not own any material derivative financial instruments and does not maintain a trading portfolio.

RETURN ON EQUITY AND OTHER RATIOS

The rates of return on average daily assets and stockholders' equity, the dividend payout ratio, and the average daily stockholders' equity to average daily assets for the years ended December 31, 2009, 2008 and 2007 were as follows:

	2009			2008			2007

Percent of net income to:
Average daily total assets		0.78	%		0.91	%		1.04	%

Average daily stockholders' equity		8.94	%		13.04	%		13.94	%

Percentage of dividends declared per
common share to basic earnings per
weighted average number of common
shares outstanding (12,851,845
shares in 2009, 12,271,927 shares in
2008 and 12,188,594 shares in 2007)		48.82	%		37.58	%		34.49	%

Percentage of average daily
stockholders' equity to average
daily total assets		8.68	%		6.96	%		7.49	%

Cash dividends were declared on April 14, July 14, October 13, 2009 and January 12, 2010 for each quarter of 2009, April 8, July 8, October 14, 2008 and January 13, 2009 for each quarter of 2008 and April 10, July 10 and October 9, 2007 and January 8, 2008 for each quarter of 2007.

Table of Contents

SHORT-TERM BORROWINGS

(in thousands of dollars)

The following is a schedule, at the end of the year indicated, of statistical information relating to securities sold under agreement to repurchase maturing within one year and secured by either U.S. Government agency securities or mortgage-backed securities classified as other debt securities and other short-term borrowings maturing within one year. There were no other categories of short-term borrowings for which the average balance outstanding during the period was 30 percent or more of ~~taxable loans.~~

stockholders' equity at the end of each period.

~~Table of Contents~~

~~DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS’ EQUITY;~~
~~INTEREST RATES AND INTEREST DIFFERENTIAL (Cont.)~~
~~(in thousands of dollars)~~

2008

2007

Average
Balance

Interest
Expense

Yield

Average
Balance

Interest
Expense

Yield

LIABILITIES AND STOCKHOLDERS’ EQUITY

Interest bearing liabilities:

Savings deposits

$
64,877

$
64

0.10
%
$
67,104

$
133

0.20
%

Interest bearing checking accounts

495,057

9,979

2.02

425,753

14,854

3.49

Time deposits:

In denominations under $100,000

329,783

13,924

4.22

295,328

14,289

4.84

In denominations over $100,000

528,316

20,613

3.90

462,056

24,338

5.27

Miscellaneous short-term borrowings

278,451

5,620

2.02

177,343

7,239

4.08

Long-term borrowings and subordinated debentures (1)

86,230

5,016

5.82

30,972

2,628

8.49

Total interest bearing liabilities

1,782,714

55,216

3.10
%

1,458,556

63,481

4.35
%

Noninterest bearing liabilities and stockholders’ equity:

Demand deposits

219,762

0

226,484

0

Other liabilities

17,138

0

16,234

0

Stockholders’ equity

151,060

0

137,767

0

Total liabilities and stockholders’ equity

$
2,170,674

$
55,216

$
1,839,041

$
63,481

~~(1)~~

~~Long-term~~

	2009			2008			2007

Outstanding at year end:
Federal funds purchased	$	9,600		$	19,000		$	70,010
Securities sold under agreements to repurchase	$	127,118		$	137,769		$	154,913
Other short-term borrowings	$	215,000		$	45,000		$	90,000

Approximate average interest rate at year end:
Federal funds purchased		0.50	%		0.50	%		4.07	%
Securities sold under agreements to repurchase		0.42	%		0.43	%		3.20	%
Other short-term borrowings		0.38	%		0.65	%		4.31	%

Highest amount outstanding as of any month end
during the year:
Federal funds purchased	$	94,300		$	126,700		$	96,850
Securities sold under agreements to repurchase	$	133,072		$	175,427		$	154,913
Other short-term borrowings	$	220,000		$	163,700		$	90,000

Approximate average outstanding during the year:
Federal funds purchased	$	25,195		$	50,171		$	22,950
Securities sold under agreements to repurchase	$	125,195		$	153,363		$	121,372
Other short-term borrowings	$	119,849		$	73,981		$	32,247

Approximate average interest rate during the year:
Federal funds purchased		0.56	%		2.53	%		5.33	%
Securities sold under agreements to repurchase		0.46	%		1.85	%		3.52	%
Other short-term borrowings		0.39	%		2.09	%		5.09	%

Securities sold under agreements to repurchase include fixed-rate, term transactions initiated by the Bank, as well as corporate sweep accounts. Other short-term borrowings consist of Federal Home Loan Bank advances and ~~subordinated debentures interest expense was reduced by interest capitalized on construction in process for 2007.~~

Federal Reserve TAF borrowings.

Table ~~of Contents~~

~~DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS’ EQUITY;~~
~~INTEREST RATES AND INTEREST DIFFERENTIAL (Cont.)~~
~~(in thousands of dollars)~~

2007

2006

Average
Balance

Interest
Expense

Yield

Average
Balance

Interest
Expense

Yield

LIABILITIES AND STOCKHOLDERS’ EQUITY

Interest bearing liabilities:

Savings deposits

$
67,104

$
133

0.20
%
$
67,818

$
143

0.21
%

Interest bearing checking accounts

425,753

14,854

3.49

405,209

12,789

3.16

Time deposits:

In denominations under $100,000

295,328

14,289

4.84

264,087

10,787

4.08

In denominations over $100,000

462,056

24,338

5.27

430,378

21,382

4.97

Miscellaneous short-term borrowings

177,343

7,239

4.08

144,637

5,594

3.87

Long-term borrowings and subordinated debentures (1)

30,972

2,628

8.49

30,973

2,529

8.17

Total interest bearing liabilities

1,458,556

63,481

4.35
%

1,343,102

53,224

3.96
%

Noninterest bearing liabilities and stockholders’ equity:

Demand deposits

226,484

0

219,997

0

Other liabilities

16,234

0

13,418

0

Stockholders’ equity

137,767

0

121,954

0

Total liabilities and stockholders’ equity

$
1,839,041

$
63,481

$
1,698,471

$
53,224

Net interest differential - yield on average daily earning assets

$
55,596

3.22
%

$
53,457

3.38
%


~~(1)~~	~~Long-term borrowings and subordinated debentures interest expense was reduced by interest capitalized on construction in process for 2007.~~

~~Table of Contents~~

~~ANALYSIS OF CHANGES IN INTEREST DIFFERENTIALS~~
~~(fully taxable equivalent basis)~~
~~(in thousands of dollars)~~

~~YEAR ENDED DECEMBER 31,~~

2008 Over (Under) 2007 (1)

2007 Over (Under) 2006 (1)

Volume

Rate

Total

Volume

Rate

Total

INTEREST AND LOAN FEE INCOME (2)

Loans:

Taxable

$
17,372

$
(20,674
)
$
(3,302
)
$
10,045

$
849

$
10,894

Tax exempt

5

(24
)

(19
)

(211
)

49

(162
)
Investments:

Available for sale

3,260

1,331

4,591

587

944

1,531

Short-term investments

(206
)

(486
)

(692
)

224

(8
)

216

Interest bearing deposits

20

(39
)

(19
)

(82
)

(1
)

(83
)

Total interest income

20,451

(19,892
)

559

10,563

1,833

12,396

INTEREST EXPENSE

Savings deposits

(4
)

(65
)

(69
)

(1
)

(9
)

(10
)
Interest bearing checking accounts

2,134

(7,009
)

(4,875
)

671

1,394

2,065

Time deposits:

In denominations under $100,000

1,566

(1,931
)

(365
)

1,368

2,134

3,502

In denominations over $100,000

3,168

(6,893
)

(3,725
)

1,626

1,330

2,956

Miscellaneous short-term borrowings

3,021

(4,640
)

(1,619
)

1,321

324

1,645

Long-term borrowings and subordinated debentures

3,435

(1,047
)

2,388

0

99

99

Total interest expense

13,320

(21,585
)

(8,265
)

4,985

5,272

10,257

INCREASE (DECREASE) IN INTEREST DIFFERENTIALS

$
7,131

$
1,693

$
8,824

$
5,578

$
(3,439
)
$
2,139


~~(1)~~	The earning assets and interest bearing liabilities used to calculate interest differentials are based on average daily balances for 2008, 2007 and 2006. The changes in volume represent “changes in volume times the old rate”. The changes in rate represent “changes in rate times old volume”. The changes in rate/volume were also calculated by “change in rate times change in volume” and allocated consistently based upon the relative absolute values of ~~the changes in volume and changes in rate.~~

~~(2)~~	Tax exempt income was converted to a fully taxable equivalent basis at a 35 percent tax rate for 2008, 2007 and 2006. The tax equivalent rate for tax exempt loans and tax exempt securities acquired after January 1, 1983 included the TEFRA adjustment applicable to nondeductible interest expense.

Contents

ITEM 1a. RISK FACTORS

In addition to the other information in this Annual Report on Form 10-K, shareholders or prospective investors should carefully consider the following risk factors:

~~Our business may be adversely affected by conditions~~A continued downturn in the ~~financial markets and economic conditions generally.~~

~~The United States has been~~economy, particularly in a recession since December, 2007. Business activity across a wide range of industries and regions is greatly reduced and many businesses and local governments are experiencing serious difficulty in remaining profitable and providing services due to the lack of consumer spending and the lack of liquidity in the credit markets. Unemployment has increased significantly. Since mid-2007, and particularly during the second half of 2008, the financial services industry and the securities markets generally were materially and adversely affected by significant declines in the values of nearly all asset classes and by a serious lack of liquidity. This was initially triggered by declines in home prices and the values of subprime mortgages, but spread to all mortgage and real estate asset classes, to leveraged bank loans and to nearly all asset classes, including equities. The global markets have been characterized by substantially increased volatility and short-selling and an overall loss of investor confidence, initially in financial institutions, but more recently in companies in a number of other industries and in the broader markets.

Market conditions have also led to the failure or merger of a number of prominent financial institutions. Financial institution failures or near-failures have resulted in further losses as a consequence of defaults on securities issued by them and defaults under contracts entered into with such entities as counterparties. Furthermore, declining asset values, defaults on mortgages and consumer loans, and the lack of market and investor confidence, as well as other factors, have all combined to increase credit default swap spreads, to cause rating agencies to lower credit ratings, and to otherwise increase the cost and decrease the availability of liquidity, despite very significant declines in Federal Reserve borrowing rates and other government actions. Some banks and other lenders have suffered significant losses and have become reluctant to lend, even on a secured basis, due to the increased risk of default and the impact of declining asset values on the value of collateral. The foregoing has significantly weakened the strength and liquidity of some financial institutions worldwide. In 2008, the U.S. government, the Federal Reserve and other regulators have taken numerous steps to increase liquidity and to restore investor confidence, including committing to invest at least $250 billion in the equity of other banking organizations, but asset values have continued to decline and access to liquidity for many organizations continues to be very limited.

As a result of these financial economic crises, many lending institutions, including us, have experienced declines in the performance of their loans, including commercial loans, commercial real estate loans and consumer loans. Moreover, competition among depository institutions for deposits and quality loans has increased significantly. In addition, the values of real estate collateral supporting many commercial loans and home mortgages have declined and may continue to decline. Bank and bank holding company stock prices have been negatively affected, as has the ability of banks and bank holding companies to raise capital or borrow in the debt markets has become more difficult compared to recent years. As a result, there is a potential for new federal or state laws and regulations regarding lending and funding practices and liquidity standards, and bank regulatory agencies are expected to be very aggressive in responding to concerns and trends identified in examinations, including the expected issuance of many formal or informal enforcement actions or orders. The impact of new legislation in response to those developments, may negatively impact our operations by restrictingNorthern Indiana, where our business ~~operations, including our ability to originate or sell loans, and adversely impact our financial performance or our stock price.~~

In addition, further negative market developments may affect consumer confidence levels and may cause adverse changes in payment patterns, causing increases in delinquencies and default rates, which may impact our charge-offs and provision for credit losses. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on us and others in the financial services industry.

~~Overall, during the past year, the general business environment has had~~is primarily conducted, could have an adverse effect on our business, ~~and there can be no assurance that the environment will improve in the near term. Until conditions improve, we expect our business, financial condition and~~ results of operations ~~to be adversely affected.~~

~~Our business is concentrated in~~ and ~~dependent upon the continued growth and welfare of our primary market areas.~~financial condition.

We operate ~~primarily~~branch offices in four geographical markets ~~all of which are located~~concentrated in Northern Indiana and ~~are further described~~a loan production office in ~~the “Business” section included under Item 1 of Part I of this Form 10-K. We have developed a particularly strong presence~~central Indiana located in Indianapolis. Our most mature market, the South Region, ~~which~~ includes Kosciusko County and portions of contiguous

~~Table of Contents~~

~~counties,~~ counties. The Bank was founded in this market in 1872. Warsaw is this region’s primary city. The Bank entered the North Region in 1990, which includes portions of Elkhart and St. Joseph ~~County,~~counties. This region includes the cities of Elkhart and ~~the~~South Bend. The Central Region ~~which~~ includes portions of Elkhart County and contiguous ~~counties. These~~counties and is anchored by the city of Goshen. The North and Central regions represent ~~the more~~relatively mature ~~markets. In addition, we have experienced rapid growth in~~markets with nearly 20 years of business activity. We entered the East Region in 1999, which includes Allen and DeKalb ~~Counties. The Company also operates~~counties. Fort Wayne represents the primary city in this market. We have experienced rapid commercial loan growth in this market over the past 10 years. We entered the Indianapolis market in 2006 with the opening of a loan production office in ~~Indianapolis, which is staffed by commercial lending officers and consider our presence in this market as more mature and strong than in previous years.~~ Marion County.

Our success depends upon the business activity, population, income levels, deposits and real estate activity in these markets. Although our customers’ business and financial interests may extend well beyond these market areas, adverse economic conditions that affect these market areas could reduce our growth rate, affect the ability of our customers to repay their loans to us and generally affect our financial condition and results of operations. ~~Areas~~

In late 2007 and all of 2008 and 2009, the United States economy experienced a severe downturn. Certain areas of our geographical ~~market~~markets have seen notably worse economic conditions than those suffered by the country at-large. As reported for November 2009, the 13 counties in which we operate had unemployment rates between 9.5% and 14.5%. In particular, Elkhart County has suffered from adverse business and economic conditions that have resulted in ~~levels~~a county-wide level of unemployment of approximately 14.5%, which is well above the national ~~average. Because~~average of 9.6%. A continued downturn in economic conditions, particularly within our primary market areas in Northern Indiana, could result in a decrease in demand for our products and services, an increase in loan delinquencies and defaults and high or increased levels of problem assets and foreclosures. Moreover, because of our geographic concentration, we are less able than other regional or national financial institutions to diversify our credit risks across multiple markets.

Difficult economic and market conditions have adversely affected our industry.

we potentially face increased regulation of our industry and compliance with such regulation may increase our costs and limit our ability to pursue business opportunities;

customer demand for loans secured by real estate could be reduced due to weaker economic conditions, an increase in unemployment, a decrease in real estate values or an increase in interest rates;

the process we use to estimate losses inherent in our credit exposure requires difficult, subjective and complex judgments, including forecasts of economic conditions and how these economic

conditions might impair the ability of our borrowers to repay their loans. The level of uncertainty concerning economic conditions may adversely affect the accuracy of our estimates which may, in turn, impact the reliability of the process;

the value of the portfolio of investment securities that we hold may be adversely affected; and

we may be required to pay significantly higher FDIC premiums because market developments have significantly depleted the insurance fund of the FDIC and reduced the ratio of reserves to insured deposits.

We must effectively manage our credit risk.

There are risks inherent in making any loan, including risks inherent in dealing with individual borrowers, risks of nonpayment, risks resulting from uncertainties as to the future value of collateral and risks resulting from changes in economic and industry conditions. We attempt to minimize our credit risk through prudent loan application approval procedures, careful monitoring of the concentration of our loans within specific industries, a centralized credit administration department and periodic independent reviews of outstanding loans by our loan review department. However, we cannot make assurances that such approval and monitoring procedures will reduce these credit risks.

The majority of the Bank’s loan portfolio is invested in commercial and commercial real estate loans. The Bank focuses on traditional commercial and industrial lending but is also involved in commercial real estate activity in its markets. In general, commercial loans represent higher dollar volumes to fewer customers. As a result, we may assume greater lending risks than other community banking-type financial institutions that have a lesser concentration of such loans and are more retail oriented.

Commercial and industrial and agri-business loans make up a significant portion of our loan portfolio.

Commercial and industrial and agri-business loans were $899.8 million, or approximately 44.7% of our total loan portfolio, as of December 31, 2009. Our commercial loans are primarily made based on the identified cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. Most often, this collateral is accounts receivable, inventory, machinery or real estate. Credit support provided by the borrower for most of these loans and the probability of repayment is based on the liquidation of the pledged collateral and enforcement of a personal guarantee, if any exists. Whenever possible, we require a personal guarantee on commercial loans. As a result, in the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers. The collateral securing other loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business.

Our loan portfolio includes commercial real estate loans, which involve risks specific to real estate value.

Commercial real estate loans were $799.7 million, or approximately 39.7% of our total loan portfolio, as of December 31, 2009. The market value of real estate can fluctuate significantly in a short period of time as a result of market conditions in the geographic area in which the real estate is located. Although a significant portion of such loans are secured by real estate as a secondary form of collateral, continued adverse developments affecting real estate values in one or more of our markets could increase the credit risk associated with our loan portfolio. Additionally, real estate lending typically involves higher loan principal amounts and the repayment of the loans generally is dependent, in large part, on sufficient income from the properties securing the loans to cover operating expenses and debt service. Economic events or governmental regulations outside of the control of the borrower or lender could negatively impact the future cash flow and market values of the affected properties.

If the loans that are collateralized by real estate become troubled and the value of the real estate has been significantly impaired, then we may not be able to recover the full contractual amount of principal and interest that we anticipated at the time of originating the loan, which could cause us to increase our provision for loan losses and adversely affect our operating results and financial condition.

Our consumer loans generally have a higher degree of risk of default than our other loans.

At December 31, 2009, consumer loans totaled $57.5 million, or 2.9% of our total loan and lease portfolio. Consumer loans typically have shorter terms and lower balances with higher yields as compared to one-to-four

Our continued pace of growth may require us to raise additional capital in the future, but that capital may not be available when it is needed.

We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. ~~We anticipate that our existing capital resources will satisfy our capital requirements for the foreseeable future. We have~~In February 2009, we accepted a capital investment of $56.0 million under the ~~Department of~~U.S. Treasury’s ~~Troubled Asset Repurchase Program’s~~ Capital Purchase ~~Plan, which will~~Program, and in November 2009 we raised $57.9 million in a public offering of common stock to further strengthen our capital position. However, we may at some point need to raise additional capital to support our continued growth. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial performance. Accordingly, we cannot ~~assure you~~make assurances of our ability to raise additional capital, if needed, on terms acceptable to us. If we cannot raise additional capital when needed, our ability to further expand our operations through internal growth ~~de novo branching and/~~or acquisitions could be materially impaired.

Interest rates and other conditions impact our results of operations.

Our profitability is significantly driven by the spread between the interest rates earned on investments and loans and the interest rates paid on deposits and other interest-bearing liabilities. Like most banking institutions, our net interest spread and margin will be affected by general economic conditions and other factors, including fiscal and monetary policies of the federal government, that influence market interest rates and our ability to respond to changes in such rates. At any given time, our assets and liabilities will be such that they are affected differently by a given change in interest rates. As a result, an increase or decrease in rates, the length of loan terms or the mix of adjustable and fixed rate loans in our portfolio could have a positive or negative effect on our net income, capital and liquidity. We measure interest rate risk under various rate scenarios and using specific criteria and assumptions. A summary of this process, along with the results of our net interest income simulations is presented at “Quantitative and Qualitative Disclosures About Market Risk” included under Item 7a of Part II of this Form 10-K. Although we believe our current level of interest rate sensitivity is reasonable and effectively managed, significant fluctuations in interest rates may have an adverse effect on our business, ~~financial condition and~~ results of ~~operations.~~

operations and financial condition.

Our allowance for loan losses may prove to be insufficient to absorb potential losses in our loan portfolio.

We ~~established~~determined our allowance for loan losses pursuant to our established guidelines and practices and ~~maintain it at~~maintained a level considered adequate by management to absorb loan losses that are inherent in the portfolio. The amount of future loan losses is susceptible to changes in economic, operating and other conditions ~~( in~~(in our ~~market~~markets as well as the United States), including changes in interest rates, which may be beyond our control, and such losses may exceed current estimates. At December 31, ~~2008,~~2009, our allowance for loan losses as a percentage of total loans was ~~1.03%~~1.59% and as a percentage of total ~~non-performing~~nonperforming loans was ~~89%~~105%. Because of the nature of our loan portfolio and our concentration in commercial and industrial loans, which tend to be larger loans, the movement of a small number of loans to nonperforming status can have a significant impact on these ratios. Although management believes that the allowance for loan losses is adequate to absorb probable incurred losses on any existing loans, we cannot predict loan losses with certainty, and we cannot assure you that our allowance for loan losses will prove sufficient to cover actual loan losses in the future. Loan losses in excess of our reserves may adversely affect our business, ~~financial condition and~~ results of ~~operations.~~operations and financial condition.

Liquidity risks could affect operations and jeopardize our business, results of operations and financial condition.

Liquidity is essential to our business. An inability to raise funds through deposits, borrowings, the sale of loans and other sources could have a substantial negative effect on our liquidity. Our primary sources of funds consist of cash from operations, investment maturities and sales and deposits. Additional ~~information regarding~~liquidity is provided by brokered deposits, CDARS deposits, repurchase agreements and our ~~allowance for loan losses~~participation in the Federal Reserve Bank’s Term Auction Facility, as well as the ability to borrow from the Federal Reserve Bank and the ~~methodology we use~~Federal Home Loan Bank. However, the Federal Reserve Bank’s Term Auction Facility will no longer be available after March 8, 2010. Our access to ~~determine an appropriate level of reserves is located~~funding sources in amounts adequate to finance or capitalize our activities or on terms that are acceptable to us could be impaired by factors that affect us directly or the financial services industry or economy in general, such as further disruptions in the ~~“Management’s Discussion~~financial markets or negative views and ~~Analysis” section included under Item 7 of Part II of this Form 10-K.~~

expectations about the prospects for the financial services industry.

Since late 2007, and particularly during the second half of 2008 and much of 2009, the financial services industry and the credit markets generally have been materially and adversely affected by significant declines in asset values and by a lack of liquidity. The liquidity issues have been particularly acute for regional and community banks, as many of the larger financial institutions have significantly curtailed their lending to regional and community banks to reduce their exposure to the risks of other banks. In addition, many of the larger correspondent lenders have reduced or even eliminated federal funds lines for their correspondent customers. Furthermore, regional and community banks generally have less access to the capital markets than do the national and super-regional banks because of their smaller size and limited analyst coverage. Any decline in available funding could adversely impact our ability to originate loans, invest in securities, meet our expenses, pay dividends to our shareholders, or fulfill obligations such as repaying our borrowings or meeting deposit withdrawal demands, any of which could have a material adverse impact on our liquidity, business, results of operations and financial condition.

In addition, approximately 20% of our deposits are concentrated in public funds from a small number of municipalities and government agencies. Public deposits can be cyclical in nature and are often reduced in June and December of each year. If these government entities withdraw their deposits at inopportune times, or if we lose one or more of these deposit customers, the Bank would need to find a replacement source of liquidity for the funds withdrawn. If the Bank is unable to find a replacement source of liquidity, the Bank’s liquidity could be adversely affected.

Declines in asset values may result in impairment charges and adversely affect the value of our investments, financial performance and capital.

We maintain an investment portfolio that includes, but is not limited to, mortgage-backed securities. The market value of investments in our portfolio has become increasingly volatile over the past year. The market value of investments may be affected by factors other than the underlying performance of the servicer of the securities or the mortgages underlying the securities, such as ratings downgrades, adverse changes in the business climate and a lack of liquidity in the secondary market for certain investment securities. On a monthly basis, we evaluate investments and other assets for impairment indicators. We may be required to record additional impairment charges if our investments suffer a decline in value that is considered other-than-temporary. If we determine that a significant impairment has occurred, we would be required to charge against earnings the credit-related portion of the other-than-temporary impairment, which could have a material adverse effect on our results of operations in the periods in which the write-offs occur.

We may experience difficulties in managing our growth, and our growth strategy involves risks that may negatively impact our net income.

~~As part of our general growth strategy,~~

Although we do not have any current plans to do so, we may expand into additional communities or attempt to strengthen our position in our current markets through opportunistic acquisitions of all or part of other financial institutions, including FDIC-assisted transactions, or by opening new ~~branches and acquiring existing branches of other financial institutions.~~branches. To the extent that we undertake ~~additional~~acquisitions or new branch openings, ~~and acquisitions,~~ we are likely ~~to continue~~ to experience the effects of higher operating expenses relative to operating income from the new operations, which may have an adverse effect on our levels of reported net income, return on average equity and return on average assets. Other effects of engaging in such growth strategies may include potential diversion of our management’s time and attention and general disruption to our business.

Although we do not have any current plans to do so, we may also acquire banks and related businesses that we believe provide a strategic fit with our business. We may also engage in de novo branching as we have in the past and intend to do in the Indianapolis market in the future.

To the extent that we grow through acquisitions and ~~de novo bank formations,~~branch openings, we cannot assure you that we will be able to adequately and profitably manage this growth. Acquiring other banks and businesses will involve similar risks to those commonly associated with branching, but may also involve additional risks, including:

	·
	•	potential exposure to unknown or contingent liabilities of banks and businesses we acquire;

	·
	•	exposure to potential asset quality issues of the acquired bank or related business;

	·
	•	difficulty and expense of integrating the operations and personnel of banks and businesses we acquire; and

	·
	•	the possible loss of key employees and customers of the banks and businesses we acquire.

Attractive acquisition opportunities may not be available to us in the future.

We expect that other banking and financial service companies, many of which have significantly greater resources than us, will compete with us in acquiring other financial institutions if we pursue such acquisitions. This competition could increase prices for potential acquisitions that we believe are attractive. Also, acquisitions are subject to various regulatory approvals. If we fail to receive the appropriate regulatory approvals, we will not be able to consummate an acquisition that we believe is in our best interests. Among other things, our regulators consider our capital, liquidity, profitability, regulatory compliance and levels of goodwill and intangibles when considering acquisition and expansion proposals. Any acquisition could be dilutive to our earnings and shareholders’ equity per share of our common stock.

Higher FDIC deposit insurance premiums and assessments could adversely affect our financial condition.

FDIC insurance premiums increased substantially in 2009, and we expect to pay higher FDIC premiums in the future. Bank failures have significantly depleted the FDIC’s Deposit Insurance Fund and reduced the Deposit Insurance Fund’s ratio of reserves to insured deposits. The FDIC adopted a revised risk-based deposit insurance assessment schedule on February 27, 2009, which raised deposit insurance premiums. On May 22, 2009, the FDIC also implemented a special assessment equal to five basis points of each insured depository institution’s assets minus Tier 1 capital as of June 30, 2009, but no more than 10 basis points times the institution’s assessment base for the second quarter of 2009, to be collected on September 30, 2009. Additional special assessments may be imposed by the FDIC for future periods. On November 12, 2009, the FDIC adopted a uniform three basis-point increase in assessment rates, which is effective on January 1, 2011. Also, on November 12, 2009, the FDIC adopted a rule that required the Bank to prepay its quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012, along with their risk-based assessment for the third quarter of 2009.

We participate in the FDIC’s Temporary Liquidity Guarantee Program, or TLG, for noninterest-bearing transaction deposit accounts. Banks that participate in the TLG’s noninterest-bearing transaction account guarantee will pay the FDIC an annual assessment of 10 basis points on the amounts in such accounts above the amounts covered by FDIC deposit insurance. To the extent that these TLG assessments are insufficient to cover any loss or expenses arising from the TLG program, the FDIC is authorized to impose an emergency special assessment on all FDIC-insured depository institutions. The FDIC has authority to impose charges for the TLG program upon depository institution holding companies, as well. The TLG was scheduled to end December 31, 2009, but the FDIC has extended it to June 30, 2010 at an increased charge of 15 to 25 basis points beginning January 1, 2010, depending on the depository institution’s risk assessment category rating assigned with respect to regular FDIC assessments if the institution elects to remain in the TLG. These changes have caused the premiums and TLG assessments charged by the FDIC to increase. These actions have significantly increased our noninterest expense in 2009 and are expected to increase our costs for the foreseeable future.

We face intense competition in all phases of our business from other banks and financial institutions.

The banking and financial services business in our market is highly competitive. Our competitors include large regional banks, local community banks, savings and loan associations, securities and brokerage companies, mortgage companies, insurance companies, finance companies, money market mutual funds, credit unions, farm credit services and other ~~non-bank~~nonbank financial service providers. Many of these competitors are not subject to the same regulatory restrictions as we are and are able to provide customers with a feasible alternative to traditional banking services.

Increased competition in our market may also result in a decrease in the amounts of our loans and deposits, reduced spreads between loan rates and deposit rates or loan terms that are more favorable to the borrower. Any of these results could have a material adverse effect on our ability to grow and remain profitable. If increased competition causes us to significantly discount the interest rates we offer on loans or increase the amount we pay on deposits, our net interest income could be adversely impacted. If increased competition causes us to relax our underwriting standards, we could be exposed to higher losses from lending activities. Additionally, many of our competitors are much larger in total assets and capitalization, have greater access to capital markets, ~~and~~possess larger lending limits and offer a broader range of financial services than we can offer.

Government regulation can result in limitations on our operations.

We ~~must effectively manage our credit risk.~~

~~There~~operate in a highly regulated environment and are ~~risks inherent in making any loan,~~subject to supervision and regulation by a number of governmental regulatory agencies, including ~~risks inherent in dealing with individual borrowers, risks~~the Board of nonpayment, risks resulting from uncertainties as to the future value of collateral and risks resulting from changes in economic and industry conditions. We attempt to minimize our credit risk through prudent loan application approval procedures, careful monitoringGovernors of the concentration of our loans within specific industries, a centralized credit administration department and periodic independent reviews of outstanding loans by our loan review department. However, we cannot assure you that such approval and monitoring procedures will reduce these credit risks.

~~The majority of~~Federal Reserve System, the Bank’s loan portfolio is invested in commercial and commercial real estate loans. These loans represent higher dollar volumes to fewer customers. As a result, we may assume greater lending risks than other community banking-type financial institutions that have a lesser concentration of such loans and are more retail oriented. Our lending activityFederal Deposit Insurance Corporation, and the ~~risks commonly associated with such lending are further described in the “Management’s Discussion and Analysis” section included under Item 7~~Indiana Department of ~~Part II of this Form 10-K.~~

Financial Institutions. Regulations adopted by these

We cannot predict the effect on our operations of recent legislative and regulatory initiatives that were enacted in response to the ongoing financial crisis.

United States federal, state and foreign governments have taken or are ~~primarily made based on~~considering extraordinary actions in an attempt to deal with the ~~identified cash flow~~worldwide financial crisis. To the extent adopted, many of these actions have been in effect for only a limited time, and have produced limited or no relief to the ~~borrower~~capital, credit and ~~secondarily on~~real estate markets. There is no assurance that these actions or other actions under consideration will ultimately be successful.

In the ~~underlying collateral provided~~United States, the federal government has adopted the Emergency Economic Stabilization Act of 2008 and the American Recovery and Reinvestment Act of 2009. With authority granted under these laws, the U.S. Treasury has proposed a financial stability plan that is intended to:

invest in financial institutions and purchase troubled assets and mortgages from financial institutions for the purpose of stabilizing and providing liquidity to the United States financial markets;

temporarily increase the limit on FDIC deposit insurance coverage to $250,000 per depositor through December 31, 2009 (which was extended to December 31, 2013 under the Helping Families Save Their Homes Act of 2009); and

provide for various forms of economic stimulus, including to assist homeowners restructure and lower mortgage payments on qualifying loans.

Numerous other actions have been taken by the ~~borrower. Most often, this collateral is accounts receivable, inventory, machinery or real estate. Credit support provided~~United States Congress, the Federal Reserve, the U.S. Treasury, the FDIC, the SEC and others to address the liquidity and credit crisis that has followed the sub-prime mortgage crisis that commenced in 2007, including the financial stability plan adopted by the ~~borrower for most~~U.S. Treasury. In addition, President Obama recently announced a financial regulatory reform proposal, and the House and Senate are expected to consider competing proposals over the coming years.

There can be no assurance that the financial stability plan proposed by the U.S. Treasury, the other proposals under consideration or any other legislative or regulatory initiatives will be effective at dealing with the ongoing economic crisis and improving economic conditions globally, nationally or in our markets, or that the measures adopted will not have adverse consequences. The terms and costs of these ~~loans and~~activities, or the probability of repayment is based on the liquidation of the pledged collateral and enforcement of a personal guarantee, if any exists. Whenever possible, we require a personal guarantee on commercial loans. As a result, in the case of loans secured by accounts receivable, the availability of funds for the repaymentfailure of these ~~loans may be substantially dependent on~~actions to help stabilize the ability of the borrower to collect amounts due from its customers. The collateral securing other loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business.

~~Our loan portfolio has a large concentration of commercial real estate loans, which involve risks specific to real estate value.~~

Real estate lending (including commercial, construction, and, to a much lesser extent, residential) is a large portion of our loan portfolio. The market value of real estate can fluctuate significantly in a short period of time as a result of market conditions in the geographic area in which the real estate is located. Although a significant portion of such loans are secured by real estate as a secondary form of collateral, continued adverse developments affecting real estate values in one or more of ourfinancial markets, could increase the credit risk associated with our loan portfolio. Additionally, real estate lending typically involves higher loan principal amounts and the repayment of the loans generally is dependent, in large part, on sufficient income from the properties securing the loans to cover operating expenses and debt service. Economic events or governmental regulations outside of the control of the borrower or lender could negatively impact the future cash flowasset prices, and market ~~values~~liquidity, and a continuation or worsening of ~~the affected properties.~~

~~If the loans that are collateralized by real estate become troubled during a time when~~current financial market and economic conditions, ~~are declining or have declined, then we may not be able to realize the amount of security that we anticipated at the time of originating the loan, which~~ could ~~cause us to increase our provision for loan losses~~materially and adversely affect our ~~operating~~business, results of operations, financial condition and the trading prices of our securities.

Negative developments in the financial industry and the credit markets may subject us to additional regulation.

As a result of ongoing challenges facing the United States economy, the potential exists for new laws and regulations regarding lending and funding practices and liquidity standards to be promulgated, and bank regulatory agencies are expected to be active in responding to concerns and trends identified in examinations, including the expected issuance of many formal enforcement orders. Negative developments in the financial industry and credit markets, and the impact of new legislation in response to those developments, may negatively impact our operations by restricting our business operations, including our ability to originate or sell loans, and may adversely impact our financial performance.

Changes in future rules applicable to TARP recipients could adversely affect our business, results of operations and financial condition.

~~Our consumer loans generally have a higher degree of risk of default than our other loans.~~

~~At December 31, 2008, consumer loans totaled $55.1~~On February 27, 2009, we issued $56.0 million ~~or 3%,~~ of our ~~total loan~~Fixed Rate Cumulative Perpetual Preferred Stock, Series A, or the Series A Preferred Stock, to the U.S. Treasury pursuant to the TARP Capital Purchase Program. The rules and ~~lease portfolio. Consumer loans typically have shorter terms~~policies applicable to recipients of capital under the TARP Capital Purchase Program continue to evolve and ~~lower balances with higher yields as compared~~their scope, timing and effect cannot be predicted. Any redemption of the securities sold to ~~one-to-four family residential loans, but generally carry higher risks of default. Consumer loan collections are dependent~~the U.S. Treasury to avoid these restrictions would require prior Federal Reserve and U.S. Treasury approval. Based on guidelines recently issued by the Federal Reserve, institutions seeking to redeem TARP Capital Purchase Program preferred stock must demonstrate an ability to access the long-term debt markets without reliance on the ~~borrower’s continuing financial stability,~~FDIC’s TLG, successfully demonstrate access to public equity markets and ~~thus are more likely~~meet a number of additional requirements and considerations before such institutions can redeem any securities sold to ~~be affected by adverse personal circumstances. Furthermore,~~ the ~~application of various federal~~U.S. Treasury.

Our ability to attract and ~~state laws, including bankruptcy~~retain management and ~~insolvency laws,~~key personnel may ~~limit the amount which can be recovered on these loans.~~

~~Our community banking strategy relies heavily on our management team,~~affect future growth and earnings, and the ~~unexpected loss of key managers may~~recent economic stimulus legislation imposes new compensation restrictions that could adversely affect our ~~operations.~~ability to do so.

Much of our success ~~to date~~and growth has been influenced strongly by our ability to attract and to retain ~~senior~~ management experienced in banking and financial services and familiar with the communities in our market areas. Our ability to retain the executive officers, ~~the current~~ management teams, branch managers and loan officers of our bank subsidiary will continue to be important to the successful implementation of our strategy. It is also critical, as we grow, to be able to attract and retain qualified additional management and loan officers with the appropriate level of experience and knowledge about our market areas to implement our community-based operating strategy. The unexpected loss of services of any key management personnel, or the inability to recruit and retain qualified personnel in the future, could have an adverse effect on our business, ~~financial condition and~~ results of ~~operations.~~

operations and financial condition.

~~Government regulation can result~~The American Recovery and Reinvestment Act of 2009 that was signed into law in ~~limitations~~February 2009 includes extensive new restrictions on our ~~operations.~~

~~We operate in a highly regulated environment and are subject~~ability to supervision and regulation by a number of governmental regulatory agencies, including the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Indiana Department of Financial Institutions. Regulations adopted by these agencies, which are generally intended to provide protection for depositors and customers rather than for the benefit of shareholders, govern a comprehensive range of matters relating to ownership and control of our shares, our acquisition of other companies and businesses, permissible activities for us to engage in, maintenance of adequate capital levelspay retention awards, bonuses and other ~~aspects of our operations. These bank regulators possess broad authority to prevent or~~

~~Table of Contents~~

~~remedy unsafe or unsound practices or violations of law. The laws and regulations applicable to~~incentive compensation during the banking industry could change at any time and we cannot predict the effects of these changes on our business and profitability. Increased regulation could increase our cost of compliance and adversely affect profitability. For example, new legislation or regulation may limit the mannerperiod in which we have any outstanding securities held by the U.S. Treasury that were issued under the TARP Capital Purchase Program. Many of the restrictions may ~~conduct~~not be limited to our ~~business, including~~senior executives and could cover other employees whose contributions to revenue and performance can be significant. The limitations may adversely affect our ability to ~~offer new products, obtain financing,~~recruit and retain these key employees in addition to our senior executive officers, especially if we are competing for talent against institutions that are not subject to the same restrictions. The Federal Reserve, and perhaps the FDIC, are contemplating proposed rules governing the compensation practices of financial institutions and these rules, if adopted, may make it more difficult to attract ~~deposits, make loans~~ and ~~achieve satisfactory interest spreads.~~

retain the people we need to operate our businesses and limit our ability to promote our objectives through our compensation and incentive programs.

We have a continuing need for technological change and we may not have the resources to effectively implement new technology.

The financial services industry is constantly undergoing rapid technological changes with frequent introductions of new technology-driven products and services. In addition to better serving customers, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our future success will depend in part upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience as well as to create additional efficiencies in our operations as we continue to grow and expand our market areas. Many of our larger competitors have substantially greater resources to invest in technological improvements. As a result, they may be able to offer additional or superior products to those that we will be able to offer, which would put us at a competitive disadvantage. Accordingly, we cannot provide ~~you with assurance~~assurances that we will be able to effectively implement new technology-driven products and services or be successful in marketing such products and services to our customers.

~~There is a limited trading market for our common shares, and you may not be able to resell your shares at or above the price you paid for them.~~

Although our common shares are listed for trading on the Global Select Market of the NASDAQ Stock Market, the trading in our common shares has less liquidity than many other companies quoted on the NASDAQ Global Select Market. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the market of willing buyers and sellers of our common shares at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which we have no control. We cannot assure you that volume of trading in our common shares will increase in the future. Additionally, general market forces may have a negative effect on our stock price, independent of factors affecting our stock specifically.

System failure or breaches of our network security could subject us to increased operating costs as well as litigation and other liabilities.

The computer systems and network infrastructure we use could be vulnerable to unforeseen problems. Our operations are dependent upon our ability to protect our computer equipment against damage from physical theft, fire, power loss, telecommunications failure or a similar catastrophic event, as well as from security breaches, denial of service attacks, viruses, worms and other disruptive problems caused by hackers. Any damage or failure that causes an interruption in our operations could have a material adverse effect on our financial condition and results of operations. Computer break-ins, phishing and other disruptions could also jeopardize the security of information stored in and transmitted through our computer systems and network infrastructure, which may result in significant liability to us and may cause existing and potential customers to refrain from doing business with us. Although we,

We are subject to certain operational risks, including, but not limited to, customer or employee fraud and data processing system failures and errors.

Employee errors and misconduct could subject us to financial losses or regulatory sanctions and seriously harm our reputation. Misconduct by our employees could include hiding unauthorized activities from us, improper or unauthorized activities on behalf of our customers or improper use of confidential information. It is not always possible to prevent employee errors and misconduct, and the precautions we take to prevent and detect this activity may not be effective in all cases. Employee errors could also subject us to financial claims for negligence.

We maintain a system of internal controls and insurance coverage to mitigate operational risks, including data processing system failures and errors and customer or employee fraud. Should our internal controls fail to prevent or detect an occurrence, or if any resulting loss is not insured or exceeds applicable insurance limits, it could have a material adverse effect on our business, ~~financial condition and~~ results of ~~operations.~~

operations and financial condition.

IfWe may be subject to a higher consolidated effective tax rate if there is a change in tax laws or if LCB Funding, Inc. fails to qualify as a real estate investment ~~trust,~~trust.

The Bank holds certain investment securities in its wholly-owned subsidiary LCB Investments II, Inc., which is incorporated in Nevada. Pursuant to the State of Indiana’s current tax laws and regulations, we ~~may be~~are not subject to ~~a higher consolidated~~Indiana income tax for income earned through that subsidiary. If there are changes in tax laws or interpretations thereof requiring us to pay state taxes for income generated by LCB Investments II, Inc., the resulting tax consequences could increase our effective tax ~~rate.~~rate or cause us to have a tax liability for prior years.

The Bank also holds certain commercial real estate loans, residential real estate loans and other loans in a real estate investment trust through ~~its wholly-owned subsidiary~~ LCB Investments II, Inc.~~, which is incorporated in Nevada.~~ Qualification as a real estate investment trust involves application of specific provisions of the Internal Revenue Code relating to various asset tests. If LCB Funding, Inc. fails to meet any of the required provisions for real estate investment trusts, or there are changes in tax laws or interpretations thereof, it could no longer qualify as a real estate investment trust and the resulting tax consequences would increase our effective tax rate or cause us to have a tax liability for prior years.

ITEM ~~1b.~~1b. UNRESOLVED STAFF COMMENTS

We have no unresolved SEC staff comments.

The Company conducts its operations from the following branch locations:

Main/Headquarters
~~Main/Headquarters~~	202 East Center St.	Warsaw	~~Warsaw~~	IN
Warsaw Drive-up	East Center St.	Warsaw	~~Warsaw~~	IN
Akron	102 East Rochester	Akron	~~Akron~~	IN
Argos	100 North Michigan	Argos	~~Argos~~	IN
Auburn	1220 East 7th St.	Auburn	~~Auburn~~	IN
Bremen	1600 State Road 331	Bremen	~~Bremen~~	IN
Columbia City	601 Countryside Dr.		Columbia City	IN
Concord	4202 Elkhart Rd.	Goshen	~~Goshen~~	IN
Cromwell	111 North Jefferson St.	Cromwell	~~Cromwell~~	IN
Elkhart Beardsley	864 East Beardsley St.	Elkhart	~~Elkhart~~	IN
Elkhart East	22050 State Road 120	Elkhart	~~Elkhart~~	IN
Elkhart Hubbard Hill	58404 State Road 19	Elkhart	~~Elkhart~~	IN
Elkhart Northwest	1208 North Nappanee St.	Elkhart	~~Elkhart~~	IN
Fort Wayne North	302 East DuPont Rd.		Fort Wayne	IN
Fort Wayne Northeast	10411 Maysville Rd.		Fort Wayne	IN
Fort Wayne Southwest	10429 Illinois Rd.		Fort Wayne	IN
Fort Wayne Jefferson Blvd	6851 West Jefferson Blvd.		Fort Wayne	IN
Goshen Downtown	102 North Main St.	Goshen	~~Goshen~~	IN
Goshen South	2513 South Main St.	Goshen	~~Goshen~~	IN
Granger	12830 State Road 23	Granger	~~Granger~~	IN
Huntington	1501 North Jefferson St.	Huntington	~~Huntington~~	IN
Kendallville East	631 Professional Way	Kendallville	~~Kendallville~~	IN
LaGrange	901 South Detroit	LaGrange	~~LaGrange~~	IN
Ligonier Downtown	222 South Cavin St.	Ligonier	~~Ligonier~~	IN
Ligonier South	1470 U.S. Highway 33 South	Ligonier	~~Ligonier~~	IN
Medaryville	Main St.	Medaryville	~~Medaryville~~	IN
Mentone	202 East Main St.	Mentone	~~Mentone~~	IN
Middlebury	712 Wayne Ave.	Middlebury	~~Middlebury~~	IN
Milford	State Road 15 North	Milford	~~Milford~~	IN
Mishawaka	5015 North Main St.	Mishawaka	~~Mishawaka~~	IN
Nappanee	202 West Market St.	Nappanee	~~Nappanee~~	IN
North Webster	644 North Main St.		North Webster	IN
Pierceton	202 South First St.	Pierceton	~~Pierceton~~	IN
Plymouth	862 East Jefferson St.	Plymouth	~~Plymouth~~	IN
Rochester	507 East 9th St.	Rochester	~~Rochester~~	IN
Shipshewana	895 North Van Buren St.	Shipshewana	~~Shipshewana~~	IN
Silver Lake	102 Main St.		Silver Lake	IN
South Bend Northwest	21113 Cleveland Rd.		South Bend	IN
Syracuse	502 South Huntington	Syracuse	~~Syracuse~~	IN
Warsaw East	3601 Commerce Dr.	Warsaw	~~Warsaw~~	IN
Warsaw North	420 Chevy Way	Warsaw	~~Warsaw~~	IN
Warsaw West	1221 West Lake St.	Warsaw	~~Warsaw~~	IN
Winona Lake	99 Chestnut St.		Winona Lake	IN
Winona Lake East	1324 Wooster Rd.		Winona Lake	IN

The Company leases from third parties the real estate and buildings for its Milford and Winona Lake East offices. In addition, the Company leases the real estate for its four freestanding ATMs. The Company also leases from a third party office space in Indianapolis, Indiana, for a loan production office. All the other branch facilities are owned by the Company. The Company also owns parking lots in downtown Warsaw for the use and convenience of Company employees and customers, as well as leasehold improvements, equipment, furniture and fixtures necessary to operate the banking facilities.

In addition, the Company owns buildings at 110 South High St., Warsaw, Indiana, and 114-118 East Market St., Warsaw, Indiana, which it uses for various offices, a building at 113 East Market St., Warsaw, Indiana, which it uses for office and computer facilities, and a building at 109 South Buffalo St., Warsaw, Indiana, which it uses for training and development. ~~The Company also leases from third parties office space in Indianapolis, Indiana, for a loan production office.~~

None of the Company’s assets are the subject of any material encumbrances.

ITEM 3. LEGAL PROCEEDINGS

There are no material pending legal proceedings other than ordinary routine litigation incidental to the business to which the Company and the Bank are a party or of which any of their property is subject.

ITEM 4. ~~SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS~~

~~No matter was submitted to a vote of security holders during the fourth quarter of 2008.~~

RESERVED

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

4th
Quarter

3rd
Quarter

2nd
Quarter

1st
Quarter

2008

Trading prices (per share)*

Low

$
14.93

$
18.52

$
19.00

$
16.87

High

$
24.10

$
30.09

$
25.00

$
23.97

Dividends declared (per share)

$
0.155

$
0.155

$
0.155

$
0.140

2007

Trading prices (per share)*

Low

$
18.25

$
20.05

$
20.71

$
21.85

High

$
25.00

$
25.98

$
23.81

$
25.92

Dividends declared (per share)

$
0.140

$
0.140

$
0.140

$
0.125


*	~~The trading ranges are the high and low prices as obtained from The Nasdaq Stock Market.~~

	4th	3rd	2nd	1st
	Quarter	Quarter	Quarter	Quarter
2009

Trading prices (per share)*
Low	$16.35	$17.80	$17.10	$14.14
High	$22.24	$22.49	$21.04	$23.87

Dividends declared (per share)	$0.155	$0.155	$0.155	$0.155


2008

Trading prices (per share)*
Low	$14.93	$18.52	$19.00	$16.87
High	$24.10	$30.09	$25.00	$23.97

Dividends declared (per share)	$0.155	$0.155	$0.155	$0.140

* The trading ranges are the high and low prices as obtained from The Nasdaq Stock Market.

The Company paid dividends as set forth in the table above. The Company’s ability to pay dividends to shareholders is largely dependent upon the dividends it receives from the Bank, and the Bank is subject to regulatory limitations on the amount of cash dividends it may pay. In addition, as a result of the ~~Company’s~~Company's participation in the TARP Capital Purchase Program, the Company may not increase the quarterly dividends it pays on the ~~Company’s~~Company's common stock above $0.155 per share for three years, without the consent of Treasury, unless Treasury no longer holds shares of the Series A Preferred Stock. See “Business – Supervision and Regulation – The Company – Dividend Payments” and “Business - Supervision and Regulation – The Bank – Dividend Payments” for a more detailed description of these limitations.

The following table provides information about purchases by the Company and its affiliates during the quarter ended December 31, ~~2008~~2009 of equity securities that are registered by the Company pursuant to Section 12 of the Exchange Act:

ISSUER PURCHASES OF EQUITY SECURITIES

Period

Total Number of
Shares Purchased

Average Price
Paid per Share

Total Number of
Shares Purchased as
Part of Publicly
Announced Plans or
Programs

Maximum Number (or
Appropriate Dollar
Value) of Shares that
May Yet Be Purchased
Under the Plans or
Programs

10/01/08-10/31/08

0

$
0.00

0

$
0.00

11/01/08-11/30/08

758

21.57

0

0.00

12/01/08-12/31/08

0

0.00

0

0.00

Total

758

$
21.57

0

$
0.00

				Maximum Number (or
			Total Number of	Appropriate Dollar
			Shares Purchased as	Value) of Shares that
			Part of Publicly	May Yet Be Purchased
	Total Number of	Average Price	Announced Plans or	Under the Plans or
Period	Shares Purchased	Paid per Share	Programs	Programs

10/01/09-10/31/09	0	$0.00	0	$0.00
11/01/09-11/30/09	772	20.12	0	0.00
12/01/09-12/31/09	0	0.00	0	0.00

Total	772	$20.12	0	$0.00

The shares purchased during the periods were credited to the deferred share accounts of ~~eight non-employee~~seven nonemployee directors under the Company’s directors’ deferred compensation plan.

STOCK PRICE PERFORMANCE GRAPH

The graph below compares the cumulative total return of the Company, the Nasdaq Market Index and a peer group index.

INDEX	2004	2005	2006	2007	2008	2009
Lakeland Financial Corporation	$100.00	$104.08	$134.46	$112.75	$132.28	$98.80
NASDAQ Market Index	100.00	101.37	111.03	121.92	72.49	104.31
Peer Group Index	100.00	100.58	114.89	83.98	64.15	45.63

Table of Contents

INDEX

2003

2004

2005

2006

2007

2008

Lakeland Financial Corporation

$
100.00

$
115.12

$
119.82

$
154.78

$
129.79

$
152.27

NASDAQ Market Index

100.00

108.59

110.08

120.56

132.39

78.72

Peer Group Index

100.00

119.17

118.45

134.88

95.73

73.33

Lakeland Financial Peer Group
9/30/2009

Company	Institution Key	Ticker	State	Assets
Alliance Financial Corporation	100700	ALNC	NY	1,456,276
AmericanWest Bancorporation	100865	AWBC	WA	1,763,431
Ameris Bancorp	100594	ABCB	GA	2,207,475
Arrow Financial Corporation	100134	AROW	NY	1,836,283
Atlantic Southern Financial Group, Inc.	4093166	ASFN	GA	1,083,677
Bancorp Rhode Island, Inc.	4054977	BARI	RI	1,569,880
Bancorp, Inc.	4054569	TBBK	DE	2,041,034
BancTrust Financial Group, Inc.	100351	BTFG	AL	2,036,069
Bank of Florida Corporation	4047172	BOFL	FL	1,488,008
Bank of Granite Corporation	100304	GRAN	NC	1,009,669
Bank of Kentucky Financial Corporation	1024571	BKYF	KY	1,391,669
Bank of Marin Bancorp	4164467	BMRC	CA	1,126,529
Bank of the Ozarks, Inc.	1018441	OZRK	AR	2,889,686
Bar Harbor Bankshares	100824	BHB	ME	1,060,707
BNC Bancorp	4086131	BNCN	NC	1,704,645
Bryn Mawr Bank Corporation	100154	BMTC	PA	1,195,525
Cadence Financial Corporation	1018635	CADE	MS	1,767,699
Camden National Corporation	101149	CAC	ME	2,272,746
Capital Bank Corporation	4042314	CBKN	NC	1,734,950
Capital City Bank Group, Inc.	100774	CCBG	FL	2,491,937
Cardinal Financial Corporation	4019138	CFNL	VA	1,893,403
Cascade Bancorp	100589	CACB	OR	2,272,047
Cascade Financial Corporation	102173	CASB	WA	1,646,987
Cass Information Systems, Inc.	100886	CASS	MO	1,033,395
Center Bancorp, Inc.	100687	CNBC	NJ	1,349,516
Center Financial Corporation	4084856	CLFC	CA	2,201,842
CenterState Banks, Inc.	4053925	CSFL	FL	1,783,823
Centrue Financial Corporation	1021347	TRUE	MO	1,338,474
Century Bancorp, Inc.	100209	CNBKA	MA	2,051,247
Citizens & Northern Corporation	100693	CZNC	PA	1,283,378
City Bank	1009626	CTBK	WA	1,219,356
City Holding Company	100199	CHCO	WV	2,596,236
CNB Financial Corporation	100790	CCNE	PA	1,090,300
CoBiz Financial Inc.	1017371	COBZ	CO	2,537,665
Colony Bankcorp, Inc.	100882	CBAN	GA	1,290,891
Columbia Bancorp	1025077	CBBO	OR	1,057,717
Commonwealth Bankshares, Inc.	100912	CWBS	VA	1,145,184
Community Bankers Trust Corporation	4100717	BTC	VA	1,239,138
Crescent Banking Company	100005	CSNT	GA	1,030,472
Crescent Financial Corporation	4066238	CRFN	NC	1,063,703
Dearborn Bancorp, Inc.	1024255	DEAR	MI	1,042,337
Eagle Bancorp, Inc.	4002078	EGBN	MD	1,682,773
Eastern Virginia Bankshares, Inc.	1974273	EVBS	VA	1,105,727
Encore Bancshares, Inc.	4057668	EBTX	TX	1,600,720
Enterprise Bancorp, Inc.	1025202	EBTC	MA	1,287,427
Enterprise Financial Services Corp	1024631	EFSC	MO	2,518,625
EuroBancshares, Inc.	4086027	EUBK	PR	2,806,909
Farmers Capital Bank Corporation	100257	FFKT	KY	2,273,259

Table of Contents

Fidelity Southern Corporation	100845	LION	GA	1,912,394
Financial Institutions, Inc.	1016825	FISI	NY	2,138,205
First Bancorp, Inc.	1019988	FNLC	ME	1,331,842
First Business Financial Services, Inc.	1021886	FBIZ	WI	1,073,653
First California Financial Group, Inc.	100349	FCAL	CA	1,469,628
First Chester County Corporation	100793	FCEC	PA	1,306,681
First Citizens Banc Corp	100876	FCZA	OH	1,103,720
First Community Bancshares, Inc.	100792	FCBC	VA	2,298,341
First Financial Corporation	100502	THFF	IN	2,500,913
First Financial Service Corporation	101772	FFKY	KY	1,107,566
First M&F Corporation	1018386	FMFC	MS	1,676,469
First Mariner Bancorp	1024706	FMAR	MD	1,410,427
First of Long Island Corporation	100265	FLIC	NY	1,507,614
First Regional Bancorp	100282	FRGB	CA	2,175,019
First Security Group, Inc.	4050826	FSGI	TN	1,202,908
First State Bancorporation	100565	FSNM	NM	2,886,347
First United Corporation	100525	FUNC	MD	1,681,749
Firstbank Corporation	100768	FBMI	MI	1,429,810
FNB United Corp.	100805	FNBN	NC	2,193,906
German American Bancorp, Inc.	100551	GABC	IN	1,233,815
Great Florida Bank	4091674	GFLB	FL	1,716,557
Green Bankshares, Inc.	1019938	GRNB	TN	2,794,217
Guaranty Bancorp	4093621	GBNK	CO	2,057,378
Hampton Roads Bankshares, Inc.	4066242	HMPR	VA	2,938,994
Hawthorn Bancshares, Inc.	1023919	HWBK	MO	1,240,228
Heritage Commerce Corp	4019167	HTBK	CA	1,367,610
Heritage Financial Corporation	1024198	HFWA	WA	1,017,956
Home BancShares, Inc.	1022914	HOMB	AR	2,631,736
Horizon Bancorp	100750	HBNC	IN	1,321,224
Horizon Financial Corp.	1024822	HRZB	WA	1,300,100
Hudson Valley Holding Corp.	1016867	HUVL	NY	2,578,790
Independent Bank Corporation	100319	IBCP	MI	2,962,028
Indiana Community Bancorp	101857	INCB	IN	1,052,998
Intervest Bancshares Corporation	1023951	IBCA	NY	2,382,170
Lakeland Bancorp, Inc.	1022451	LBAI	NJ	2,769,463
Lakeland Financial Corporation	100608	LKFN	IN	2,469,882
LNB Bancorp, Inc.	100612	LNBB	OH	1,181,179
Macatawa Bank Corporation	4004314	MCBC	MI	1,981,772
MainSource Financial Group, Inc.	100513	MSFG	IN	2,934,326
MBT Financial Corp.	4056273	MBTF	MI	1,442,512
Mercantile Bancorp, Inc.	1018583	MBR	IL	1,685,805
Mercantile Bank Corporation	113567	MBWM	MI	2,017,350
Merchants Bancshares, Inc.	100353	MBVT	VT	1,405,994
Metro Bancorp, Inc.	4048256	METR	PA	2,086,495
MetroCorp Bancshares, Inc.	4039909	MCBI	TX	1,629,732
MidWestOne Financial Group, Inc.	1021746	MOFG	IA	1,529,676
NewBridge Bancorp	100346	NBBC	NC	2,009,544
Old Second Bancorp, Inc.	100625	OSBC	IL	2,699,094
Orrstown Financial Services, Inc.	100631	ORRF	PA	1,159,996
PAB Bankshares, Inc.	106981	PABK	GA	1,251,219
Pacific Continental Corporation	4049245	PCBK	OR	1,150,508
Pacific Mercantile Bancorp	4055039	PMBC	CA	1,110,533
Peapack-Gladstone Financial Corporation	1137117	PGC	NJ	1,487,679
Peoples Bancorp Inc.	100532	PEBO	OH	2,004,754
Peoples Bancorp of North Carolina, Inc.	4050385	PEBK	NC	1,041,231
Porter Bancorp, Inc.	1022071	PBIB	KY	1,728,762

Table of Contents

Preferred Bank	1023519	PFBC	CA	1,411,817
PremierWest Bancorp	4054224	PRWT	OR	1,715,550
Princeton National Bancorp, Inc.	100504	PNBC	IL	1,287,059
QCR Holdings, Inc.	1024092	QCRH	IL	1,749,304
Royal Bancshares of Pennsylvania, Inc.	100416	RBPAA	PA	1,361,810
S.Y. Bancorp, Inc.	100548	SYBT	KY	1,763,533
Savannah Bancorp, Inc.	100844	SAVB	GA	1,041,358
SCBT Financial Corporation	1019950	SCBT	SC	2,776,684
Seacoast Banking Corporation of Florida	100425	SBCF	FL	2,139,915
Shore Bancshares, Inc.	1027751	SHBI	MD	1,157,685
Sierra Bancorp	4064269	BSRR	CA	1,307,049
Simmons First National Corporation	100431	SFNC	AR	2,915,437
Smithtown Bancorp, Inc.	100654	SMTB	NY	2,670,257
Southern Community Financial Corporation	4072468	SCMF	NC	1,725,341
Southside Bancshares, Inc.	1021743	SBSI	TX	2,941,563
State Bancorp, Inc.	100446	STBC	NY	1,596,464
StellarOne Corporation	1032007	STEL	VA	2,982,264
Sterling Bancorp	100450	STL	NY	2,136,805
Suffolk Bancorp	100453	SUBK	NY	1,671,816
Summit Financial Group, Inc.	1021909	SMMF	WV	1,577,793
Tennessee Commerce Bancorp, Inc.	4056797	TNCC	TN	1,335,751
TIB Financial Corp.	108287	TIBB	FL	1,717,622
Tower Bancorp, Inc.	100663	TOBC	PA	1,378,936
TriCo Bancshares	100546	TCBK	CA	2,095,666
Union Bankshares Corporation	100575	UBSH	VA	2,583,284
Univest Corporation of Pennsylvania	100671	UVSP	PA	2,117,849
Virginia Commerce Bancorp, Inc.	4053565	VCBI	VA	2,734,112
VIST Financial Corp.	100598	VIST	PA	1,276,395
Wainwright Bank & Trust Company	100490	WAIN	MA	1,009,883
Washington Trust Bancorp, Inc.	100491	WASH	RI	2,888,065
West Bancorporation, Inc.	1021570	WTBA	IA	1,499,611
West Coast Bancorp	100183	WCBO	OR	2,653,357
Yadkin Valley Financial Corporation	4140013	YAVY	NC	2,051,672

ITEM 6. SELECTED FINANCIAL DATA

2008

2007

2006

2005

2004

(in thousands except share and per share data)

Interest income

$
118,484

$
117,973

$
105,551

$
80,616

$
60,182

Interest expense

55,216

63,417

53,224

30,353

16,833

Net interest income

63,268

54,556

52,327

50,263

43,349

Provision for loan losses

10,207

4,298

2,644

2,480

1,223

Net interest income after provision for loan losses

53,061

50,258

49,683

47,783

42,126

Other noninterest income

21,861

19,477

18,281

16,358

15,693

Gain on sale of credit card portfolio

0

0

0

863

0

Gain on redemption of Visa shares

642

0

0

0

0

Net gains on sale of real estate mortgages held for sale

786

676

581

934

987

Net securities gains (losses)

39

89

(68
)

(69
)

0

Noninterest expense

(47,481
)

(42,923
)

(40,242
)

(38,432
)

(36,959
)

Income before income tax expense

28,908

27,577

28,235

27,437

21,847

Income tax expense

9,207

8,366

9,514

9,479

7,302

Net income

$
19,701

$
19,211

$
18,721

$
17,958

$
14,545

Basic weighted average common shares outstanding*

12,271,927

12,188,594

12,069,300

11,927,756

11,735,410

Basic earnings per common share*

$
1.61

$
1.58

$
1.55

$
1.51

$
1.24

Diluted weighted average common shares outstanding*

12,459,802

12,424,137

12,375,467

12,289,466

12,128,154

Diluted earnings per common share*

$
1.58

$
1.55

$
1.51

$
1.46

$
1.20

Cash dividends declared*

$
0.61

$
0.55

$
0.38

$
0.46

$
0.42

	2009			2008			2007			2006			2005
	(in thousands except share and per share data)

Interest income	$	116,343		$	118,484		$	117,973		$	105,551		$	80,616

Interest expense		36,062			55,216			63,417			53,224			30,353

Net interest income		80,281			63,268			54,556			52,327			50,263

Provision for loan losses		21,202			10,207			4,298			2,644			2,480

Net interest income after provision
for loan losses		59,079			53,061			50,258			49,683			47,783
Other noninterest income		20,547			22,236			19,844			18,668			16,771
Gain on sale of credit card portfolio		0			0			0			0			863
Gain on redemption of Visa shares		0			642			0			0			0
Mortgage banking income		1,695			411			309			194			521
Net securities gains (losses)		2			39			89			(68	)		(69	)
Noninterest expense		(53,475	)		(47,481	)		(42,923	)		(40,242	)		(38,432	)

Income before income tax expense		27,848			28,908			27,577			28,235			27,437

Income tax expense		8,869			9,207			8,366			9,514			9,479

Net income		18,979			19,701			19,211			18,721			17,958

Dividends and accretion of discount on
preferred stock		2,694			0			0			0			0

Net income available to common shareholders	$	16,285		$	19,701		$	19,211		$	18,721		$	17,958

Basic weighted average common shares
outstanding*		12,851,845			12,271,927			12,188,594			12,069,300			11,927,756

Basic earnings per common share*	$	1.27		$	1.61		$	1.58		$	1.55		$	1.51

Diluted weighted average common shares
outstanding*		12,952,444			12,459,802			12,424,137			12,375,467			12,289,466

Diluted earnings per common share*	$	1.26		$	1.58		$	1.55		$	1.51		$	1.46

Cash dividends declared*	$	0.62		$	0.61		$	0.55		$	0.38		$	0.46

*Share and per share data have been adjusted for a 2-for-1 stock split on April 28, 2006.

	2009		2008		2007		2006		2005
	(in thousands)
Balances at December 31,

Total assets	$	2,571,505	$	2,377,445	$	1,989,133	$	1,836,706	$	1,634,613

Total loans	$	2,012,010	$	1,833,334	$	1,523,720	$	1,353,837	$	1,198,730

Total deposits	$	1,851,125	$	1,885,299	$	1,478,918	$	1,475,765	$	1,266,245

Total short-term borrowings	$	354,051	$	202,609	$	316,165	$	187,484	$	211,542

Long-term borrowings	$	40,042	$	90,043	$	44	$	45	$	46

Subordinated debentures	$	30,928	$	30,928	$	30,928	$	30,928	$	30,928

Total stockholders' equity	$	279,994	$	149,880	$	146,270	$	130,187	$	113,334

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

~~OVERVIEW~~

Lakeland Financial Corporation is the holding company for Lake City Bank. The Company is headquartered in Warsaw, Indiana and operates 43 offices in twelve counties in northern Indiana and a loan production office in Indianapolis, Indiana. The Company earned $19.0 million for the year 2009 versus $19.7 million for 2008, a decrease of 3.7%. The decrease was driven primarily by an $11.0 million increase in the provision for loan losses, a $6.0 million increase in noninterest expense and a $1.1 million decrease in noninterest income. Offsetting these negative impacts was a $17.0 million increase in net interest income. The Company earned $19.7 million for the year 2008 versus $19.2 million for 2007, an increase of 2.6%. The increase was driven primarily by an $8.7 million increase in net interest income and a $3.1 million increase in noninterest income. Offsetting these positive impacts was a $5.9 million increase in the provision for loan losses and a $4.6 million increase in noninterest expense. The Company earned $19.2 million for the year 2007 versus $18.7 million for 2006, an increase of 2.6%. The increase was driven primarily by a $2.2 million increase in net interest income and a $1.3 million increase in noninterest income. In addition, the Company’s effective tax rate decreased to 30.3% for 2007 compared to 33.7% for 2006. Offsetting these positive impacts was a $2.5 million increase in noninterest expense and a $1.7 million increase in the provision for loan losses.

Basic earnings per share for the year ~~2008~~2009 was $1.27 per share versus $1.61 per share ~~versus~~for 2008 and $1.58 ~~per share~~ for ~~2007 and $1.55 for 2006.~~2007. Diluted earnings per share for the year ended ~~2008~~2009 was ~~$1.58~~$1.26 per share versus ~~$1.55~~$1.58 per share for the year ended ~~2007~~2008 and ~~$1.51~~$1.55 for the year ended ~~2006.~~2007. Diluted earnings per share reflect the potential dilutive impact of warrants and stock ~~options~~awards granted under employee ~~stock option~~equity incentive plans.

Basic and diluted earnings per share for 2009 were also impacted by the Company’s issuance of 3.6 million common shares during the year and the Company’s participation in the TARP Capital Purchase Program.

The Company’s total assets were $2.572 billion as of December 31, 2009 versus $2.377 billion as of December 31, 2008, ~~versus $1.989 billion as of December 31, 2007,~~ an increase of ~~$388.3~~$194.1 million or ~~19.5%~~8.2%. This increase was primarily due to a ~~$292.4~~$166.5 million increase in commercial loans from ~~$1.241 billion at December 31, 2007 to~~ $1.533 billion at December 31, 2008 to $1.700 billion at December 31, 2009.

RESULTS OF OPERATIONS

The Company reported net income of $19.0 million in 2009, a decrease of $722,000, or 3.7%, versus net income of $19.7 million in 2008.

Net interest income increased $17.0 million, or 26.9%, to $80.3 million versus $63.3 million in 2008. Net interest income increased primarily due to the expansion of the net interest margin from 3.14% in 2008 to 3.51% in 2009 resulting from a large decrease in interest expense that offset an increase in interest income. In addition, increases in average earning assets contributed to the increase in net interest income. Particularly a 10.9% increase in commercial loans reflecting our continued strategic focus on commercial lending as a key driver of the business, contributed to the increase.

Interest income was also affected by an increase in nonaccrual loans. Nonaccrual loans were $30.5 million, or 1.52% of total loans, at year end versus $20.8 million, or 1.14% of total loans, at the end of 2008. There were 31 relationships totaling $31.8 million classified as impaired as of December 31, 2009 versus 22 relationships totaling $20.3 million at the end of 2008. The increase in nonaccrual loans resulted primarily from the addition of three commercial relationships totaling $10.6 million. The increase in impaired loans resulted from the three commercial relationships mentioned previously, as well as one other commercial relationship of $2.1 million. Net charge-offs were $8.0 million in 2009 versus $7.1 million in 2008, representing 0.42% and 0.43% of average daily loans in 2009 and 2008. Total nonperforming loans were $30.7 million, or 1.53% of total loans, at year end 2009 versus $21.3 million, or 1.16% of total loans, at the end of 2008.

The provision for loan loss expense was $21.2 million in 2009, resulting in an allowance for loan losses at December 31, 2009 of $32.1 million, which represented 1.59% of the loan portfolio, versus a provision for loan loss expense of $10.2 million in 2008 and an allowance for loan losses of $18.9 million at the end of 2008, or 1.03% of the loan portfolio. The higher provision in 2009 versus 2008 was attributable to a number of factors, but was primarily a result of an increase in net charge-offs, general growth in the loan portfolio, as well as higher allocations on specific watch list credits. The level of loan loss provision was also influenced by other factors related to the growth in the loan portfolio, such as the continued emerging market risk, the continued emerging concentration risk, commercial loan focus and large credit concentration, new industry lending activity, general economic conditions and historical loss percentages. In addition, management gave consideration to changes in the allocation for specific watch list credits in determining the appropriate level of the loan loss provision. Management’s overall view on current credit quality was also a factor in the determination of the provision for loan losses. The Company’s management continues to monitor the adequacy of the provision based on loan levels, asset quality, economic conditions and other factors that may influence the assessment of the collectability of loans.

Noninterest income was $22.2 million in 2009 versus $23.3 million in 2008, a decrease of $1.1 million, or 4.7%. The 2009 decrease was driven in a large part, by a change related to the processing of merchant credit card activities. Prior to the third quarter of 2009, transaction driven revenue and expenses related to this category were reported on a gross basis in merchant card fee income in noninterest income and credit card interchange fees in noninterest expense. Beginning in the second quarter of 2009, the Company began converting clients to a new third party processor for this activity. As a result, only net revenues with the new processor are being recognized in merchant card fee income in noninterest income. This change was driven by the structure of the agreement with the third party processor, and not due to any change in the Company’s accounting policies. Service charges on deposit accounts decreased $358,000, or 4.2%, also affecting noninterest income. The decrease was due primarily to decreases in retail NSF and overdraft fees as we believe retail customers have been spending less because of the general economic environment. Mortgage banking income increased by $1.3 million, or 312.4%, offsetting some of the decreases in noninterest income. The increase was driven by lower mortgage interest rates, which has led to increased loan refinance volumes as well as a larger pipeline of mortgage loan applications. Loan, insurance and service fees also increased $354,000, or 11.1%, driven by higher fee income on increased debit card activity generated by requirements under a rewards checking program. Additionally, noninterest income in 2008 was positively impacted due to a nonrecurring gain of $642,000 related to the VISA initial public offering and the redemption of some of the shares we owned in connection with the offering.

As a result of these factors, income before income tax expense decreased $1.1 million, or 3.7%, from $28.9 million in 2008 to $27.8 million in 2009. Income tax expense was $8.9 million in 2009 versus $9.2 million in 2008. Income tax as a percentage of income before tax was 31.8% in both 2009 and 2008. Net income decreased $722,000, or 3.7%, to $19.0 million in 2009 versus $19.7 million in 2008. Basic earnings per share in 2009 was $1.27, a decrease of 21.1%, versus $1.61 in 2008. Earnings per share in 2009 were impacted by the Company’s issuance of an additional 3.6 million shares of common stock, as well as $2.7 million in dividends and accretion of discount on preferred stock related to the Company’s participation in the TARP Capital Purchase Program. The Company’s net income performance represented a 12.7% return on January 1, 2009, stockholders’ equity versus 13.5% in 2008. The net income performance resulted in a 0.78% return on average daily assets in 2009 versus 0.91% in 2008.

The Company reported record net income of $19.7 million in 2008, an increase of $490,000, or 2.6%, versus net income of $19.2 million in 2007. Net interest income increased $8.7 million, or 16.0%, to $63.3 million versus $54.6 million in 2007. Net interest income increased primarily due to increases in average earning assets, particularly a 22.4% increase in commercial loans as a result of our continued strategic focus on commercial lending as a key driver of the business. Interest income increased $511,000, or 0.4%, from $118.0 million in 2007 to $118.5 million in 2008. The increase was driven primarily by increases in average earning assets. Interest expense decreased $8.2 million, or 12.9%, from $63.4 million in 2007 to $55.2 million in 2008. The decrease was primarily the result of a 101 basis point decrease in the Company’s daily cost of funds over the year due to a decrease in market rates over the same time period. The Company had a net interest margin of 3.14% in 2008 versus 3.22% in

~~Table of Contents~~

2007, primarily due to a decline in the prime rate from 7.25% to 3.25% during 2008, which was led by changes in the Fed Fund rate by the Federal Open Market Committee. Average earning assets increased by $318.5 million from $1.7 billion in 2007 to $2.0 billion in 2008. This increase was due primarily to loan growth led by significant growth in five counties: St. Joseph, Kosciusko, Allen, Hamilton and Elkhart and with balanced growth in the Bank’s other regions. Deposits increased to fund the loan growth during 2008, driven primarily by increases of $69.3 million in interest bearing transaction accounts, $37.3 million in average brokered deposit balances and $36.9 million in average other time deposit account balances. The increase in interest bearing transaction accounts was driven primarily by the addition of a new product, which ~~pays~~paid a higher interest rate on balances up to a maximum balance amount when certain conditions ~~are~~were met during each interest cycle. In addition, loan growth was funded by a $97.0 million increase in the average balance in Federal Home Loan Bank advances. Management believes that the growth in the loan portfolio will likely continue in a measured, but prudent fashion as a result of our strategic focus on commercial lending and in conjunction with the general expansion and penetration of the geographical markets the Company serves, as well as our expansion in the Indianapolis market and the continued progress that we are making in that relatively new market.

Nonaccrual loans were $20.8 million, or 1.14% of total loans, at year end versus $7.0 million, or 0.46% of total loans, at the end of 2007. There were 22 relationships totaling $20.3 million classified as impaired as of December 31, 2008 versus five relationships totaling $6.7 million at the end of 2007. The increase in impaired and nonperforming loans resulted primarily from the addition of four commercial relationships totaling $14.4 million. Net charge-offs were $7.1 million in 2008 versus $3.0 million in 2007, representing 0.43% and 0.21% of average daily loans in 2008 and 2007. Total nonperforming loans were $21.3 million, or 1.16% of total loans, at year end 2008 versus $7.4 million, or 0.49% of total loans, at the end of 2007. The provision for loan loss expense was $10.2 million in 2008, resulting in an allowance for loan losses at December 31, 2008 of $18.9 million, which represented 1.03% of the loan portfolio, versus a provision for loan loss expense of $4.3 million in 2007 and an allowance for loan losses of $15.8 million at the end of 2007, or 1.04% of the loan portfolio. The higher provision in 2008 versus 2007 was attributable to a number of factors, but was primarily a result of an increase in net charge-offs, general growth in the loan portfolio, as well as higher allocations on specific watch list credits. The level of loan loss provision was also influenced by other factors related to the growth in the loan portfolio, such as the continued emerging market risk, the continued emerging concentration risk, commercial loan focus and large credit concentration, new industry lending activity, general economic conditions and historical loss percentages. In addition, management gave consideration to changes in the allocation for specific watch list credits in determining the appropriate level of the loan loss provision. Management’s overall view on current credit quality was also a factor in the determination of the provision for loan losses. ~~The Company’s management continues to monitor the adequacy~~

Noninterest expense increased $4.6 million, or 10.6%, from $42.9 million in 2007 to $47.5 million in 2008. Other expense increased by $1.8 million, or 20.1%, driven by regulatory expenses which increased by $1.5 million due to the Company’s resumption of regular FDIC insurance premiums, as prior credits expired early in 2008. ~~We expect our premiums to continue to increase as we increase our deposit base and as the FDIC will charge higher assessments due to the current troubled economy.~~ Salaries and employee benefits increased by $1.7 million, or 7.0%, driven by normal salary increases, increased health insurance and performance-based incentive expense, the addition of revenue producing staff and enhanced staff in administrative positions. Data processing fees and supplies increased $549,000, or 17.7%, driven by the implementation of a new corporate treasury management platform and contractual increases in existing operating services. Net occupancy expense increased by $348,000, or 12.7%, primarily as a result of higher maintenance and repair costs and higher property tax expense that resulted from the Indiana property tax reapportionment process.

As a result of these factors, income before income tax expense increased $1.3 million, or 4.8%, from $27.6 million in 2007 to $28.9 million in 2008. Income tax expense was $9.2 million in 2008 versus $8.4 million in 2007. Income tax as a percentage of income before tax was 31.8% in 2008 versus 30.3% in 2007. The increase in the tax rate was driven by a lower percentage of revenue being derived from tax-advantaged sources in 2008 versus 2007. Net income increased $490,000, or 2.6%, to $19.7 million in 2008 versus $19.2 million in 2007. Basic earnings per

~~Table of Contents~~

share in 2008 was $1.61, an increase of 1.9%, versus $1.58 in 2007. The Company’s net income performance represented a 13.5% return on January 1, 2008, stockholders’ equity versus 14.8% in 2007. The net income performance resulted in a 0.91% return on average daily assets in 2008 versus 1.04% in 2007.

~~RESULTS OF OPERATIONS~~

~~2007 versus 2006~~

The Company reported record net income of $19.2 million in 2007, an increase of $490,000, or 2.6%, versus net income of $18.7 million in 2006. Net interest income increased $2.2 million, or 4.3%, to $54.6 million versus $52.3 million in 2006. Net interest income increased primarily due to increases in average earning assets, particularly a 14% increase in commercial loans as a result of our strategic focus on commercial lending. Interest income increased $12.4 million, or 11.8%, from $105.6 million in 2006 to $118.0 million in 2007. The increase was driven primarily by increases in average earning assets, as well as a 14 basis point increase in the tax equivalent yield on average earning assets over the year. Interest expense increased $10.2 million, or 19.2%, from $53.2 million in 2006 to $63.4 million in 2007. The increase was primarily the result of a 36 basis point increase in the Company’s daily cost of funds over the year. The Company had a net interest margin of 3.22% in 2007 versus 3.38% in 2006. Average earning assets increased by $148.7 million from $1.6 billion in 2006 to $1.7 billion in 2007. This loan growth was led by significant growth in Elkhart and Allen Counties and with balanced growth in the Bank’s other regions. Deposits increased to fund the loan growth during 2007, driven primarily by increases of $23.9 million in average brokered deposit balances, $20.5 million in interest bearing transaction accounts and $39.1 million in average other time deposit account balances.

Nonaccrual loans were $7.0 million, or 0.46% of total loans, at year end versus $13.8 million, or 1.02% of total loans, at the end of 2006. There were five relationships totaling $6.7 million classified as impaired as of December 31, 2007 versus five relationships totaling $13.3 million at the end of 2006. The decrease in impaired and nonperforming loans resulted from the transfer to other real estate of a single borrowing relationship, a residential and commercial real estate developer. Net charge-offs were $3.0 million in 2007 versus $955,000 in 2006, representing 0.21% and 0.08% of average daily loans in 2007 and 2006. Total nonperforming loans were $7.4 million, or 0.49% of total loans, at year end 2007 versus $14.1 million, or 1.04% of total loans, at the end of 2006. The provision for loan loss expense was $4.3 million in 2007, resulting in an allowance for loan losses at December 31, 2007 of $15.8 million, which represented 1.04% of the loan portfolio, versus a provision for loan loss expense of $2.6 million in 2006 and an allowance for loan losses of $14.5 million at the end of 2006, or 1.07% of the loan portfolio. The higher provision in 2007 versus 2006 was attributable to a number of factors, but was primarily a result of an increase in net charge-offs, general growth in the loan portfolio, as well as higher allocations on specific watch list credits. The level of loan loss provision was also influenced by other factors related to the growth in the loan portfolio, such as emerging market risk, commercial loan focus and large credit concentration, new industry lending activity, general economic conditions and historical loss percentages. In addition, management gave consideration to changes in the allocation for specific watch list credits in determining the appropriate level of the loan loss provision. Management’s overall view on current credit quality was also a factor in the determination of the provision for loan losses. The Company’s management continued to monitor the adequacy of the provision based on loan levels, asset quality, economic conditions and other factors that may influence the assessment of the collectability of loans.

Noninterest income was $20.2 million in 2007 versus $18.8 million in 2006, an increase of $1.4 million, or 7.7%. The 2007 increase was driven by a $592,000, or 23.2%, increase in wealth advisory fees. Additionally, noninterest income increased due to a $201,000, or 15.6%, increase in investment brokerage fees. Merchant card fee income increased due to higher volume activity in interchange and merchant fees as well as new business generation. Loan, insurance and service fees increased $191,000, or 8.3%, driven by higher fee income on debit card activity. Offsetting these increases was a decrease of $109,000, or 5.6%, in other income.

Noninterest expense increased $2.7 million, or 6.7%, from $40.2 million in 2006 to $42.9 million in 2007. Salaries and employee benefits increased by $1.4 million, or 6.4%, driven by normal salary increases and higher health care cost, which represented approximately $542,000 of the total increase. Data processing fees and supplies increased $449,000, or 18.3%, driven by higher data processing fees, software license fees and maintenance fees related to new services offered to clients. Net occupancy expense increased from $2.5 million in 2006 to $2.7 million in 2007, primarily as a result of higher maintenance and repair costs and higher property tax expense.

As a result of these factors, income before income tax expense decreased $658,000, or 2.3%, from $28.2 million in 2006 to $27.6 million in 2007. Income tax expense was $8.4 million in 2007 versus $9.5 million in 2006. Income tax as a percentage of income before tax was 30.3% in 2007 versus 33.7% in 2006. The decrease in the tax rate was driven by the formation of a captive real estate investment trust in the fourth quarter of 2006, which

~~Table of Contents~~FINANCIAL

provides the Company with an alternative vehicle for raising capital should the need arise. Additionally, the ownership structure of this real estate investment trust provided certain state income tax benefits which also lowered the Company’s effective tax rate. Net income increased $490,000, or 2.6%, to $19.2 million in 2007 versus $18.7 million in 2006. Basic earnings per share in 2007 was $1.58, an increase of 1.9%, versus $1.55 in 2006. The Company’s net income performance represented a 14.8% return on January 1, 2007, stockholders’ equity versus 16.5% in 2006. The net income performance resulted in a 1.04% return on average daily assets in 2007 versus 1.10% in 2006.

~~FINANCIAL~~ CONDITION

As of December 31, ~~2008,~~2009, the Company had 43 ~~offices~~branches serving twelve counties in northern Indiana and one loan production office in Indianapolis. Since 1996, the Company has added seventeen new offices through acquisition and internal growth. The Company will consider future acquisition and expansion opportunities, including FDIC assisted transactions, with an emphasis on markets that it believes would be receptive to its business philosophy of client-focused, independent banking, as well as increased penetration in existing markets where opportunities for market share growth exist.

Total assets of the Company were $2.572 billion as of December 31, 2009, an increase of $194.1 million, or 8.2%, when compared to $2.377 billion as of December 31, ~~2008, an increase of $388.3 million, or 19.5%, when compared to $1.989 billion as of December 31, 2007.~~

2008. Total cash and cash equivalents decreased by ~~$3.7~~$8.0 million, or ~~5.4%~~12.5%, to $56.0 million at December 31, 2009 from $64.0 million at December 31, ~~2008 from $67.7 million at December 31, 2007.~~

2008.

Total securities available for sale increased by ~~$59.3~~$23.0 million, or ~~18.1%~~5.9%, to $410.0 million at December 31, 2009 from $387.0 million at December 31, ~~2008 from $327.8 million at December 31, 2007.~~2008. The portfolio ~~contains~~contained mostly collateralized mortgage obligations and other securities which ~~are~~were either directly or indirectly backed by the federal government or a local municipal government and collateralized mortgage obligations rated AAA by S&P or Aaa by Moody’s at the time of purchase. As of December 31, ~~2008,~~2009, the Company had ~~$85.1~~$72.5 million of collateralized mortgage obligations which were not issued by the federal government or government sponsored agencies, but were rated AAA by S&P and/or Aaa by Moody’s at the time of purchase. The investment portfolio did not contain any corporate debt instruments or trust preferred instruments as of December 31, ~~2008.~~2009. The increase in securities available for sale was a result of a number of activities in the securities portfolio. Paydowns from prepayments of ~~$51.7~~$98.1 million were received, and the amortization of premiums, net of the accretion of discounts, was ~~$41,000.~~$546,000. Maturities and calls of securities totaled ~~$14.8~~$16.9 million. These portfolio decreases were offset by securities purchases totaling ~~$143.2~~$129.2 million. The fair value of the securities ~~decreased $17.4~~increased $9.6 million due to ~~the liquidity crisis that affected financial markets in 2008 and the current unsettled economic situation which resulted in lower~~higher market values for securities which were ~~not~~ backed directly or indirectly by the federal ~~government (private label MBS).~~government. The investment portfolio is managed to provide for an appropriate balance between credit risk and investment return and to limit the Company’s exposure to risk to an acceptable level.

~~Fourteen~~

Six of the 24 private label ~~MBS~~collateralized mortgage obligations in the investment portfolio were still rated AAA/Aaa as of December 31, ~~2008,~~2009, but ~~ten were~~eighteen had been downgraded by S&P, Fitch and/or Moody’s, including ~~four~~sixteen which were ranked below investment grade by one or more rating agencies. The Company ~~with the assistance of an outside expert, analyzes projections~~independently, analyzed valuations for ~~all of~~ these securities that ~~includes~~include projections of future performance in the underlying collateral ~~under~~using various scenarios and ~~under various~~ prepayment assumptions. The Company used Bloomberg analytics and other third party assistance in preparing this analysis. Based on the analyses as of December 31, ~~2008,~~2009, the ~~projections indicate that principal and interest payments expected to be collected over the life~~Company realized

Real estate mortgages held for sale ~~decreased~~increased by ~~$136,000,~~$1.1 million, or ~~25.3%~~279.3%, to $1.5 million at December 31, 2009 from $401,000 at December 31, ~~2008 from $537,000 at December 31, 2007.~~2008. The balance of this asset category is subject to a high degree of variability depending on, among other things, recent mortgage loan rates and the timing of loan sales into the secondary market. The Company generally sells to third parties almost all of the mortgage loans it originates. During ~~2008, $41.0~~2009, $121.9 million in real estate mortgages were originated for sale and ~~$40.8~~$119.9 million in mortgages were sold, compared to ~~$37.5~~$41.0 million and ~~$38.9~~$40.8 million in ~~2007.~~

2008.

Total loans, excluding real estate mortgages held for sale, increased by ~~$309.6~~$178.7 million, or ~~20.3%~~9.8%, to $2.012 billion at December 31, 2009 from $1.833 billion at December 31, ~~2008 from $1.524 billion at December 31, 2007.~~2008. The mix of loan types within the Company’s portfolio continued a trend toward a higher percentage of the total loan portfolio being in commercial loans. This general increase in commercial loans iswas a result of the Company’s long standing strategic focus toward emphasizing origination of commercial loans. The portfolio breakdown at year end 2009 and 2008 reflected 84% commercial and industrial and agri-business, 13% residential real estate and home equity and 3% consumer ~~loans compared to 82% commercial and industrial and agri-business, 15% residential real estate and home equity and 3% consumer loans at December 31, 2007.~~

loans.

At December 31, ~~2008,~~2009, the allowance for loan losses was $32.1 million, or 1.59% of total loans outstanding, versus $18.9 million, or 1.03% of total loans outstanding ~~versus $15.8 million, or 1.04% of total loans outstanding~~ at December 31, ~~2007.~~2008. The process of identifying probable credit losses is a subjective process. Therefore, the Company maintains a general allowance to cover probable incurred credit losses within the entire portfolio. The methodology management uses to determine the adequacy of the loan loss reserve includes the following considerations.

The Company has a relatively high percentage of commercial and commercial real estate loans, most of which are extended to ~~small-~~small or medium-sized ~~businesses.~~businesses from a wide variety of industries. Commercial loans represent higher dollar loans to fewer customers and therefore higher credit risk than other types of loans. Pricing is adjusted to manage the higher credit risk associated with these types of loans. The majority of ~~fixed rate~~fixed-rate mortgage loans, which represent increased interest rate risk, are sold in the secondary market, as well as some variable rate mortgage loans. The remainder of the variable rate mortgage loans and a small number of ~~fixed rate~~fixed-rate mortgage loans are retained. Management believes the allowance for loan losses is at a level commensurate with the overall risk exposure of the loan portfolio. However, if economic conditions do not stabilize or improve, certain borrowers may experience difficulty and the level of nonperforming loans, charge-offs and delinquencies could rise and require further increases in the provision for loan losses.

Loans are charged against the allowance for loan losses when management believes that the principal is uncollectible. Subsequent recoveries, if any, are credited to the allowance. The allowance is an amount that management believes will be adequate to absorb probable incurred credit losses relating to specifically identified loans based on an evaluation, as well as other probable incurred losses inherent in the loan portfolio. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans and current economic conditions that may affect the borrower’s ability to repay. Management also considers trends in adversely classified loans based upon a monthly review of those credits. An appropriate level of general allowance is determined after considering the following factors: application of historical loss percentages, emerging market risk, commercial loan focus and large credit concentrations, new industry lending activity and current economic conditions. Federal regulations require insured institutions to classify their own assets on a regular basis. The regulations provide for three categories of classified loans – substandard, doubtful and loss. The regulations also contain a special mention category. Special mention is defined as loans that do not currently expose an insured institution to a sufficient degree of risk to warrant classification as substandard, doubtful or loss, but do possess credit deficiencies or potential weaknesses deserving management’s close attention. Assets classified as substandard or doubtful require the institution to establish specific allowances for loan losses. If an asset or portion thereof is classified as loss, the insured institution must either establish specified allowances for loan losses in the amount of 100% of the portion of the asset classified loss, or charge off such amount. At December 31, ~~2008,~~2009, on the basis of management’s review of the loan portfolio, the Company had loans totaling ~~$98.8~~$178.0 million on the classified loan list versus ~~$79.3~~$98.8 million on December 31, ~~2007.~~2008. As of December 31, ~~2008,~~2009, the Company had ~~$47.2~~$75.0 million of assets classified special mention, ~~$46.2~~$100.6 million classified as substandard, ~~$5.4 million~~$369,000 classified as doubtful and $0 classified as loss as compared to ~~$39.4~~$47.2 million, ~~$39.7~~$46.2 million, ~~$244,000~~$5.4 million and $0 at December 31, ~~2007.~~

2008. In addition, at December 31, 2009 the Company had two relationships accounted for as troubled debt restructurings – a $176,000 mortgage loan with an allocation of $35,000 and a $6.3 million commercial credit with an allocation of $2.5 million. The Company has no commitments to lend additional funds to either of the borrowers. There were no troubled debt restructurings at December 31, 2008.

Allowance estimates are developed by management taking into account actual loss experience, adjusted for current economic conditions. The Company discusses this methodology with regulatory authorities to ensure

The allowance for loan losses increased ~~$3.1~~70.1% or $13.2 million, from ~~$15.8~~$18.9 million December 31, ~~2007~~2008 to ~~$18.9~~$32.1 million at December 31, ~~2008.~~2009. Pooled loan allocations increased ~~$2.1~~$3.2 million from ~~$4.9 million at December 31, 2007 to~~ $7.0 million at December 31, 2008 to $10.2 million at December 31, 2009, which was a result of an increase in pooled loan balances of ~~$290.0~~$101.3 million year over year and an increase in ~~commercial~~ loan allocations due to increased historical charge-offs and the current economic environment. Specific loan allocations ~~decreased $182,000~~increased $8.8 million from ~~$10.6 million at December 31, 2007 to~~ $10.4 million at December 31, ~~2008.~~2008 to $19.2 million at December 31, 2009. This ~~decrease~~increase was primarily due to the ~~payoffs received on previously~~higher classified ~~commercial credits, charge-offs taken during 2008 as well as the well-collateralized nature of newly classified loans.~~loan balance. The unallocated component of the allowance for loan losses increased ~~$1.1 million~~ from ~~$322,000 at December 31, 2007 to~~ $1.4 million at December 31, 2008 to $2.7 million at December 31, 2009 primarily due to the uncertainty in the current economic conditions.

The Company has experienced growth in total loans over the last three years of ~~$634.6~~$658.2 million, or ~~52.9%~~48.6%. The concentration of this loan growth was in the commercial loan ~~portfolio. Commercial~~portfolio while the percentage of commercial loans ~~comprised~~to all loans has remained relatively constant at 84%, ~~82%~~84% and ~~80%~~82% of the total loan portfolio at December 31, 2009, 2008 ~~2007~~ and ~~2006.~~2007. Traditionally, this type of lending may have more credit risk than other types of lending because of the size and diversity of the credits. The Company

~~Table of Contents~~

manages this risk by adjusting its pricing to the perceived risk of each individual credit and by diversifying the portfolio by customer, product, industry and geography. Management has historically considered growth and portfolio composition when determining loan loss allocations. Management believes that it is prudent to continue to provide for loan losses in a manner consistent with its historical approach due to the loan growth described above and current economic conditions.

As a result of the methodology in determining the adequacy of the allowance for loan losses, the provision for loan losses was $21.2 million in 2009 versus $10.2 million in ~~2008 versus $4.3 million in 2007.~~2008. At December 31, ~~2008,~~2009, total nonperforming loans increased by ~~$13.8~~$9.4 million to ~~$21.3~~$30.7 million from ~~$7.4~~$21.3 million at December 31, ~~2007.~~2008. Loans delinquent 90 days or more that were included in the accompanying financial statements as accruing totaled ~~$478,000~~$190,000 versus ~~$409,000~~$478,000 at December 31, ~~2007.~~2008. For December 31, 2009 and 2008, $29.7 million and $20.3 million of impaired loans were also included in the total for nonaccrual loans. Total impaired loans increased by ~~$13.6~~$11.5 million to $31.8 million at December 31, 2009 from $20.3 million at December 31, ~~2008~~2008. The increase in nonaccrual loans resulted primarily from ~~$6.7 million at December 31, 2007.~~the addition of three commercial relationships totaling $10.6 million. As discussed earlier. The increase in impaired ~~and nonperforming~~ loans resulted primarily from the ~~addition of four~~three commercial relationships ~~totaling $14.4~~mentioned previously, as well as one other commercial relationship of $2.1 million. ~~The $20.3 million in impaired loans are all in nonaccrual status.~~ The Company allocated ~~$3.2~~$6.7 million and ~~$2.3~~$3.2 million of the allowance for loan losses to the impaired loans in ~~2008~~2009 and ~~2007.~~2008. A loan is impaired when full payment under the original loan terms is not expected. Impairment is evaluated in total for smaller-balance loans of similar nature such as residential mortgage, consumer, and credit card loans, and on an individual loan basis for other loans. If a loan is impaired, a portion of the allowance may be allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral.

Management believes that the regional economic conditions continue to worsen in the Company’s markets and does not foresee a rapid recovery from this distressed economic environment. In addition, slow downs in certain industries, including residential and commercial real estate development, recreational vehicle and mobile home manufacturing and other regional industries are occurring. The Company believes that the impact of these industry-specific issues will be mitigated by its overall expansion strategy, which promotes diversification among industries as well as a continued focus on enforcement of a strong credit environment and an aggressive position on loan work-out situations.

Management does not foresee a rapid recovery from the current distressed economic conditions in the Company’s markets as certain industries, including residential and commercial real estate development, recreational vehicle and mobile home manufacturing and other regional industries continue to experience general slow-downs and shrinkage from their levels a few years ago. The Company’s continued growth strategy promotes diversification among industries as well as continued focus on enforcement of a strong credit environment and an aggressive position in loan work-out situations. While the Company believes that the impact of these industry-specific issues will be somewhat mitigated by its overall expansion strategy, the economic recession impacting its entire geographic footprint will continue to present challenges.

Total deposits ~~increased~~decreased by ~~$406.4~~$34.2 million, or ~~27.5%~~1.8%, to $1.851 billion at December 31, 2009 from $1.885 billion at December 31, ~~2008 from $1.479 billion at December 31, 2007.~~2008. The ~~increase~~decrease resulted from ~~increases~~decreases of ~~$165.1~~$185.1 million in brokered deposits, ~~$151.6~~$75.3 million in ~~interest bearing transaction accounts, $82.8~~public fund certificates of deposit, $19.9 million in other certificates of deposit and ~~$58.3~~$7.2 million in interest bearing transaction accounts. These decreases were offset by increases of $104.5 million in certificates of deposit of $100,000 and ~~over. The increase~~over, $45.2 million in ~~interest bearing~~money market accounts, $44.3 million in CDARS certificates of deposit, $30.6

Total short-term borrowings ~~decreased~~increased by ~~$113.6~~$151.4 million, or ~~35.9%~~74.8%, to $354.1 million at December 31, 2009 from $202.6 million at December 31, ~~2008~~2008. The increase resulted primarily from ~~$316.2 million at December 31, 2007. The decrease resulted from decreases of $51.0~~$85.0 million in ~~federal funds purchased, $45.0~~borrowings under the Federal Reserve Bank’s Term Auction Facility and an $85 million increase in ~~other~~ short-term borrowings ~~primarily short-term advances~~ from the Federal Home Loan Bank of ~~Indianapolis, $17.1 million~~Indianapolis. The increases were offset by decreases in securities sold under agreements to repurchase of $10.7 million and ~~$402,000~~$9.4 million in ~~U.S. Treasury demand notes. In addition, long-term borrowings increased by $90.0 million as a result of long-term advances from the Federal Home Loan Bank of Indianapolis.~~

federal funds purchased.

The Company believes that a strong, appropriately managed capital position is critical to long-term earnings and expansion. Bank regulatory agencies exclude the market value adjustment created by ~~SFAS No. 115~~current accounting guidance (AFS adjustment) from capital adequacy calculations. Excluding this adjustment from the calculation, the Company had a total risk-based capital ratio of ~~10.2%~~15.4% and a Tier I risk-based capital ratio of ~~9.3%~~14.1% as of December 31, ~~2008.~~2009. These ratios met or exceeded the Federal Reserve’s “well-capitalized” minimums of 10.0% and 6.0%, respectively. To further strengthen the ~~Company’s~~Company's capital position, the Company issued 3.6 million additional common shares resulting in net proceeds to the Company of $57.9 million in November 2009. In addition, on February 27, 2009, the Company participated in ~~Treasury’s~~Treasury's TARP Capital Purchase Program. Pursuant to the program, the Company issued to Treasury 56,044 shares of the Series A Preferred ~~Stock and a warrant to purchase 396,538 shares of the Company’s common stock.~~Stock. The $56.0 million received by the Company in connection with this investment qualifies as Tier 1 regulatory capital for the Company.

In conjunction with this issuance of preferred stock, the Company issued a warrant to purchase 396,538 shares of the Company's common stock. The warrant has subsequently been adjusted to 198,267 shares as a result of the successful common equity offering.

The ability to maintain these ratios is a function of the balance between net income and a prudent dividend policy. Total stockholders’ equity increased by 86.8% to $280.0 million as of December 31, 2009 from $149.9 million as of December 31, 2008. The increase in 2009 resulted from net income of $19.0 million, as well as the following factors:

cash dividends of $10.1 million,

a favorable change in the AFS adjustment for the market valuation on securities held for sale of $5.8 million, net of tax,

positive pension liability adjustment of $242,000, net of tax,

$12,000 for net treasury stock sold,

$796,000 related to stock option exercises,

$322,000 in stock compensation expense,

$89,000 in stock award exercise expense,

$53.8 million from the issuance of preferred stock, net of accretion, and

$57.9 million from the issuance of common stock.

Total stockholders’ equity increased by 2.5% to ~~$149.9~~$150.0 million as of December 31, 2008 from $146.3 million as of December 31, 2007. The increase in 2008 resulted from net income of $19.7 million, as well as the following factors:


• ·	cash dividends of $7.4 million,


• ·	an unfavorable change in the AFS adjustment for the market valuation on securities held for sale of $10.4 million, net of tax,


• ·	negative pension liability adjustment of $629,000, net of tax,


• ·	$211,000 for the acquisition of treasury stock, and


• ·	$2.1 million related to stock option exercises.

~~Total stockholders’ equity increased by 12.4% to $146.3 million as of December 31, 2007 from $130.2 million as of December 31, 2006.~~

The ~~increase in 2007 resulted from net income of $19.2 million, as well as the following factors:~~


•	~~cash dividends of $6.6 million,~~

•	~~a favorable change in the AFS adjustment for the market valuation on securities held for sale of $1.9 million, net of tax,~~

•	~~positive minimum pension liability adjustment of $232,000, net of tax,~~

•	~~$243,000 for the acquisition of treasury stock and~~

•	~~$1.2 million related to stock option exercises.~~

~~The 2008~~2009 AFS adjustment was primarily related to a ~~574~~222 basis point ~~decrease~~increase in the two to five year U.S. Treasury rates during ~~2008.~~2009. Management has factored this into the determination of the size of the AFS portfolio to ~~assure~~help ensure that stockholders’ equity iswill be adequate under various scenarios.

Critical Accounting Policies

Certain of the Company’s accounting policies are important to the portrayal of the Company’s financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances. Some of the facts and circumstances which could affect these judgments include changes in interest rates, in the performance of the economy or in the financial condition of borrowers. Management believes that its critical accounting policies include determining the allowance for loan losses and the valuation of mortgage servicing rights.

The Company maintains an allowance for loan losses to provide for probable incurred credit losses. Loan losses are charged against the allowance when management believes that the principle is uncollectable. Subsequent recoveries, if any, are credited to the allowance. Allocations of the allowance are made for specific loans and for pools of similar types of loans, although the entire allowance is available for any loan that, in management’s judgment, should be charged against the allowance. A provision for loan losses is taken based on management’s ongoing evaluation of the appropriate allowance balance. A formal evaluation of the adequacy of the loan loss allowance is conducted at least monthly and more often if deemed necessary. The ultimate recovery of all loans is susceptible to future market factors beyond the Company’s control.

The level of loan loss provision is influenced by growth in the overall loan portfolio, emerging market risk, emerging concentration risk, commercial loan focus and large credit concentration, new industry lending activity, general economic conditions and historical loss analysis. In addition, management gives consideration to changes in the allocation for specific watch list credits in determining the appropriate level of the loan loss provision. Furthermore, management’s overall view on credit quality is a factor in the determination of the provision.

The determination of the appropriate allowance is inherently subjective, as it requires significant estimates. The Company has an established process to determine the adequacy of the allowance for loan losses that generally includes consideration of the following factors: changes in the nature and volume of the loan portfolio, overall portfolio quality and current economic conditions that may affect the borrowers’ ability to repay. Consideration is not limited to these factors, although they represent the most commonly cited factors. With respect to specific allocation levels for individual credits, management generally considers the amounts and timing of expected future cash flows and the valuation of collateral as the primary measures. Management also considers trends in adversely classified loans based upon an ongoing review of those credits. With respect to pools of similar loans, we generally use percentage allocations based upon historical analysis. We may also adjust these allocations for other factors cited above. An appropriate level of general allowance for pooled loans is determined after considering the following: application of historical loss percentages, emerging market risk, commercial loan focus and large credit

~~Table of Contents~~

concentration, new industry lending activity and general economic conditions. It is also possible that the following could affect the overall process: social, political, economic and terrorist events or activities. All of these factors are susceptible to significant change. As a result of this detailed process, the allowance results in two forms of allocations, specific and general. These two components represent the total allowance for loan losses deemed adequate to cover probable losses inherent in the loan portfolio.

Commercial loans are subject to a dual standardized grading process administered by the credit administration and internal loan review functions. A credit grade is assigned to each commercial loan by both the commercial loan officer and the loan review department. These grade assignments are performed independent of each other and a loan may or may not be graded the same. The grade given by the loan review department is ~~the~~ assigned in the Company’s loan system for individual credits. The need for specific allocation of the loan loss reserve is considered for individual credits when graded special mention, substandard, doubtful or loss. Other considerations with respect to specific allocations for individual credits include, but are not limited to, the following: (a) does the customer’s cash flow or net worth appear insufficient to repay the loan; (b) is there adequate collateral to repay the loan; (c) has the loan been criticized in a regulatory examination; (d) is the loan on non-accrual; (e) are there other reasons where the ultimate ~~collectibility~~collectability of the loan is in question; or (f) are there unique loan characteristics require special monitoring. Specific allowances are established in cases where management has identified significant conditions or circumstances related to an individual credit that we believe ~~indicates~~indicate the loan is impaired.

Allocations are also applied to categories of loans not considered individually impaired but for which the rate of loss is expected to be consistent with or greater than historical averages. Such allocations are based on past loss experience and information about specific borrower situations and estimated collateral values. In addition, general allocations are made for other pools of loans, including non-classified loans. These general pooled loan

allocations are performed for similar portfolios of consumer and residential real estate loans, and loans within certain industry categories believed to present unique risk of loss. General allocations of the allowance are primarily made based on a five-year historical average for loan losses for these portfolios, judgmentally adjusted for economic factors and portfolio trends.

Due to the imprecise nature of estimating the allowance for loan losses, the Company’s allowance for loan losses includes an unallocated component. The unallocated component of the allowance for loan losses incorporates the Company’s judgmental determination of inherent losses that may not be fully reflected in other allocations, including factors such as the level of classified credits, economic uncertainties, industry trends impacting specific portfolio segments, broad portfolio quality trends and trends in the composition of the Company’s large commercial loan portfolio and related large dollar exposures to individual borrowers.

The Company adopted ~~SFAS No. 156~~the current accounting guidance on January 1, 2007, and for sales of mortgage loans beginning in 2007, mortgage servicing rights (MSRs) are initially recognized as assets for the full fair value of retained servicing rights on loans sold. Subsequent measurement uses the amortization method where all servicing rights are expensed in proportion to, and over the period of, estimated net servicing revenues. Impairment is evaluated based on the fair value of the rights, using groupings of the underlying loans as to type and interest rate. Fair value is determined based upon discounted cash flows using market-based assumptions.

To determine the fair value of MSRs, the Company uses a valuation model that calculates the present value of estimated future net servicing income. In using this valuation method, the Company incorporates assumptions that market participants would use in estimating future net servicing income, which include estimates of prepayment speeds, discount rate, cost to service, escrow account earnings, contractual servicing fee income, ancillary income, late fees, and float income. The Company compares the valuation model inputs and results to published industry data in order to validate the model results and assumptions.

The most significant assumption used to value MSRs is prepayment rate. In general, during periods of declining interest rates, the value of MSRs decline due to increasing prepayment speeds attributable to increased mortgage refinancing activity. Prepayment rates are estimated based on published industry consensus prepayment rates. Prepayments will increase or decrease in correlation with market interest rates and actual prepayments generally differ from initial estimates. If actual prepayment rates are different than originally estimated, the Company may receive less mortgage servicing income, which could reduce the value of the MSRs. Other assumptions used in estimating the fair value of MSRs do not generally fluctuate to the same degree as prepayment rates, and therefore the fair value of MSRs is less sensitive to changes in these other assumptions.

The servicing assets had a fair value of $2.1 million ~~and $2.5 million~~ at both December 31, ~~2008~~2009 and ~~2007, respectively.~~2008. At December 31, ~~2008,~~2009, key economic assumptions and the sensitivity of the current fair value of mortgage servicing rights to an immediate 10% and 20% adverse changes in those assumptions are as follows:

Fair value of mortgage servicing assets

$
2,148

Constant prepayment speed (PSA)

287

Impact on fair value of 10% adverse change

$
(110
)

Impact on fair value of 20% adverse change

(206
)

Discount rate

9.4
%

Impact on fair value of 10% adverse change

$
(54
)

Impact on fair value of 20% adverse change

(107
)

	(dollars in thousands)
Fair value of mortgage servicing assets	$	2,136
Constant prepayment speed (PSA)		299
Impact on fair value of 10% adverse change	$	(112	)
Impact on fair value of 20% adverse change		(216	)
Discount rate		9.5	%
Impact on fair value of 10% adverse change	$	(53	)

These sensitivities are hypothetical and should not be relied upon. As the figures indicate, changes in value based on a 10% and 20% variation in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in value may not be linear. Also, in this table, the effect of a variation in a particular assumption on the value of the servicing asset is calculated without changing any other assumption; in reality, changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments), which might magnify or counteract the sensitivities.

On a monthly basis, the Company evaluates the possible impairment of MSRs based on the difference between the carrying amount and the current fair value of MSRs. For purposes of evaluating and measuring impairment, the Company stratifies its portfolios on the basis of certain risk characteristics, including loan type and interest rate. If impairment exists, a valuation allowance is established for any excess of amortized cost over the current fair value, by risk stratification, through a charge to income. If the Company later determines that all or a

portion of the impairment no longer exists for a particular strata, a reduction of the valuation allowance may be recorded as an increase to income.

The fair values of securities available for sale are determined on a recurring basis by obtaining quoted prices on nationally recognized securities exchanges or pricing models utilizing significant observable inputs such as matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities. Different judgments and assumptions used in pricing could result in different estimates of value.

At the end of each reporting period securities held in the investment portfolio are evaluated on an individual security level for ~~other-than-temporary~~other than temporary impairment in accordance with ~~SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities.~~current accounting guidance. An impairment is ~~other-than-temporary~~other than temporary if the decline in the fair value of the security is below its amortized cost and it is probable that all amounts due according to the contractual terms of a debt security will not be received.

Significant judgments are required in determining impairment, which include making assumptions regarding the estimated prepayments, loss assumptions and the change in interest rates.

We consider the following factors when determining an other-than-temporary impairment for a security or investment:


• ·	The length of time and the extent to which the market value has been less than amortized cost;


• ·	The financial condition and near-term prospects of the issuer;


• ·	The underlying fundamentals of the relevant market and the outlook for such market for the near future; and


• ·	Our intent and ability to hold the security for a period of time sufficient to allow for any anticipated recovery in market value.

For the private label mortgage-backed securities, additional independent analysis is performed to determine if an other-than-temporary impairment needs to be recorded for these securities. ~~This~~The independent analysis ~~includes outside,~~utilizes third party ~~assistance and includes projecting~~reports which include projections of the cash flows of the individual securities ~~using~~under several different scenarios ~~regarding~~based upon assumptions as to collateral defaults, prepayment speeds, expected losses and the severity of potential losses.

Based upon the initial review using the third party reports, securities may be identified for further analysis. If any are identified, management makes assumptions as to prepayment speeds, default rates, severity of losses and lag time until losses are actually recorded for each security based upon historical data for each security and other factors. Cash flows for each security using these assumptions are generated and the net present value is computed using an appropriate discount rate (the current accounting yield) for the individual security. The net present value is then compared to the book value of the security to determine if there is any other-than-temporary impairment that must be recorded.

If, in management’s judgment, an other-than-temporary impairment exists, the cost basis of the security will be written down to the then-current fair value, and the unrealized loss will be transferred from accumulated other comprehensive loss as an immediate reduction of current earnings (as if the loss had been realized in the

~~Table of Contents~~

period of other than temporary impairment). In addition, discount accretion will be discontinued on any bond that meets one or both of the following: (1) the rating by S&P, Moody’s or Fitch decreases to below “A” and/or (2) the cash flow analysis on a security indicates under any scenario modeled by the third party there is a potential to not receive the full amount invested in the security.

Newly Issued But Not Yet Effective Accounting Standards

In June 2009, the FASB ~~Statement~~amended previous guidance relating to transfers of ~~Financial Accounting Standards No. 141 (revised 2007),~~ ~~Business Combinations~~ ~~is effective for fiscal years beginning after December 15, 2008. SFAS No. 141(R) establishes principles~~financial assets and ~~requirements for how~~eliminates the acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree; recognizes and measures the goodwill acquired in the business combination orconcept of a ~~gain from a bargain purchase; determines what information to disclose to enable users~~qualifying special purpose entity. This guidance must be applied as of the ~~financial statements~~beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. This guidance must be applied to ~~evaluate~~transfers occurring on or after the ~~nature~~effective date. Additionally, on and ~~financial effects~~after the effective date, the concept of a qualifying special-purpose entity is no longer relevant for accounting purposes. Therefore, formerly qualifying special-purpose entities should be evaluated for consolidation by reporting entities on and after the ~~business combination.~~effective date in accordance with the applicable consolidation guidance. The disclosure provisions were also amended and apply to


	Commercial		Residential Real Estate Mortgage		Installment		Line of Credit		Total		Percent


Original maturity of one day	$	546,097	$	0	$	0	$	86,500	$	632,597		34.50	%

Other within one year		160,015		21,879		17,217		37,912	$	237,023		12.93

After one year, within five years		684,267		24,074		31,632		3,682	$	743,655		40.56

Over five years		122,584		70,520		2,325		4,053	$	199,482		10.88

Nonaccrual loans		20,053		757		0		0	$	20,810		1.13


Total loans	$	1,533,016	$	117,230	$	51,174	$	132,147	$	1,833,567		100.0	%


	$ 100,000 or more		% of Total			Other		% of Total


Within three months	$	316,149		49.59	%	$	61,943		17.17	%

Over three months, within six months		129,300		20.28			65,282		18.10

Over six months, within twelve months		133,336		20.91			143,025		39.64

Over twelve months		58,788		9.22			90,521		25.09


Total time certificates of deposit	$	637,573		100.00	%	$	360,771		100.00	%


	Payments Due by Period

	Total		One year or less		1-3 years		4-5 years		After 5 years

	(in thousands)
Certificates of deposit	$	426,895	$	355,103	$	67,948	$	3,734	$	110
Long-term debt		90,043		50,000		25,000		15,000		43
Operating leases		43		34		9		0		0
Subordinated debentures		30,928		0		0		0		30,928

Total contractual long-term cash obligations	$	547,909	$	405,137	$	92,957	$	18,734	$	31,081


	Amount of Commitment Expiration Per Period

	Total Amount Committed		One year or less		Over one year

	(in thousands)
Unused loan commitments	$	770,746	$	538,989	$	231,757
Commercial letters of credit		1,165		1,165		0
Standby letters of credit		25,825		18,052		7,773

Total commitments and letters of credit	$	797,736	$	558,206	$	239,530

	Payments Due by Period
			One year						After 5
	Total		or less		1-3 years		4-5 years		years
					(in thousands)
Certificates of deposit	$	288,768	$	231,567	$	52,039	$	5,125	$	37
Long-term debt		40,042		0		25,000		15,000		42
Operating leases		69		42		7		6		14
Subordinated debentures		30,928		0		0		0		30,928
Total contractual long-term cash
obligations	$	359,807	$	231,609	$	77,046	$	20,131	$	31,021


	2007								2006

	Average Balance			Interest Income		Yield (1)			Average Balance			Interest Income		Yield (1)

ASSETS
Earning assets:
Loans:
Taxable (2)(3)	$	1,401,480		$	102,840		7.34	%	$	1,264,490		$	91,946		7.27	%
Tax exempt (1)		2,588			166		6.41			5,995			328		5.47

Investments: (1)
Available for sale		306,293			15,140		4.94			293,931			13,609		4.63

Short-term investments		17,412			863		4.96			12,896			647		5.02

Interest bearing deposits		1,486			68		4.58			3,269			151		4.62


Total earning assets		1,729,259			119,077		6.89	%		1,580,581			106,681		6.75	%

Nonearning assets:
Cash and due from banks		44,565			0					56,235			0

Premises and equipment		26,042			0					24,750			0

Other nonearning assets		54,220			0					50,597			0

Less allowance for loan losses		(15,045	)		0					(13,692	)		0


Total assets	$	1,839,041		$	119,077				$	1,698,471		$	106,681


	2008 Over (Under) 2007 (1)									2007 Over (Under) 2006 (1)

	Volume			Rate			Total			Volume			Rate			Total

INTEREST AND LOAN FEE INCOME (2)
Loans:
Taxable	$	17,372		$	(20,674	)	$	(3,302	)	$	10,045		$	849		$	10,894
Tax exempt		5			(24	)		(19	)		(211	)		49			(162	)
Investments:
Available for sale		3,260			1,331			4,591			587			944			1,531

Short-term investments		(206	)		(486	)		(692	)		224			(8	)		216

Interest bearing deposits		20			(39	)		(19	)		(82	)		(1	)		(83	)


Total interest income		20,451			(19,892	)		559			10,563			1,833			12,396


INTEREST EXPENSE
Savings deposits		(4	)		(65	)		(69	)		(1	)		(9	)		(10	)
Interest bearing checking accounts		2,134			(7,009	)		(4,875	)		671			1,394			2,065

Time deposits:
In denominations under $100,000		1,566			(1,931	)		(365	)		1,368			2,134			3,502
In denominations over $100,000		3,168			(6,893	)		(3,725	)		1,626			1,330			2,956

Miscellaneous short-term borrowings		3,021			(4,640	)		(1,619	)		1,321			324			1,645

Long-term borrowings and subordinated debentures		3,435			(1,047	)		2,388			0			99			99


Total interest expense		13,320			(21,585	)		(8,265	)		4,985			5,272			10,257


INCREASE (DECREASE) IN INTEREST DIFFERENTIALS	$	7,131		$	1,693		$	8,824		$	5,578		$	(3,439	)	$	2,139


	Within One Year			After One Year Within Five Years			After Five Years Within Ten Years			Over Ten Years

Securities available for sale:

US Treasury securities
Fair value	$	1,025		$	0		$	0		$	0
Yield		3.38	%		0	%		0	%		0	%

Government agencies and corporations
Fair value		10,943			4,742			0			0
Yield		4.61	%		3.88	%		0	%		0	%

Mortgage-backed securities
Fair value		177			18,653			82,152			213,687
Yield		6.47	%		3.72	%		4.87	%		5.25	%

State and municipal securities
Fair value		578			3,442			33,618			18,013
Yield		3.63	%		4.15	%		4.54	%		4.35	%



Total debt securities available for sale:
Fair value	$	12,723		$	26,837		$	115,770		$	231,700
Yield		4.49	%		3.81	%		4.77	%		5.18	%


	2005					2004

	Allowance For Loan Losses		Loans as Percentage of Gross Loans			Allowance For Loan Losses		Loans as Percentage of Gross Loans

Allocated allowance for loan losses:
Commercial	$	10,870		80.46	%	$	8,696		78.84	%
Real estate		187		6.24			136		5.40
Installment		509		5.67			398		5.29
Credit cards and personal credit lines		688		7.63			789		10.47


Total allocated allowance for loan losses		12,254		100.00	%		10,019		100.00	%


Unallocated allowance for loan losses		520					735


Total allowance for loan losses	$	12,774				$	10,754


	4th Quarter		3rd Quarter		2nd Quarter		1st Quarter

2008

Trading prices (per share)*
Low	$	14.93	$	18.52	$	19.00	$	16.87
High	$	24.10	$	30.09	$	25.00	$	23.97

Dividends declared (per share)	$	0.155	$	0.155	$	0.155	$	0.140

2007

Trading prices (per share)*
Low	$	18.25	$	20.05	$	20.71	$	21.85
High	$	25.00	$	25.98	$	23.81	$	25.92

Dividends declared (per share)	$	0.140	$	0.140	$	0.140	$	0.125


Period	Total Number of Shares Purchased		Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		Maximum Number (or Appropriate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs


10/01/08-10/31/08		0	$	0.00		0	$	0.00
11/01/08-11/30/08		758		21.57		0		0.00
12/01/08-12/31/08		0		0.00		0		0.00


Total		758	$	21.57		0	$	0.00


INDEX	2003		2004		2005		2006		2007		2008

Lakeland Financial Corporation	$	100.00	$	115.12	$	119.82	$	154.78	$	129.79	$	152.27
NASDAQ Market Index		100.00		108.59		110.08		120.56		132.39		78.72
Peer Group Index		100.00		119.17		118.45		134.88		95.73		73.33


*	~~Assumes $100 invested on December 31, 2003 and dividends were reinvested.~~


Fair value of mortgage servicing assets	$	2,148
Constant prepayment speed (PSA)		287
Impact on fair value of 10% adverse change	$	(110	)
Impact on fair value of 20% adverse change		(206	)
Discount rate		9.4	%
Impact on fair value of 10% adverse change	$	(54	)
Impact on fair value of 20% adverse change		(107	)

	Amount of Commitment Expiration Per Period
	Total
	Amount		One year		Over one
	Committed		or less		year
			(in thousands)
Unused loan commitments	$	864,634	$	590,615	$	274,019
Commercial letters of credit		1,200		1,200		0
Standby letters of credit		39,445		34,276		5,169
Total commitments and letters of credit	$	905,279	$	626,091	$	279,188


																						Fair Value 12/31/2008

	Year 1			Year 2			Year 3			Year 4			Year 5			Thereafter			Total

Rate sensitive assets:
Fixed interest rate loans	$	233,791		$	154,216		$	127,716		$	121,875		$	165,540		$	62,159		$	865,297		$	882,148
Average interest rate		6.19	%		6.55	%		6.63	%		6.52	%		5.92	%		6.32	%		6.32	%
Variable interest rate loans	$	655,893		$	69,715		$	46,169		$	26,468		$	31,962		$	137,830		$	968,037		$	964,679
Average interest rate		3.37	%		3.26	%		3.49	%		3.26	%		3.26	%		3.26	%		3.34	%
Fixed interest rate securities	$	205,454		$	78,307		$	29,830		$	16,545		$	10,998		$	62,914		$	404,048		$	386,859
Average interest rate		5.46	%		6.30	%		7.04	%		5.36	%		5.62	%		5.25	%		5.75	%
Variable interest rate securities	$	169		$	0		$	0		$	0		$	0		$	0		$	169		$	171
Average interest rate		5.98	%		0.00	%		0.00	%		0.00	%		0.00	%		0.00	%		5.98	%
Other interest-bearing assets	$	6,858		$	0		$	0		$	0		$	0		$	0		$	6,858		$	6,858
Average interest rate		0.58	%		0.00	%		0.00	%		0.00	%		0.00	%		0.00	%		0.58	%
Rate sensitive liabilities:
Non-interest bearing checking	$	230,716		$	0		$	0		$	0		$	0		$	0		$	230,716		$	230,716
Average interest rate
Savings & interest bearing checking	$	656,239		$	0		$	0		$	0		$	0		$	0		$	656,239		$	656,239
Average interest rate		1.08	%		0.00	%		0.00	%		0.00	%		0.00	%		0.00	%		1.08	%
Time deposits	$	849,234		$	88,286		$	46,850		$	7,229		$	6,209		$	536		$	998,344		$	1,013,798
Average interest rate		3.38	%		4.03	%		4.53	%		4.47	%		4.25	%		4.25	%		3.51	%
Fixed interest rate borrowings	$	70,288		$	0		$	25,000		$	0		$	15,000		$	43		$	110,331		$	114,291
Average interest rate		2.80	%		0.00	%		4.61	%		0.00	%		4.49	%		6.15	%		3.44	%
Variable interest rate borrowings	$	182,321		$	0		$	0		$	0		$	0		$	30,928		$	213,249		$	213,283
Average interest rate		3.53	%		0.00	%		0.00	%		0.00	%		0.00	%		1.41	%		1.15	%

	2009
	Principal/Notional Amount Maturing in:
	(dollars in thousands)
																					Fair
																					Value
	Year 1			Year 2			Year 3			Year 4			Year 5			Thereafter			Total		12/31/2009
Rate sensitive assets:
Fixed interest rate loans	$	209,742		$	165,359		$	155,828		$	195,205		$	78,716		$	85,199		$	890,049	$	901,670
Average interest rate		6.26	%		6.40	%		6.29	%		5.93	%		6.12	%		6.09	%
Variable interest rate loans	$	745,623		$	109,501		$	68,996		$	36,013		$	40,245		$	121,583		$	1,121,961	$	1,116,860
Average interest rate		3.98	%		3.89	%		3.63	%		3.29	%		3.40	%		3.43	%
Fixed interest rate securities	$	72,265		$	48,019		$	41,500		$	41,071		$	43,193		$	171,433		$	417,481	$	409,880
Average interest rate		4.97	%		5.08	%		5.43	%		5.20	%		4.45	%		2.64	%
Variable interest rate securities	$	145		$	0		$	0		$	0		$	0		$	0		$	145	$	148
Average interest rate		6.00	%		0.00	%		0.00	%		0.00	%		0.00	%		0.00	%
Other interest-bearing assets	$	7,019		$	0		$	0		$	0		$	0		$	0		$	7,019	$	7,019
Average interest rate		0.21	%		0.00	%		0.00	%		0.00	%		0.00	%		0.00	%
Rate sensitive liabilities:
Non-interest bearing checking	$	259,415		$	0		$	0		$	0		$	0		$	0		$	259,415	$	259,415
Average interest rate
Savings & interest bearing checking	$	724,947		$	0		$	0		$	0		$	0		$	0		$	724,947	$	724,947
Average interest rate		0.98	%		0.00	%		0.00	%		0.00	%		0.00	%		0.00	%
Time deposits	$	688,822		$	126,693		$	40,312		$	7,231		$	3,264		$	441		$	866,763	$	870,727
Average interest rate		2.20	%		2.82	%		3.20	%		4.12	%		2.89	%		2.89	%
Fixed interest rate borrowings	$	97,074		$	0		$	25,000		$	0		$	15,000		$	42		$	137,116	$	138,436
Average interest rate		0.28	%		0.00	%		2.53	%		0.00	%		3.21	%		6.15	%
Variable interest rate borrowings	$	256,977		$	0		$	0		$	0		$	0		$	30,928		$	287,905	$	287,813
Average interest rate		0.47	%		0.00	%		0.00	%		0.00	%		0.00	%		3.31	%


CONSOLIDATED BALANCE SHEETS (in thousands except share data)

December 31	2008			2007

ASSETS
Cash and due from banks	$	57,149		$	56,278
Short-term investments		6,858			11,413

Total cash and cash equivalents		64,007			67,691

Securities available for sale (carried at fair value)		387,030			327,757
Real estate mortgage loans held for sale		401			537

Loans, net of allowance for loan losses of $18,860 and $15,801		1,814,474			1,507,919

Land, premises and equipment, net		30,519			27,525
Bank owned life insurance		33,966			21,543
Accrued income receivable		8,599			9,126
Goodwill		4,970			4,970
Other intangible assets		413			619
Other assets		33,066			21,446

Total assets	$	2,377,445		$	1,989,133

LIABILITIES AND STOCKHOLDERS’ EQUITY

LIABILITIES
Noninterest bearing deposits	$	230,716		$	255,348
Interest bearing deposits		1,654,583			1,223,570

Total deposits		1,885,299			1,478,918

Short-term borrowings
Federal funds purchased		19,000			70,010
Securities sold under agreements to repurchase		137,769			154,913
U.S. Treasury demand notes		840			1,242
Other short-term borrowings		45,000			90,000

Total short-term borrowings		202,609			316,165

Accrued expenses payable		17,163			15,497
Other liabilities		1,523			1,311
Long-term borrowings		90,043			44
Subordinated debentures		30,928			30,928

Total liabilities		2,227,565			1,842,863

Commitments, off-balance sheet risks and contingencies (Notes 1 and 19)

STOCKHOLDERS’ EQUITY

Common stock: 90,000,000 shares authorized, no par value 12,373,080 shares issued and 12,266,849 outstanding as of December 31, 2008 12,207,723 shares issued and 12,111,703 outstanding as of December 31, 2007		1,453			1,453
Additional paid-in capital		20,632			18,078
Retained earnings		141,371			129,090
Accumulated other comprehensive loss		(12,024	)		(1,010	)
Treasury stock, at cost (2008 - 106,231 shares, 2007 - 96,020 shares)		(1,552	)		(1,341	)

Total stockholders’ equity		149,880			146,270

Total liabilities and stockholders’ equity	$	2,377,445		$	1,989,133


CONSOLIDATED STATEMENTS OF INCOME (in thousands except share and per share data)

Years Ended December 31	2008		2007		2006

NET INTEREST INCOME
Interest and fees on loans
Taxable	$	99,538	$	102,840	$	91,946
Tax exempt		113		137		279
Interest and dividends on securities
Taxable		16,202		11,591		10,123
Tax exempt		2,411		2,474		2,405
Interest on short-term investments		220		931		798

Total interest income		118,484		117,973		105,551

Interest on deposits		44,580		53,614		45,101
Interest on borrowings
Short-term		5,620		7,239		5,594
Long-term		5,016		2,564		2,529

Total interest expense		55,216		63,417		53,224

NET INTEREST INCOME		63,268		54,556		52,327

Provision for loan losses		10,207		4,298		2,644

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		53,061		50,258		49,683

NONINTEREST INCOME
Wealth advisory fees		3,278		3,142		2,550
Investment brokerage fees		1,872		1,491		1,290
Service charges on deposit accounts		8,603		7,238		7,260
Loan, insurance and service fees		2,811		2,483		2,292
Merchant card fee income		3,471		3,286		2,943
Other income		1,826		1,837		1,946
Net gains on sales of real estate mortgage loans held for sale		786		676		581
Net securities gains/(losses)		39		89		(68	)
Gain on redemption of Visa shares		642		0		0

Total noninterest income		23,328		20,242		18,794

NONINTEREST EXPENSE
Salaries and employee benefits		25,482		23,817		22,378
Net occupancy expense		3,082		2,734		2,510
Equipment costs		1,941		1,906		1,799
Data processing fees and supplies		3,645		3,096		2,626
Credit card interchange		2,321		2,204		1,988
Other expense		11,010		9,166		8,941

Total noninterest expense		47,481		42,923		40,242

INCOME BEFORE INCOME TAX EXPENSE		28,908		27,577		28,235

Income tax expense		9,207		8,366		9,514

NET INCOME	$	19,701	$	19,211	$	18,721

BASIC WEIGHTED AVERAGE COMMON SHARES		12,271,927		12,188,594		12,069,300

BASIC EARNINGS PER COMMON SHARE	$	1.61	$	1.58	$	1.55

DILUTED WEIGHTED AVERAGE COMMON SHARES		12,459,802		12,424,137		12,375,467

DILUTED EARNINGS PER COMMON SHARE	$	1.58	$	1.55	$	1.51

									Accumulated
									Other						Total
	Preferred		Common			Retained			Comprehensive			Treasury			Stockholders'
	Stock		Stock			Earnings			Income (Loss)			Stock			Equity

Balance at January 1, 2007	$	0	$	17,978		$	116,516		$	(3,178	)	$	(1,129	)	$	130,187

Comprehensive income:
Net income							19,211									19,211
Other comprehensive income, net of tax										2,168						2,168
Comprehensive income																21,379
Cash dividends declared, $.545 per share							(6,637	)								(6,637	)
Treasury shares purchased under deferred directors' plan
(10,557 shares)				243									(243	)		0
Treasury stock sold and distributed under deferred directors'
plan (1,322 shares)				(31	)								31			0
Stock issued for stock option exercises (98,117 shares, net of
8,202 shares redeemed)				771												771
Tax benefit of stock option exercises				396												396
Stock option expense				174												174
Balance at December 31, 2007		0		19,531			129,090			(1,010	)		(1,341	)		146,270
Comprehensive income:
Net income							19,701									19,701
Other comprehensive income (loss), net of tax										(11,029	)					(11,029	)
Comprehensive income																8,672
Cash dividends declared, $.605 per share							(7,417	)								(7,417	)
Treasury shares purchased under deferred directors' plan
(10,211 shares)				211									(211	)		0
Stock issued for stock option exercises (165,357 shares)				1,354												1,354
Tax benefit of stock option exercises				756												756
Stock option expense				233												233
Adjustment to initially apply measurement date provision of
SFAS No. 158, net of tax of $8 (Note 13)							(3	)		15						12
Balance at December 31, 2008		0		22,085			141,371			(12,024	)		(1,552	)		149,880


	Common Stock		Additional Paid-in Capital			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Treasury Stock			Total Stockholders’ Equity

Balance at January 1, 2006	$	1,453	$	14,287		$	102,327		$	(3,814	)	$	(919	)	$	113,334

Comprehensive income:
Net income							18,721									18,721
Other comprehensive income, net of tax										1,084						1,084

Comprehensive income																19,805
Adjustment to initially apply SFAS No. 158, net of tax of $305										(448	)					(448	)
Cash dividends declared, $.375 per share							(4,532	)								(4,532	)
Treasury shares purchased under deferred directors’ plan (9,361 shares)				210									(210	)		0
Stock issued for stock option exercises (145,700 shares)				1,148												1,148
Tax benefit of stock option exercises				692												692
Stock option expense				188												188

Balance at December 31, 2006		1,453		16,525			116,516			(3,178	)		(1,129	)		130,187
Comprehensive income:
Net income							19,211									19,211
Other comprehensive income, net of tax										2,168						2,168

Comprehensive income																21,379
Cash dividends declared, $.545 per share							(6,637	)								(6,637	)
Treasury shares purchased under deferred directors’ plan (10,557 shares)				243									(243	)		0
Treasury stock sold and distributed under deferred directors’ plan (1,322 shares)				(31	)								31			0
Stock issued for stock option exercises (98,117 shares, net of 8,202 shares redeemed)				771												771
Tax benefit of stock option exercises				396												396
Stock option expense				174												174

Balance at December 31, 2007		1,453		18,078			129,090			(1,010	)		(1,341	)		146,270
Comprehensive income:
Net income							19,701									19,701
Other comprehensive income (loss), net of tax										(11,029	)					(11,029	)

Comprehensive income																8,672
Cash dividends declared, $.605 per share							(7,417	)								(7,417	)
Treasury shares purchased under deferred directors’ plan (10,211 shares)				211									(211	)		0
Stock issued for stock option exercises (165,357 shares)				1,354												1,354
Tax benefit of stock option exercises				756												756
Stock option expense				233												233
Adjustment to initially apply measurement date provision of SFAS No. 158, net of tax of $8 (Note 12)							(3	)		15						12

Balance at December 31, 2008	$	1,453	$	20,632		$	141,371		$	(12,024	)	$	(1,552	)	$	149,880

CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
Years Ended December 31	2009			2008			2007
Cash flows from operating activities:
Net income	$	18,979		$	19,701		$	19,211
Adjustments to reconcile net income to net cash from operating activities:
Depreciation		2,252			1,940			1,721
Provision for loan losses		21,202			10,207			4,298
Loss on sale and write down of other real estate owned		154			285			127
Amortization of intangible assets		206			206			206
Amortization of loan servicing rights		587			399			416
Net change in loan servicing rights valuation allowance		0			(23	)		(49	)
Loans originated for sale		(121,900	)		(41,000	)		(37,539	)
Net gain on sales of loans		(2,085	)		(786	)		(676	)
Proceeds from sale of loans		121,969			41,544			39,526
Net gain on sale of Visa redemption shares		0			(642	)		0
Net (gain) loss on sale of premises and equipment		(7	)		(10	)		1
Net gain on securities available for sale		(2	)		(39	)		(89	)
Impairment on available for sale securities		225			0			0
Net securities amortization (accretion)		546			(41	)		473
Stock compensation expense		411			233			174
Earnings on life insurance		(207	)		(965	)		(810	)
Death benefit received on life insurance		(319	)		0			0
Tax benefit of stock option exercises		(191	)		(756	)		(396	)
Net change:
Accrued income receivable		(1	)		527			(406	)
Accrued expenses payable		(2,882	)		564			3,770
Other assets		(14,358	)		(2,326	)		1,858
Other liabilities		(317	)		334			1,216
Total adjustments		5,283			9,651			13,821
Net cash from operating activities		24,262			29,352			33,032

Cash flows from investing activities:
Proceeds from sale of securities available for sale		0			0			31,612
Proceeds from maturities, calls and principal paydowns of
securities available for sale		114,976			66,527			43,628
Purchases of securities available for sale		(129,154	)		(143,153	)		(104,007	)
Purchase of life insurance		(2,147	)		(11,458	)		(163	)
Net increase in total loans		(187,129	)		(317,454	)		(178,171	)
Proceeds from sales of land, premises and equipment		16			114			85
Purchases of land, premises and equipment		(1,318	)		(5,038	)		(4,155	)
Proceeds from sales of other real estate owned		391			120			11
Net cash from investing activities		(204,365	)		(410,342	)		(211,160	)

Cash flows from financing activities:
Net increase in total deposits		(34,174	)		406,381			3,153
Net increase (decrease) in short-term borrowings		151,442			(113,556	)		128,681
Proceeds from long-term borrowings		40,000			90,000			0
Payments on long-term borrowings		(90,001	)		(1	)		(1	)
Common dividends paid		(7,698	)		(7,417	)		(6,637	)
Preferred dividends paid		(2,021	)		0			0
Proceeds from issuance of preferred stock and warrant		56,044			0			0
Proceeds from issuance of common stock		57,922			0			0
Proceeds from stock option exercise		796			2,110			1,167
Purchase of treasury stock		(231	)		(211	)		(243	)
Net cash from financing activities		172,079			377,306			126,120
Net change in cash and cash equivalents		(8,024	)		(3,684	)		(52,008	)
Cash and cash equivalents at beginning of the year		64,007			67,691			119,699
Cash and cash equivalents at end of the year	$	55,983		$	64,007		$	67,691
Cash paid during the year for:
Interest	$	39,274		$	56,508		$	59,822
Income taxes		11,700			8,445			8,427
Supplemental non-cash disclosures:
Loans transferred to other real estate		464			692			5,328


	Years Ended December 31,

	2008			2007			2006

	(in thousands)

Unrealized holding gain/(loss) on securities available for sale arising during the period	$	(17,394	)	$	3,272		$	1,188
Reclassification adjustment for (gains)/losses included in net income		(39	)		(89	)		68

Net securities gain /(loss) activity during the period		(17,433	)		3,183			1,256
Tax effect		7,048			(1,247	)		(267	)

Net of tax amount		(10,385	)		1,936			989

Net gain (loss) on defined benefit pension plans		(1,179	)		277			160
Amortization of net actuarial loss		113			114			0

Net gain/(loss) activity during the period		(1,066	)		391			160
Tax effect		422			(159	)		(65	)

Net of tax amount		(644	)		232			95


Other comprehensive income/(loss), net of tax	$	(11,029	)	$	2,168		$	1,084

				Current
	Balance			Period		Balance
	at 12/31/08			Change		at 12/31/09

Unrealized loss on securities
available for sale	$	(10,210	)	$	5,790	$	(4,420	)
Unrealized loss on defined benefit
pension plans		(1,814	)		241		(1,573	)

Total	$	(12,024	)	$	6,031	$	(5,993	)


	Fair Value		Gross Unrealized Gain		Gross Unrealized Losses

	(in thousands)

2008

U.S. Treasury securities	$	1,025	$	24	$	0
U.S. Government agencies		15,685		232		0
Mortgage-backed securities		314,669		3,907		(21,920	)
State and municipal securities		55,651		970		(400	)

Total	$	387,030	$	5,133	$	(22,320	)


2007

U.S. Treasury securities	$	1,206	$	5	$	0
U.S. Government agencies		18,555		48		(32	)
Mortgage-backed securities		250,495		1,210		(1,873	)
State and municipal securities		57,501		1,037		(149	)

Total	$	327,757	$	2,300	$	(2,054	)

			Gross		Gross
	Fair		Unrealized		Unrealized			Amortized
	Value		Gain		Losses			Cost
2009	(in thousands)
U.S. Treasury securities	$	992	$	0	$	(13	)	$	1,005
U.S. Government agencies		4,610		22		0			4,588
Residential mortgage-backed securities		270,796		7,598		(1,078	)		264,276
Non-agency residential mortgage-backed securities		72,495		46		(15,933	)		88,382
State and municipal securities		61,135		1,898		(138	)		59,375
Total	$	410,028	$	9,564	$	(17,162	)	$	417,626

2008
U.S. Treasury securities	$	1,025	$	24	$	0		$	1,001
U.S. Government agencies		15,685		232		0			15,453
Residential mortgage-backed securities		229,571		3,907		(228	)		225,892
Non-agency residential mortgage-backed securities		85,098		0		(21,692	)		106,790
State and municipal securities		55,651		970		(400	)		55,081
Total	$	387,030	$	5,133	$	(22,320	)	$	404,217


	Fair Value

	(in thousands)
Due in one year or less	$	12,546
Due after one year through five years		8,184
Due after five years through ten years		33,618
Due after ten years		18,013

		72,361
Mortgage-backed securities		314,669

Total debt securities	$	387,030


	Less than 12 months				12 months or more				Total

	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses

	(in thousands)

2008


U.S. Treasury securities	$	0	$	0	$	0	$	0	$	0	$	0
U.S. Government agencies		0		0		0		0		0		0
Mortgage-backed securities		97,113		15,362		26,080		6,558		123,193		21,920
State and municipal securities		14,663		373		877		27		15,540		400

Total temporarily impaired	$	111,776	$	15,735	$	26,957	$	6,585	$	138,733	$	22,320


2007


U.S. Treasury securities	$	0	$	0	$	0	$	0	$	0	$	0
U.S. Government agencies		0		0		12,890		32		12,890		32
Mortgage-backed securities		45,424		740		98,068		1,133		143,492		1,873
State and municipal securities		9,595		132		1,734		17		11,329		149

Total temporarily impaired	$	55,019	$	872	$	112,692	$	1,182	$	167,711	$	2,054


	Less than 12 months		12 months or more		Total

2008


U.S. Treasury securities		0		0		0
U.S. Government agencies		0		0		0
Mortgage-backed securities		31		17		48
State and municipal securities		37		2		39

Total temporarily impaired		68		19		87


2007


U.S. Treasury securities		0		0		0
U.S. Government agencies		0		4		4
Mortgage-backed securities		12		46		58
State and municipal securities		20		18		38

Total temporarily impaired		32		68		100

	Less than		12 months
	12 months		or more		Total
2009

U.S. Treasury securities		1		0		1
U.S. Government agencies		0		0		0
Residential mortgage-backed securities		18		4		22
Non-agency residential mortgage-backed securities		0		23		23
State and municipal securities		15		1		16
Total temporarily impaired		34		28		62

2008

U.S. Treasury securities		0		0		0
U.S. Government agencies		0		0		0
Residential mortgage-backed securities		12		12		24
Non-agency residential mortgage-backed securities		19		5		24
State and municipal securities		37		2		39
Total temporarily impaired		68		19		87

	Accumulated
	Credit Losses
	in 2009
	(in thousands)
Balance January 1, 2009	$	0
Additions related to other-than-temporary impairment losses not previously recognized		225
Balance December 31, 2009	$	225

								12/31/2009	1-Month	3-Month	6-Month
		Other Than			December 31, 2009			Lowest	Constant	Constant	Constant
		Temporary	Purchase Par	Book		Market	Unrealized	Credit	Default	Default	Default	Credit
Description	CUSIP	Impairment	Value	Value		Value	Gain/(Loss)	Rating	Rate	Rate	Rate	Support
					(in thousands)
CWALT 2006-32CB A16	02147XAR8	No	2,177,596	2,075,438	1,238,050	1,238,050	(837,388)	CCC	1.88	3.10	3.30	10.72
CWHL 2006-18 2A7	12543WAJ7	No	4,820,096	4,726,609	3,922,931	3,922,931	(803,678)	CCC	5.29	7.76	4.41	4.44
CWALT 2005-J10 1A7	12667G4N0	No	5,011,000	4,961,209	4,046,533	4,046,533	(914,676)	B-	5.75	2.21	2.35	7.80
CWALT 2005-46CB A1	12667G6U2	No	4,683,948	4,464,695	3,190,330	3,190,330	(1,274,365)	CCC	2.23	2.01	1.67	5.01
CWALT 2005-J8 1A3	12667GJ20	No	6,517,771	6,249,113	5,264,143	5,264,143	(984,970)	B-	0.00	0.00	0.46	6.67
CHASE 2006-S3 1A5	16162XAE7	No	3,730,933	3,723,937	2,940,460	2,940,460	(783,477)	CCC	2.55	3.83	2.82	5.21
CHASE 2006-S2 2A5	16163BBA1	No	4,231,708	4,213,214	4,113,813	4,113,813	(99,401)	CCC	1.83	1.25	2.86	5.79
FHAMS 2006-FA1 1A3	32051GS63	No	3,955,078	3,848,419	3,283,783	3,283,783	(564,636)	CCC	N/A	N/A	N/A	4.32
GSR 2006-10F 1A1	36266WAC6	No	6,426,094	5,977,823	4,223,293	4,223,293	(1,754,530)	CCC	0.00	0.00	0.00	4.64
MANA 2007-F1 1A1	59023YAA2	No	3,551,494	3,482,302	2,874,899	2,874,899	(607,403)	CCC	0.00	0.00	2.22	4.59
RALI 2006-QS4 A2	749228AB8	Yes	2,977,555	2,827,555	1,540,170	1,540,170	(1,287,385)	CC	12.94	9.91	11.94	2.34
RFMSI 2006-S5 A14	74957EAP2	No	4,567,970	4,490,983	3,650,448	3,650,448	(840,535)	CCC	3.78	6.67	5.84	3.94
RALI 2005-QS7 A5	761118AE8	No	5,327,000	5,063,804	3,800,388	3,800,388	(1,263,416)	CCC	1.94	3.67	4.97	11.51
RALI 2006-QS3 1A14	761118XS2	Yes	3,238,860	3,073,681	2,122,231	2,122,231	(951,450)	CC	11.32	9.80	10.46	6.31
RAST 2006-A14C 1A2	76114BAB4	Yes	1,559,881	1,475,392	1,014,578	1,014,578	(460,814)	C	0.00	2.03	3.01	1.43
TBW 2006-2 3A1	878048AG2	No	3,130,538	3,022,486	2,778,352	2,778,352	(244,134)	D	0.00	0.00	0.00	5.75
			$65,907,522	$63,676,661	$50,004,402	$50,004,402	$(13,672,258)


Level 1		Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2		Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3		Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

	December 31, 2009
	Fair Value Measurements Using						Assets
Assets	Level 1		Level 2		Level 3		at Fair Value
			(in thousands)
U.S. Treasury securities	$	992	$	0	$	0	$	992
U.S. Government agencies		0		4,610		0		4,610
Mortgage-backed securities		0		270,796		0		270,796
Non-agency residential mortgage-backed securities		0		72,495		0		72,495
State and municipal securities		0		61,135		0		61,135


Total assets	$	992	$	409,036	$	0	$	410,028

	December 31, 2008
	Fair Value Measurements Using						Assets
Assets	Level 1		Level 2		Level 3		at Fair Value
			(in thousands)
U.S. Treasury securities	$	1,025	$	0	$	0	$	1,025
U.S. Government agencies		0		15,685		0		15,685
Mortgage-backed securities		0		229,571		0		229,571
Non-agency residential mortgage-backed securities		0		85,098		0		85,098
State and municipal securities		0		55,651		0		55,651


Total assets	$	1,025	$	386,005	$	0	$	387,030