UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

Form 10-Q

(Mark One)

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

For the quarterly period ended June 30, 2011

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

For the transition period from ____________ to ____________

Commission file number 000-25287

TOWER FINANCIAL CORPORATION

(Exact name of Registrant as specified in its charter)

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

116 East Berry Street, Fort Wayne, Indiana 46802

(Address of principal executive offices)

(260) 427-7000

(Registrant’s telephone number)

Indicate by check whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x  No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer a non-accelerated filer, or a smaller reporting company. See the definition of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o	Accelerated filer o
Non-accelerated filer o	Smaller reporting company x
(Do not check if a smaller reporting company.)

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2of the Exchange Act). Yes o   No x

Number of shares of the issuer’s common stock, without par value, outstanding as of August 5, 2011: 4,852,761.

1

Forward-Looking Statements

This report, including the section on “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, includes "forward-looking statements." All statements regarding our anticipated results or expectations, including our financial position, business plan and strategies, are intended to be forward-looking statements within the meaning of the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict.

Typically, forward-looking statements are predictive and are not statements of historical fact, and the words "anticipate," "believe," "estimate," "seek," "expect," "plan," "intend," “think” and similar conditional expressions, as they relate to us or to management, are intended to identify forward-looking statements. Although we believe that the expectations reflected in these forward-looking statements are reasonable, and although we have based these expectations upon beliefs and assumptions we believe to be reasonable, these expectations may prove to be incorrect. Important factors that could cause actual results to differ materially from our expectations include, without limitation, the following:

· The impact of a prolonged recession on our asset quality, the adequacy of our allowance for loan losses and the sufficiency of our capital;

· the continued weakness of the local economy in our primary service area;

· the effect of general economic and monetary conditions and the regulatory environment on the Bank’s ability to attract deposits, make loans and achieve satisfactory interest spreads;

· the risk of further loan delinquencies and losses due to loan defaults by both commercial loan customers or a significant number of other borrowers;

· general changes in real estate, business and general property valuations underlying secured loans;

· the level of our non-performing substandard or doubtful assets;

· restrictions or additional capital requirements imposed on us by our regulators; and

· dependence on our key banking and management personnel.

We also refer you to a discussion of the many other risks and uncertainties described under “Risk Factors” in our Annual Report on Form 10-K, in our Quarterly Reports on Form 10-Q, or in other reports we file from time to time with the Securities and Exchange Commission, which are available on the Commission’s website at www.sec.gov.

2

INDEX

PART I.   FINANCIAL INFORMATION
Item 1.    Financial Statements		page no.
	Consolidated Condensed Balance Sheets at June 30, 2011 (unaudited) and December 31, 2010	4
	Consolidated Condensed Statements of Operations for the three and six months ended June 30, 2011 and June 30, 2010 (unaudited)	5
	Consolidated Condensed Statements of Changes in Stockholders’ Equity for  the six months ended June 30, 2011 and June 30, 2010 (unaudited)	7
	Consolidated Condensed Statements of Cash Flows for the six months June 30, 2011 and June 30, 2010 (unaudited)	8
	Notes to Consolidated Condensed Financial Statements (unaudited)	9
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations		34
Item 4.   Controls and Procedures		42
PART II.   OTHER INFORMATION
Item 1.   Legal Proceedings		43
Item 1a. Risk Factors		43
Item 6.   Exhibit		44
SIGNATURES		44

3

PART I.  FINANCIAL INFORMATION

Item 1.  FINANCIAL STATEMENTS

Tower Financial Corporation

Consolidated Condensed Balance Sheets

At June 30, 2011 (unaudited) and December 31, 2010

	June 30, 2011			December 31, 2010
ASSETS
Cash and due from banks	$	11,134,424		$	24,717,935
Short-term investments and interest-earning deposits		1,499,818			3,313,006
Federal funds sold		4,726,977			1,648,441
Total cash and cash equivalents		17,361,219			29,679,382
Long-term interest earning deposits		996,000			996,000
Securities available for sale, at fair value		120,888,531			110,108,656
FHLB and FRB stock		3,807,700			4,075,100
Loans held for sale		1,367,988			2,140,872
Loans		488,694,118			486,914,115
Allowance for loan losses		(12,017,002	)		(12,489,400	)
Net loans		476,677,116			474,424,715
		-			-
Premises and equipment, net		8,301,973			8,329,718
Accrued interest receivable		2,444,535			2,391,953
Bank owned life insurance		16,791,120			13,516,789
Other real estate owned (OREO)		3,728,845			4,284,263
Prepaid FDIC Insurance		2,037,350			2,864,527
Other assets		6,612,292			7,116,280
Total assets	$	661,014,669		$	659,928,255
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits:
Noninterest-bearing	$	87,171,004		$	92,872,957
Interest-bearing		460,724,610			483,483,179
Total deposits		547,895,614			576,356,136
		-			-
Federal Home Loan Bank (FHLB) advances		34,000,000			7,500,000
Junior subordinated debt		17,527,000			17,527,000
Accrued interest payable		1,794,934			1,415,713
Other liabilities		3,782,519			4,000,654
Total liabilities		605,000,067			606,799,503
STOCKHOLDERS' EQUITY
Preferred stock, no par value, 4,000,000 shares authorized; 0 shares and 7,750 shares issued and outstanding at June 30, 2011 and December 31, 2010, respectively		-			757,213
Common stock and paid-in-capital, no par value, 6,000,000 shares authorized;4,917,761 and 4,789,023 issued; and  4,852,761 and 4,724,023 shares outstanding at June 30, 2011 and December 31, 2010		44,520,823			43,740,155
Treasury stock, at cost, 65,000 shares at June 30, 2011and December 31, 2010		(884,376	)		(884,376	)
Retained earnings		10,323,051			8,450,579
Accumulated other comprehensive income, net of tax of $1,058,692 at June 30, 2011 and $548,730 at December 31, 2010		2,055,104			1,065,181
Total stockholders' equity		56,014,602			53,128,752
Total liabilities and stockholders' equity	$	661,014,669		$	659,928,255

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

4

Tower Financial Corporation

Consolidated Condensed Statements of Operations

For the three and six months ended June 30, 2011 and 2010

	(unaudited) Three Months Ended June 30						(unaudited) Six Months Ended June 30
	2011			2010			2011			2010
Interest income:
Loans, including fees	$	6,276,853		$	6,826,902		$	12,565,817		$	13,709,904
Securities - taxable		640,091			662,823			1,219,460			1,301,914
Securities - tax exempt		411,978			255,223			805,140			499,774
Other interest income		6,692			6,122			20,954			12,370
Total interest income		7,335,614			7,751,070			14,611,371			15,523,962
Interest expense:
Deposits		1,350,799			1,727,772			2,711,945			3,487,270
Federal funds purchased		196			111			385			111
FHLB advances		62,765			142,854			134,836			312,712
Junior subordinated debt		201,214			283,071			400,567			563,297
Total interest expense		1,614,974			2,153,808			3,247,733			4,363,390
Net interest income		5,720,640			5,597,262			11,363,638			11,160,572
Provision for loan losses		1,125,000			1,100,000			2,345,000			2,440,000
Net interest income after provision for loan losses		4,595,640			4,497,262			9,018,638			8,720,572
Noninterest income:
Trust and brokerage fees		818,384			889,681			1,702,384			1,772,647
Service charges		259,774			280,053			550,624			570,439
Loan broker fees		159,995			167,069			268,383			284,569
Gain on sale/calls of securities		386,836			41,708			445,505			42,548
Net debit card interchange income		163,571			109,876			292,157			191,639
Bank owned life insurance (BOLI) income		134,201			118,130			274,331			233,409
Other-than-temporary loss:
Total impairment loss		(1,288	)		(14,278	)		(126,287	)		(24,868	)
Loss recognized in other comprehensive income		-			-			-			-
Net impairment loss recognized in earnings		(1,288	)		(14,278	)		(126,287	)		(24,868	)
Other income		150,775			141,910			312,364			261,460
Total noninterest income		2,072,248			1,734,149			3,719,461			3,331,843
Noninterest expense:
Salaries and benefits		2,694,184			2,273,975			5,253,266			4,661,051
Occupancy and equipment		589,434			630,224			1,209,040			1,259,502
Marketing		134,504			144,975			224,288			241,667
Data processing		391,398			116,300			700,703			425,212
Loan and professional costs		420,213			421,030			781,655			859,437
Office supplies and postage		63,565			71,103			112,512			134,292
Courier services		57,105			55,790			110,829			111,124
Business development		136,008			99,832			226,627			178,840
Communication		46,591			58,502			92,967			94,861
FDIC insurance premiums		349,923			490,467			856,771			992,672
OREO Expenses		165,523			945,519			357,443			1,001,316
Other expense		243,823			334,619			458,877			587,528
Total noninterest expense		5,292,271			5,642,336			10,384,978			10,547,502
Income before income taxes		1,375,617			589,075			2,353,121			1,504,913
Income taxes expense		285,788			74,985			480,649			269,787
Net income	$	1,089,829		$	514,090		$	1,872,472		$	1,235,126

The following notes are an integral part of the financial statements

5

Tower Financial Corporation

Consolidated Condensed Statements of Operations (Continued)

For the three and six months ended June 30, 2011 and 2010

	(unaudited) Three Months Ended June 30,				(unaudited) Six Months Ended June 30,
	2011		2010		2011		2010
Net income:	$	1,089,829	$	514,090	$	1,872,472	$	1,235,126
Other comprehensive income net of tax:
Unrealized appreciation on available for sale securities		500,022		447,894		989,923		754,941
Total comprehensive income	$	1,589,851	$	961,984	$	2,862,395	$	1,990,067
Basic earnings per common share	$	0.23	$	0.13	$	0.39	$	0.30
Diluted earnings per common share	$	0.22	$	0.12	$	0.39	$	0.28
Average common shares outstanding		4,835,510		4,090,432		4,795,424		4,090,432
Average common shares and dilutive potential common shares outstanding		4,853,035		4,394,419		4,852,898		4,394,419
Dividends declared per share	$	-	$	-	$	-	$	-

The following notes are an integral part of the financial statements

6

Tower Financial Corporation

Consolidated Condensed Statements of Changes in Stockholders’ Equity

For the six months ended June 30, 2011 and 2010 (unaudited)

	Preferred Stock			Common Stock and Paid-in Capital		Retained Earnings		Accumulated Other Comprehensive Income (Loss)		Treasury Stock			Total
Balance, January 1, 2010	$	1,788,000		$	39,835,648	$	5,286,808	$	910,029	$	(884,376	)	$	46,936,109
Net income for 2010							1,235,126							1,235,126
Other Comprehensive Income (See Note 4)									754,941					754,941
Total Comprehensive Income														1,990,067
Stock based compensation expense					23,455									23,455
Balance, June 30, 2010	$	1,788,000		$	39,859,103	$	6,521,934	$	1,664,970	$	(884,376	)	$	48,949,631
Balance, January 1, 2011	$	757,213		$	43,740,155	$	8,450,579	$	1,065,181	$	(884,376	)	$	53,128,752
Net income for 2011							1,872,472							1,872,472
Other Comprehensive Income (See Note 4)									989,923					989,923
Total Comprehensive Income														2,862,395
Stock based compensation expense					23,455									23,455
Conversion of 7,750 preferred shares into 128,738 common shares		(757,213	)		757,213									-
Balance, June 30, 2011	$	-		$	44,520,823	$	10,323,051	$	2,055,104	$	(884,376	)	$	56,014,602

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

7

Tower Financial Corporation

Consolidated Condensed Statements of Cash Flows

For the six months ended June 30, 2011 and 2010e

	(unaudited) Six Months ended June 30, 2011			(unaudited) Six Months ended June 30, 2010
Cash flows from operating activities:
Net income	$	1,872,472		$	1,235,126
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization		863,136			738,401
Provision for loan losses		2,345,000			2,440,000
Stock based compensation expense		23,455			23,455
Earnings on life insurance		(274,331	)		(233,409	)
Gain on sale of securities AFS		(445,505	)		(42,548	)
Loss on disposal of premises and equipment		2,691			678
Impairment on AFS securities		126,287			24,868
Loans originated for sale		(9,889,448	)		(9,331,135	)
(Gain)Loss on sale of other real estate owned		80,997			(17	)
Proceeds from sale of loans - brokered		10,662,332			11,509,909
Write-down on OREO		138,780			876,822
Change in accrued interest receivable		(52,582	)		(92,589	)
Change in other assets		834,433			1,130,101
Change in accrued interest payable		379,221			405,635
Change in other liabilities		(218,135	)		(158,936	)
Net cash from operating activities		6,448,803			8,526,361
Cash flows from investing activities:
Net change in loans		(10,386,674	)		13,574,850
Purchase of securities AFS		(34,292,182	)		(18,272,067	)
Proceeds from calls and maturities of securities AFS		14,406,485			11,944,067
Purchase of securities HTM		-			(1,721,320	)
Proceeds from calls and maturities of securities HTM		-			611,105
Proceeds from sale of securities AFS		10,396,200			2,738,144
Proceeds from sale of OREO		1,984,983			353,795
Proceeds from sale of impaired loans		4,126,701			-
Purchase of bank owned life insurance		(3,000,000	)		-
Redemption (Purchase) of FHLB stock		267,400			(75,000	)
Purchase of premises and equipment		(309,357	)		(1,034,826	)
Net cash from (used in) investing activities		(16,806,444	)		8,118,748
Cash flows from financing activities:
Net change in deposits		(28,460,522	)		(3,392,514	)
Proceeds from long-term FHLB advances		5,000,000			-
Repayment of long-term FHLB advances		(3,500,000	)		(8,700,000	)
Net change in short-term borrowings		25,000,000			(12,000,000	)
Net cash from (used in) financing activities		(1,960,522	)		(24,092,514	)
Net change in cash and cash equivalents		(12,318,163	)		(7,447,405	)
Cash and cash equivalents, beginning of period		29,679,382			24,664,309
Cash and cash equivalents, end of period	$	17,361,219		$	17,216,904
Supplemental disclosures of cash flow information
Cash paid during the year for:
Interest	$	2,868,512		$	3,957,755
Income taxes		570,000			700,000
Noncash items:
Transfer of loans to other real estate owned		1,662,572			2,782,073

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

8

Tower Financial Corporation

Notes to Consolidated Condensed Financial Statements

Note 1 – Basis of Presentation

The accompanying unaudited consolidated financial statements are filed for Tower Financial Corporation and its wholly-owned subsidiary, Tower Bank & Trust (or the “Bank” or “Tower Bank”), and two unconsolidated subsidiary guarantor trusts, Tower Capital Trust 2, and Tower Capital Trust 3.  Also included are the Bank’s wholly-owned subsidiaries, Tower Trust Company (or the “Trust Company”) and Tower Capital Investments, which owns Tower Funding Corporation, a real estate investment trust.

The accompanying unaudited consolidated condensed financial statements were prepared in accordance with generally accepted accounting principles in the United States of America for interim periods and with instructions for Form 10-Q and, therefore, do not include all disclosures required by generally accepted accounting principles in the United States of America for complete presentation of the Company’s financial statements.  In the opinion of management, the unaudited consolidated condensed financial statements contain all adjustments necessary to present fairly its consolidated financial position at June 30, 2011 and its consolidated results of operations and comprehensive income for the three- and six-month periods ended June 30, 2011 and June 30, 2010 and change in stockholders’ equity and cashflows for the six-month periods ended June 30, 2011 and June 30, 2010.   The results for the period ended June 30, 2011 should not be considered as indicative of results for a full year.   These consolidated condensed financial statements should be read in conjunction with the audited financial statements for the years ended December 31, 2010 and  2009 and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.

Note 2 – Summary of Critical Accounting Policies

A comprehensive discussion of our critical accounting policies is disclosed in Note 1 of our Annual Report on Form 10-K for the year ended December 31, 2010.  Certain accounting policies require management to use estimates and make assumptions based on available information.  These estimates and assumptions affect the amounts reported in the financial statements and disclosures provided, and actual results could differ.  There were no material changes in the information regarding our critical accounting policies since December 31, 2010.

Note 3 – New Accounting Standards

Recently Issued Not Yet Effective Accounting Pronouncements:  In April 2011, the FASB issued ASU No. 2011-02, A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring, updated to amend previous guidance with respect to troubled debt restructurings. This updated guidance is designed to assist creditors with determining whether or not a restructuring constitutes a troubled debt restructuring. In particular, additional guidance has been added to help creditors determine whether a concession has been granted and whether a debtor is experiencing financial difficulties. Both of these conditions are required to be met for a restructuring to constitute a troubled debt restructuring. The amendments in the update are effective for the first interim period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption. The provisions of this update are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

In May 2011, the FASB issued ASU No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.  The amendments in this ASU generally represent clarifications of Topic 820, but also include some instances where a particular principle or requirement for measuring fair value or disclosing information about fair value measurements has changed.  This ASU results in common principles and requirements for measuring fair value and for disclosing information about fair value measurements in accordance with U.S. GAAP and IFRSs.  The amendments in this ASU are to be applied prospectively.  For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011.  Early application by public entities is not permitted.  The amendments of this update are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

9

In June 2011, the FASB issued ASU No. 2011-05, Amendments to Topic 220, Comprehensive Income. Under the amendments in this ASU, an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements.  In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income.  This ASU eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity.  The amendments in this ASU do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income.  The amendments of this ASU should be applied retrospectively.  For public entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011.  Early adoption is permitted because compliance with the amendments is already permitted.  The amendments do not require any transition disclosures.  Due to the recent publication of this pronouncement, the Company is evaluating the impact of this update on the Company’s financial position, results of operations and cash flows.

10

Note 4 – Securities Available for Sale

The following table summarizes the amortized cost and fair value of the available for sale investment securities portfolio at June 30, 2011 and December 31, 2010 and the corresponding  amounts of unrealized gains and losses therein:

	June 30, 2011
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Available for sale securities:
U.S. Government agency debt obligations	$	1,328,100	$	12,687	$	-		$	1,340,787
Obligations of states and political subdivisions		49,493,803		1,173,528		(247,494	)		50,419,837
Mortgage-backed securities (residential)		62,549,270		2,213,938		(240,012	)		64,523,196
Mortgage-backed securities (commercial)		4,403,563		201,148		-			4,604,711
Collateralized debt obligations		-		-		-			-
Total Securities	$	117,774,736	$	3,601,301	$	(487,506	)	$	120,888,531
	December 31, 2010
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Available for sale securities:
U.S. Government agency debt obligations	$	4,112,957	$	59,710	$	-		$	4,172,667
Obligations of states and political subdivisions		45,852,349		546,212		(639,159	)		45,759,402
Mortgage-backed securities (residential)		53,960,788		1,854,148		(325,966	)		55,488,970
Mortgage-backed securities (commercial)		4,458,652		224,365		-			4,683,017
Collateralized debt obligations		110,000		-		(105,400	)		4,600
Total Securities	$	108,494,746	$	2,684,435	$	(1,070,525	)	$	110,108,656

Total other-than-temporary impairment recognized in accumulated other comprehensive income was $153,734 and $274,596 for securities available for sale at June 30, 2011 and December 31, 2010, respectively.

11

The fair values of debt securities available for sale at June 30, 2011 and December 31, 2010, by contractual maturity, are shown below. Securities not due at a single date, primarily mortgage-backed securities, are shown separately. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties.

	6/30/2011
	Weighted Average Yield			Amortized Cost		Fair Value
Available for sale securities:
Agencies:
Due after one to five years		2.94	%	$	1,328,100	$	1,340,787
Total Agencies		2.94	%	$	1,328,100	$	1,340,787
Mortgage-backed securities:
Mortgage-backed securities (residential)		3.46	%	$	62,549,270	$	64,523,196
Mortgage-backed securities (commercial)		4.48	%		4,403,563		4,604,711
		3.53	%	$	66,952,833	$	69,127,907
Obligations of state and political subdivisions:
Due in one year or less		4.99	%	$	130,007	$	130,026
Due after one to five years		5.91	%		3,340,496		3,430,649
Due after five to ten years		5.44	%		14,097,596		14,618,370
Due after ten years		5.61	%		31,925,704		32,240,792
Total Obligations of state and political subdivisions		5.58	%	$	49,493,803	$	50,419,837
Collateralized debt obligations
Due after ten years		0.00	%	$	-	$	-
	12/31/2010
	Weighted Average Yield			Amortized Cost		Fair Value
Available for sale securities:
Agencies:
Due in one year or less		3.25	%	$	700,000	$	703,997
Due after one to five years		2.16	%		799,138		822,336
Due after five to ten years		2.58	%		2,613,819		2,646,334
Total Agencies		2.61	%	$	4,112,957	$	4,172,667
Mortgage-backed securities:
Mortgage-backed securities (residential)		3.86	%	$	53,960,788	$	55,488,970
Mortgage-backed securities (commercial)		4.22	%		4,458,652		4,683,017
		3.89	%	$	58,419,440	$	60,171,987
Obligations of state and political subdivisions:
Due in one year or less		4.99	%	$	260,457	$	262,621
Due after one to five years		5.24	%		3,168,388		3,270,587
Due after five to ten years		5.28	%		13,676,918		13,820,407
Due after ten years		5.77	%		28,746,586		28,405,787
Total Obligations of state and political subdivisions		5.58	%	$	45,852,349	$	45,759,402
Collateralized debt obligations
Due after ten years		1.15	%	$	110,000	$	4,600

Proceeds from securities sold classified as available for sale totaled $9.6 million and $2.7 million for the three months ended June 30, 2011 and June 30, 2010, respectively.  Proceeds from securities sold classified as available for sale totaled $10.4 million and $2.7 million for the six months ended June 30, 2011 and June 30, 2010, respectively.

12

Gross gains realized were $386,836 and $41,708 for the three months and $445,715 and $42,548 for the six months ended June 30, 2011 and June 30, 2010, respectively.  There were no gross losses on the sale of available for sale securities for the three and six month periods ending June 30, 2011 and June 30, 2010.  The approximate tax expense on the net gains for the three months ended June 30, 2011 and June 30, 2010 was $131,524 and $14,181, respectively.  The approximate tax expense on the net gains for the six months ended June 30, 2011 and June 30, 2010 was $151,471 and $14,466, respectively.

Securities with a carrying value of $19.0 million and $1.1 million were pledged to secure borrowings from the FHLB at June 30, 2011 and December 31, 2010, respectively.   Securities with a carrying value of $2.3 million and $4.2 million were pledged to the Federal Reserve to secure potential borrowings at the Discount Window at June 30, 2011 and December 31, 2010, respectively.  Securities with a carrying value of $19.5 million and $17.8 million were pledged at correspondent banks, including Wells Fargo, First Tennessee, First Merchants, Fifth Third and Pacific Coast Bankers Bank, to secure federal funds lines of credit at June 30, 2011 and December 31, 2010, respectively.  At June 30, 2011, there were no holdings of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of stockholders' equity.

Securities with unrealized losses at June 30, 2011 not recognized in income are as follows:

	Continuing Unrealized Losses for Less than 12 months					Continuing Unrealized Losses for More than 12 months					Total
	Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses
Available for sale securities:
U.S. Government agency debt obligations	$	-	$	-		$	-	$	-		$	-	$	-
Obligations of states and political subdivisions		10,654,406		(237,594	)		810,445		(9,900	)		11,464,851		(247,494	)
Mortgage-backed securities (residential)		8,616,680		(86,277	)		386,067		(153,735	)		9,002,747		(240,012	)
Mortgage-backed securities (commercial)		-		-			-		-			-		-
Collateralized debt obligations		-		-			-		-			-		-
Total temporarily impaired securities	$	19,271,086	$	(323,871	)	$	1,196,512	$	(163,635	)	$	20,467,598	$	(487,506	)

Securities with unrealized losses at December 31, 2010 not recognized in income are as follows:

	Continuing Unrealized Losses for Less than 12 months					Continuing Unrealized Losses for More than 12 months					Total
	Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses
Available for sale securities:
U.S. Government agency debt obligations	$	-	$	-		$	-	$	-		$	-	$	-
Obligations of states and political subdivisions		16,033,664		(588,556	)		1,427,946		(50,603	)		17,461,610		(639,159	)
Mortgage-backed securities (residential)		5,772,263		(156,769	)		416,929		(169,197	)		6,189,192		(325,966	)
Mortgage-backed securities (commercial)		-		-			-		-			-		-
Collateralized debt obligations		-		-			4,600		(105,400	)		4,600		(105,400	)
Total available for sale securities	$	21,805,927	$	(745,325	)	$	1,849,475	$	(325,200	)	$	23,655,402	$	(1,070,525	)

Unrealized losses on mortgage-backed securities and state and municipality bonds have not been recognized into income because the issuers’ bonds are of high credit quality and management does not have the intent to sell and it is likely that they will not be required to sell the securities before their anticipated recovery.  The fair value is expected to recover as the bonds approach their maturity and/or as market conditions improve.

13

As of June 30, 2011, Tower Financial Corporation’s security portfolio consisted of 224 securities, 29 of which were in an unrealized loss position. The majority of unrealized losses are related to the Company’s mortgage-backed securities, as discussed below:

Mortgage-backed Securities

At June 30, 2011, approximately 83% of the mortgage-backed securities we held were issued by U.S. government-sponsored entities and agencies, primarily Fannie Mae and Freddie Mac, institutions which the government has affirmed its commitment to support. Because the decline in market value is attributable to changes in interest rates and illiquidity, and not credit quality, and because the Company does not have the intent to sell these mortgage-backed securities and it is likely that it will not be required to sell the securities before their anticipated recovery, the Company does not consider these securities to be other-than-temporarily impaired at June 30, 2011.

As of June 30, 2011, we held $11.7 million of non-agency backed CMO investments. These investments were purchased as loan alternatives.  These bonds make up less than 18% of capital.  The Company continues to monitor these securities and obtain current market prices at least on a quarterly basis.  Based on this review, the Company does not consider these securities to be other-than-temporarily impaired at June 30, 2011, with the exception of the security discussed below.

Private Label Collateralized Mortgage Obligation

The Company owns a Private Label Collateralized Mortgage Obligation (CMO) with an original investment of $1.0 million, which is classified as a residential mortgage-backed security.  At June 30, 2011, the fair value of the investment was $386,067 and the amortized cost was $539,802.  The investment was rated Caa2 by Moody’s and CCC by S&P.  At December 31, 2010, the fair value of the investment was $416,929 and the amortized cost was $586,125.

This bond is classified as a “super senior” tranche because its cash flow is not subordinated to any other tranche in the deal and is classified as a mortgage-backed security (residential).  We used the Intex database to evaluate and model each individual loan in the underlying collateral of this security.  In 2009, we noticed that the credit quality of the underlying collateral was marginally deteriorating causing us to more aggressively monitor and analyze for other-than-temporary-impairment.  To monitor this investment, management has evaluated loan delinquencies, foreclosures, other real estate owned (OREO) and bankruptcies as a percentage of principal remaining on the loans as shown in the table below prior to making assumptions on the performing loans.

	June 30 2011	March 31 2011	December 31 2010	September 30 2010	June 30 2010
Delinquency 60+	24.01%	25.16%	22.58%	20.76%	22.48%
Delinquency 90+	22.06%	22.36%	19.79%	18.42%	20.73%
Other Real Estate Owned	1.78%	2.58%	1.73%	0.20%	0.17%
Foreclosure	9.55%	10.70%	9.42%	9.11%	10.79%
Bankruptcy	3.12%	3.08%	4.08%	4.09%	3.35%

We utilized Intex data to determine the default assumptions for all loans that are classified as “past due,” OREO or in foreclosure. A 50% severity rate was assumed on all defaults. This number was derived from the pool average over the last 12 months. The default rate differs for each State based on the severity of that State’s home price depreciation and the number of days the loan is past due.  Any foreclosure or loan classified as other real estate owned is immediately liquidated at a 50% severity. The current loan category is stratified by FICO scores and the level of asset documentation (full documentation, low documentation, or no documentation). The Loan Performance Database driven by Intex data is mined for historical probabilities of loans meeting these characteristics moving into default.  This was done for loans originated in 2006, 2007, and 2008 periods.  The average default rate is then calculated, as well as its standard deviation. Two standard deviations are then added to this mean to derive the current loan CDR assumptions; representing what management feels is a “stressed” scenario. We used the yield at the time of purchase as the discount rate for the cash flow analysis. At the time of purchase the bond was yielding 6%. Therefore, all cash flows in the OTTI analysis were discounted by 6% to get a present value. To determine the fair value, we surveyed two bond desks to see what yield it would take to sell the bond in the open market. Both desks said it would take a yield of 12%-15% to get someone to buy this bond. Management decided to use the conservative figure and discounted the cash flows by 15%. The two bond desks that were surveyed are Sterne Agee and Performance Trust.

Based on the analysis performed using the assumptions above, we have determined that this Private Label CMO is other-than-temporarily-impaired requiring us to record total credit impairment of $74,018 through June 30, 2011.  An OTTI charge of $1,288 and $16,287 was recorded for the three- and six-month periods ending June 30, 2011, respectively.

Trust Preferred Securities

The Company, through the Bank’s investment subsidiary, owns a $1 million original investment in PreTSL XXV out of a pooled $877.4 million investment at the time of purchase.  This is the Company’s only pooled trust preferred security and it is classified as a collateralized debt obligation.  At March 31, 2011, the Company took an additional OTTI charge to write-off the remaining investment.  At December 31, 2010, the fair value of the investment was $4,600 and the amortized cost was $110,000.  The investment was rated C by Moody’s and C by Fitch at June 30, 2011 and was rated Ca by Moody’s and C by Fitch at December 31, 2010.

14

The investment is divided into seven tranches.  Tower’s investment is in the fifth tranche (C-1), meaning the cashflows on the investment are subordinated to the higher placed tranches. There are sixty-eight (68) issuing participants in PreTSL XXV.  Fifty-eight (58) of the issuers are banks or bank holding companies, with the remaining issuers being insurance companies.  As of June 30, 2011, the amount of deferrals and defaults was $321.6 million, or 37% of the total pool.  Of the total $877.4 million of original collateral, $555.8 million is currently paying interest.

The Company used the OTTI evaluation model to analyze the present value of expected cash flows.  The OTTI model considered the structure and term of the collateralized debt obligation (“CDO”) and the financial condition of the underlying issuers. We evaluated the credit quality of each underlying issuer in the pool and applied a risk rating for each issuer and then put this risk rating into a relevant risk model to identify immediate default risk.  Upon completion of the analysis at March 31, 2011, our model indicated that the security 100% other-than-temporarily-impaired. The OTTI charge was recorded in the first quarter of 2011 in the amount of $110,000, which resulted in an ending book value of $0. There was no OTTI charge for the three-month period and $110,000 for the six-month period ending June 30, 2011.  This security cannot experience any additional OTTI charges.

The table below presents a roll-forward of the credit losses relating to debt securities recognized in earnings for the three and six months ended June 30, 2011:

For the three months ended June 30	2011		2010
Beginning Balance, April 1	$	1,034,072	$	761,360
Additions for amounts related to credit loss for which an OTTI was not previously recognized		-		-
Increases to the amount related to the credit loss for which other-than-temporary was previously recognized		1,288		14,278
Ending Balance, June 30	$	1,035,360	$	775,638

For the six months ended June 30	2011		2010
Beginning Balance, January 1	$	909,073	$	750,770
Additions for amounts related to credit loss for which an OTTI was not previously recognized		-		-
Increases to the amount related to the credit loss for which other-than-temporary was previously recognized		126,287		24,868
Ending Balance, June 30	$	1,035,360	$	775,638

15

Note 5 – Comprehensive Income

Comprehensive income consists of net income and other comprehensive income (“OCI”). Other comprehensive income includes unrealized gains and losses on securities available-for-sale.  Following is a summary of other comprehensive income for the three and six months ended June 30, 2011 and 2010:

	Three months ended June 30,
	2011			2010
Net Income	$	1,089,829		$	514,090
Change in securities available for sale:
Unrealized holding gains (losses) on securities for which other-than-temporary impairment has been recorded		2,260			68,788
Other-than-temporary impairment on available for sale securities associated with credit losses realized in income		1,288			14,278
Unrealized holding gains (losses) recorded in other comprehensive income		3,548			83,066
Unrealized holding gains (losses) on available for sale securities arising during the period		1,140,897			637,269
Reclassification adjustment for (gains) losses realized in income on available for sale securities		(386,836	)		(41,708	)
Net unrealized gains (losses)		754,061			595,561
Income tax expense		257,587			230,733
Total other comprehensive income		500,022			447,894
Comprehensive Income	$	1,589,851		$	961,984

	Six months ended June 30,
	2011			2010
Net Income	$	1,872,472		$	1,235,126
Change in securities available for sale:
Unrealized holding gains (losses) on securities for which other-than-temporary impairment has been recorded		(5,425	)		49,944
Other-than-temporary impairment on available for sale securities associated with credit losses realized in income		126,287			24,868
Unrealized holding gains (losses) recorded in other comprehensive income		120,862			74,812
Unrealized holding gains (losses) on available for sale securities arising during the period		1,824,526			1,111,586
Reclassification adjustment for (gains) losses realized in income on available for sale securities		(445,505	)		(42,548	)
Net unrealized gains (losses)		1,379,021			1,069,038
Income tax expense		509,960			388,909
Total other comprehensive income		989,923			754,941
Comprehensive Income	$	2,862,395		$	1,990,067

16

Note 6 - Earnings Per Share

The following table reflects the calculation of basic and diluted earnings per common share for the three- and six-month periods ended June 30, 2011 and June 30, 2010.  Options not considered in the calculation of diluted earnings per common share because they were antidilutive, totaled 74,654 and 79,404 for the three-month period and 74,654 and 79,404 for the six-month period ended June 30, 2011 and 2010, respectively.  The Company also had preferred stock which could be converted at the option of the shareholders into 303,987 shares of common stock as of June 30, 2010.  All preferred stock has been converted as of June 30, 2011.

	Three Months Ended June 30,
	2011		2010
Basic
Net income available to common stockholders	$	1,089,829	$	514,090
Weighted average common shares outstanding		4,835,510		4,090,432
Basic earnings per common share	$	0.23	$	0.13
Diluted
Net income available to common stockholders	$	1,089,829	$	514,090
Weighted average common shares outstanding		4,835,510		4,090,432
Add:  dilutive effect of assumed preferred stock conversion and stock options		17,525		303,987
Weighted average common shares and dilutive   potential common shares outstanding and preferred stock conversion		4,853,035		4,394,419
Diluted earnings per common share	$	0.22	$	0.12

	Six Months Ended June 30,
	2011		2010
Basic
Net income available to common stockholders	$	1,872,472	$	1,235,126
Weighted average common shares outstanding		4,795,424		4,090,432
Basic earnings per common share	$	0.39	$	0.30
Diluted
Net income available to common stockholders	$	1,872,472	$	1,235,126
Weighted average common shares outstanding		4,795,424		4,090,432
Add:  dilutive effect of assumed preferred stock conversion and stock options		57,474		303,987
Weighted average common shares and dilutive potential common shares outstanding and preferred stock conversion		4,852,898		4,394,419
Diluted earnings per common share	$	0.39	$	0.28

Note 7 – Equity Incentive Plans

Options to buy stock were previously granted to directors, officers and employees under the 1998 and 2001 Stock Option and Incentive Plans (the “Plans”), which together provided for issuance of up to 435,000 shares of common stock of the Company.  Options for all 435,000 shares were issued under the Plans, of which 74,654 remain outstanding as of June 30, 2011.  Option awards were granted with an exercise price equal to the market price of the Company’s stock at the date of each grant, vesting over a four-year period, and issued with a ten-year contractual term.  There was no compensation cost charged against income for options granted under the Plans in accordance with accounting standards for the three and six months ended June 30, 2011 and June 30, 2010.  No income tax benefit was recognized in the income statement for the share-based compensation arrangements.

17

A summary of the option activity under the Plans as of June 30, 2011 and changes during the six-month period then ended are presented below:

Options	Shares			Weighted- Average Aggregate Exercise Price		Weighted- Average Remaining Contractual Term		Instrinsic Value
Outstanding at January 1, 2011		76,154		$	13.37		2.72	$	-
Granted		-			-		-		-
Exercised		-			-		-		-
Forfeited or expired		(1,500	)		8.38		-		-
Outstanding at June 30, 2011		74,654			13.47		2.27		-
Vested or expected to vest at June 30, 2011		74,654			13.47		2.27		-
Exercisable at June 30, 2011		74,654			13.47		2.27		-

No further options will be granted under either of these Plans, but the plans will remain in effect for purposes of administering already existing options previously granted and still outstanding under the Plans.  As of June 30, 2011 there was no unrecognized compensation expense for the 1998 and 2001 Stock Options plan.

On April 19, 2006, at our annual meeting of stockholders, stockholders approved Tower Financial Corporation’s 2006 Equity Incentive Plan, under which 150,000 shares have been reserved for issuance as incentive stock options, nonstatutory stock options, restricted stock awards, unrestricted stock awards, performance awards, or stock appreciation rights.  As of June 30, 2011, 19,500 shares have been granted in the form of restricted stock, of which 15,125 shares have vested.  The compensation cost that has been charged against income for restricted shares awarded under the Plan was $11,728 and $11,727 for the three months and $23,455 and $23,455 for the six months ended June 30, 2011 and 2010, respectively.  Future expense related to this award will be $23,455 in 2011 and $14,062 in 2012.  The total fair value of shares vested during the six months ended June 30, 2011 was $44,498.

A summary of the restricted stock activity as of June 30, 2011 and changes during the six months ended are presented below:

For the six months ended June 30, 2011	Shares			Weighted-Average Grant-Date Fair Value
Outstanding at January 1, 2011		9,750		$	8.95
Granted		-			-
Vested		(5,375	)		8.73
Forfeited		-			-
Outstanding at June 30, 2011		4,375			9.22

Note 8 – Business Segments

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

The majority of assets and income result from the Banking segment.  The Bank is a full-service commercial bank with six Allen County locations and one Warsaw location.  The Wealth Management segment is made up of Tower Trust Company.  The Trust Company provides estate planning, investment management, and retirement planning, as well as investment brokerage services.  The Corporate and Intercompany segment includes the holding company and subordinated debentures.  We incur general corporate expenses, as well as interest expense on the subordinated debentures.

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Information reported internally for performance assessment follows:

	As of and for the three months ending June 30, 2011
			Wealth		Corporate &
	Bank		Management		Intercompany			Eliminations			Total
Income Statement Information
Net interest income	$	5,907,083	$	14,771	$	(201,214	)	$	-		$	5,720,640
Non-interest income		1,180,783		885,190		1,343,093			(1,336,818	)		2,072,248
Non-interest expense		4,491,667		621,315		179,289			-			5,292,271
Noncash items
Provision for loan losses		1,125,000		-		-			-			1,125,000
Depreciation/Amortization		361,436		12,072		-			-			373,508
Income tax expense(benefit)		319,446		93,581		(127,239	)		-			285,788
Segment Profit		1,151,753		185,065		1,089,829			(1,336,818	)		1,089,829
Balance Sheet Information
Segment Assets		662,598,450		6,859,435		72,140,008			(80,583,224	)		661,014,669

	As of for the six months ending June 30, 2011
	Bank		Wealth Management		Corporate & Intercompany			Eliminations			Total
Income Statement Information
Net interest income	$	11,727,388	$	36,817	$	(400,567	)	$	-		$	11,363,638
Non-interest income		1,935,710		1,771,229		2,386,894			(2,374,372	)		3,719,461
Non-interest expense		8,781,661		1,230,907		372,410			-			10,384,978
Noncash items
Provision for loan losses		2,345,000		-		-			-			2,345,000
Depreciation/Amortization		837,871		25,265		-			-			863,136
Income tax expense(benefit)		546,018		193,186		(258,555	)		-			480,649
Segment Profit		1,990,419		383,953		1,872,472			(2,374,372	)		1,872,472
Balance Sheet Information
Segment Assets		662,598,450		6,859,435		72,140,008			(80,583,224	)		661,014,669

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	As of for the three months ending June 30, 2010
	Bank		Wealth Management		Corporate & Intercompany			Eliminations			Total
Income Statement Information
Net interest income	$	5,864,666	$	15,667	$	(283,071	)	$	-		$	5,597,262
Non-interest income		995,270		892,762		924,656			(1,078,539	)		1,734,149
Non-interest expense		4,825,817		656,175		160,344			-			5,642,336
Noncash items
Provision for loan losses		1,100,000		-		-			-			1,100,000
Depreciation/Amortization		369,912		8,547		-			-			378,459
Income tax expense(benefit)		133,786		88,656		(147,457	)		-			74,985
Segment Profit		800,333		163,598		628,698			(1,078,539	)		514,090
Balance Sheet Information
Segment Assets		661,201,532		6,106,671		71,867,708			(80,849,146	)		658,326,765

	As of for the six months ending June 30, 2010
	Bank		Wealth Management		Corporate & Intercompany			Eliminations			Total
Income Statement Information
Net interest income	$	11,691,932	$	31,937	$	(563,297	)	$	-		$	11,160,572
Non-interest income		1,896,089		1,779,495		1,935,905			(2,279,646	)		3,331,843
Non-interest expense		8,976,552		1,255,457		315,493			-			10,547,502
Noncash items
Provision for loan losses		2,440,000		-		-			-			2,440,000
Depreciation/Amortization		720,757		17,644		-			-			738,401
Income tax expense(benefit)		368,315		194,092		(292,620	)		-			269,787
Segment Profit		1,803,154		361,883		1,349,735			(2,279,646	)		1,235,126
Balance Sheet Information
Segment Assets		661,201,532		6,106,671		71,867,708			(80,849,146	)		658,326,765

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Note 9 – Loans and Allowance for Loan Losses

Loans at June 30, 2011 and December 31, 2010 were as follows:

	June 30, 2011						December 31, 2010
	Balance			%			Balance			%
Commercial	$	228,537,642			46.7	%	$	233,882,777			48.0	%
Commercial real estate
Construction		20,653,594			4.2	%		24,588,088			5.1	%
Other		104,685,118			21.4	%		94,056,119			19.3	%
Residential real estate
Traditional		53,617,131			11.0	%		54,236,553			11.1	%
Jumbo		30,664,715			6.3	%		25,833,656			5.3	%
Home equity		36,789,129			7.6	%		38,395,005			7.9	%
Consumer		13,879,171			2.8	%		15,979,973			3.3	%
Total loans		488,826,500			100.0	%		486,972,171			100.0	%
Net deferred loan costs (fees)		(132,382	)					(58,056	)
Allowance for loan losses		(12,017,002	)					(12,489,400	)
Net loans	$	476,677,116					$	474,424,715

The following tables summarize changes in the Company’s allowance for loan losses for the periods indicated:

For the three months ended June 30, 2011:
	Commercial			Commercial Real Estate			Residential Real Estate			Home Equity		Consumer			Unallocated		Total
Beginning balance 4/1/2011	$	6,382,372		$	5,089,778		$	316,534		$	79,867	$	24,919		$	14,325	$	11,907,795
Provision expense		(1,374,844	)		2,398,273			(8,527	)		932		(3,408	)		112,574		1,125,000
Charge-offs		(718,641	)		(875,000	)		-			-		-			-		(1,593,641	)
Recoveries		566,856			4,701			-			5,951		340			-		577,848
Ending Balance 6/30/2011	$	4,855,743		$	6,617,752		$	308,007		$	86,750	$	21,851		$	126,899	$	12,017,002

For the six months ended June 30, 2011:
	Commercial			Commercial Real Estate			Residential Real Estate			Home Equity			Consumer			Unallocated		Total
Beginning balance 1/1/2011	$	5,790,945		$	6,183,365		$	386,992		$	77,051		$	28,711		$	22,336	$	12,489,400
Provision expense		2,375			2,306,433			(78,985	)		19,389			(8,775	)		104,563		2,345,000
Charge-offs		(1,541,508	)		(1,924,110	)		-			(17,408	)		-			-		(3,483,026	)
Recoveries		603,931			52,064			-			7,718			1,915			-		665,628
Ending Balance 6/30/2011	$	4,855,743		$	6,617,752		$	308,007		$	86,750		$	21,851		$	126,899	$	12,017,002

For the three months ended June 30, 2010:
Beginning balance 4/1/2010	$	12,149,885
Provision expense		1,100,000
Charge-offs		(636,281	)
Recoveries		104,696
Ending Balance 6/30/2010	$	12,718,300

For the six months ended June 30, 2010:
Beginning balance 1/1/2010	$	11,598,389
Provision expense		2,440,000
Charge-offs		(1,448,727	)
Recoveries		128,638
Ending Balance 6/30/2010	$	12,718,300

21

The following tables present the fair value of the Company’s loans sold by portfolio segment for the periods indicated:

For the three months ended June 30, 2011:
Commercial	$	1,574,333
Commercial Real Estate		1,201,862
For the six months ended June 30, 2011:
Commercial	$	2,924,839
Commercial Real Estate		1,201,862

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by class of loans based on impairment method as of June 30, 2011 and December 31, 2010:

June 30, 2011	Individually evaluated for impairment		Collectively evaluated for impairment		Total
Allowance for loan losses:
Ending allowance balance attributable to loans:
Commercial	$	851,625	$	4,004,118	$	4,855,743
Commercial Real Estate
Construction		3,562,000		753,742		4,315,742
Other		535,000		1,767,010		2,302,010
Residential Real Estate
Traditional		-		195,943		195,943
Jumbo		-		112,064		112,064
Home Equity		-		86,750		86,750
Consumer		-		21,851		21,851
Unallocated		-		126,899		126,899
Total	$	4,948,625	$	7,068,377	$	12,017,002
Loans:
Commercial	$	12,472,785	$	216,697,143	$	229,169,928
Commercial Real Estate
Construction		9,500,518		11,189,131		20,689,649
Other		5,320,923		99,525,341		104,846,264
Residential Real Estate
Traditional		-		53,727,876		53,727,876
Jumbo		-		30,728,052		30,728,052
Home Equity		-		37,009,426		37,009,426
Consumer		-		14,086,359		14,086,359
Unallocated		-		-		-
Total	$	27,294,226	$	462,963,328	$	490,257,554

22

December 31, 2010	Individually evaluated for impairment		Collectively evaluated for impairment		Total
Allowance for loan losses:
Ending allowance balance attributable to loans:
Commercial	$	794,796	$	4,996,149	$	5,790,945
Commercial Real Estate
Construction		2,547,000		664,665		3,211,665
Other		445,000		2,526,700		2,971,700
Residential Real Estate
Traditional		-		262,134		262,134
Jumbo		-		124,858		124,858
Home Equity		-		77,051		77,051
Consumer		-		28,711		28,711
Unallocated		-		22,336		22,336
Total	$	3,786,796	$	8,702,604	$	12,489,400
Loans:
Commercial	$	17,755,408	$	216,751,782	$	234,507,190
Commercial Real Estate
Construction		8,020,168		16,632,723		24,652,891
Other		5,853,845		88,362,580		94,216,425
Residential Real Estate
Traditional		-		54,373,838		54,373,838
Jumbo		-		25,899,046		25,899,046
Home Equity		-		38,620,639		38,620,639
Consumer		-		16,186,219		16,186,219
Unallocated		-		-		-
Total	$	31,629,421	$	456,826,827	$	488,456,248

The following table presents loans individually evaluated for impairment by class of loans as of June 30, 2011 and December 31, 2010:

June 30, 2011	Unpaid Principal Balance		Recorded Investment		Allowance for Loan Losses Allocated
With no related allowance recorded:
Commercial	$	8,400,267	$	8,424,745	$	-
Commercial Real Estate
Construction		1,653,580		1,657,040		-
Other		1,139,151		1,139,051		-
Residential Real Estate
Traditional		-		-		-
Jumbo		-		-		-
Home Equity		-		-		-
Consumer		-		-		-
		11,192,998		11,220,836		-
With related allowance recorded:
Commercial		4,044,673		4,048,040		851,625
Commercial Real Estate
Construction		7,798,138		7,843,478		3,562,000
Other		4,178,491		4,181,872		535,000
Residential Real Estate
Traditional		-		-		-
Jumbo		-		-		-
Home Equity		-		-		-
Consumer		-		-		-
		16,021,302		16,073,390		4,948,625
	$	27,214,300	$	27,294,226	$	4,948,625

23

December 31, 2010	Unpaid Principal Balance		Recorded Investment		Allowance for Loan Losses Allocated
With no related allowance recorded:
Commercial	$	12,803,552	$	12,826,772	$	-
Commercial Real Estate
Construction		1,850,416		1,862,150		-
Other		2,208,130		2,208,205		-
Residential Real Estate
Traditional		-		-		-
Jumbo		-		-		-
Home Equity		-		-		-
Consumer		-		-		-
		16,862,098		16,897,127		-
With related allowance recorded:
Commercial		4,910,918		4,928,636		794,796
Commercial Real Estate
Construction		6,156,859		6,158,018		2,547,000
Other		3,640,193		3,645,640		445,000
Residential Real Estate
Traditional		-		-		-
Jumbo		-		-		-
Home Equity		-		-		-
Consumer		-		-		-
		14,707,970		14,732,294		3,786,796
	$	31,570,068	$	31,629,421	$	3,786,796

The following tables present the average impaired loans, interest recognized on impaired loans, and cash-basis interest income recognized on impaired loans for the three and six months ended June 30, 2011 and June 30, 2010:

For the three months ended	June 30, 2011
Average impaired loans during the period:
Commercial	$	12,537,966
Commercial Real Estate
Construction		7,822,854
Other		7,934,163
Interest recognized on impaired loans:
Commercial		142,377
Commercial Real Estate
Construction		98,676
Other		73,432
Cash-basis interest income recognized:
Commercial		116,302
Commercial Real Estate
Construction		74,046
Other		68,993

24

For the six months ended	June 30, 2011
Average impaired loans during the period:
Commercial	$	13,545,093
Commercial Real Estate
Construction		7,935,761
Other		7,905,824
Interest recognized on impaired loans:
Commercial		301,774
Commercial Real Estate
Construction		145,920
Other		143,479
Cash-basis interest income recognized:
Commercial		250,693
Commercial Real Estate
Construction		117,364
Other		133,570

For the three months ended	June 30, 2010
Average impaired loans during the period	$	25,652,787
Interest recognized on impaired loans		203,936
Cash-basis interest income recognized		203,936

For the six months ended	June 30, 2010
Average impaired loans during the period	$	25,351,351
Interest recognized on impaired loans		382,907
Cash-basis interest income recognized		382,907

The following table presents the recorded investment in nonaccrual and loans past due over 90 days still on accrual by class of loans as of June 30, 2011 and December 31, 2010:

June 30, 2011	Nonaccrual		Loans Past Due Over 90 Days Still Accruing
Commercial	$	6,009,952	$	1,806,863
Commercial Real Estate
Construction		1,814,804		-
Other		1,234,969		-
Residential Real Estate
Traditional		597,112		249,997
Jumbo		-		-
Home Equity		48,331		69,422
Consumer		-		4,990
Total	$	9,705,168	$	2,131,272

25

December 31, 2010	Nonaccrual		Loans Past Due Over 90 Days Still Accruing
Commercial	$	6,413,675	$	1,961,597
Commercial Real Estate
Construction		3,476,643		482,512
Other		2,208,205		-
Residential Real Estate
Traditional		825,432		229,213
Jumbo		-		-
Home Equity		17,292		179
Consumer		-		27,843
Total	$	12,941,247	$	2,701,344

The following table presents the aging of the recorded investment in past due loans as of June 30, 2011 and December 31, 2010:

June 30, 2011	30 - 59 Days Past Due		60 - 89 Days Past Due		Greater than 90 Days Past Due		Total Past Due		Total Loans Not Past Due
Commercial	$	2,339,436	$	587,706	$	7,225,227		10,152,369	$	219,017,559
Commercial Real Estate
Construction		-		-		1,710,496		1,710,496		18,979,153
Other		-		168,465		1,234,969		1,403,434		103,442,830
Residential Real Estate
Traditional		6,161		40,994		847,109		894,264		52,833,612
Jumbo		-		-		-		-		30,728,052
Home Equity		340,243		318,952		117,752		776,947		36,232,479
Consumer		137,741		55,971		4,990		198,702		13,887,657
Total	$	2,823,581	$	1,172,088	$	11,140,543	$	15,136,212	$	475,121,342

December 31, 2010	30 - 59 Days Past Due		60 - 89 Days Past Due		Greater than 90 Days Past Due		Total Past Due		Total Loans Not Past Due
Commercial	$	3,377,433	$	444,713	$	5,571,355		9,393,501	$	225,113,689
Commercial Real Estate
Construction		3,487,072		-		1,862,150		5,349,222		19,303,669
Other		-		239,392		2,208,205		2,447,597		91,768,828
Residential Real Estate
Traditional		738,767		121,252		1,054,645		1,914,664		52,459,174
Jumbo		1,183,388		-		-		1,183,388		24,715,658
Home Equity		48,433		-		17,471		65,904		38,554,735
Consumer		250,040		95,625		27,843		373,508		15,812,711
Total	$	9,085,133	$	900,982	$	10,741,669	$	20,727,784	$	467,728,464

Troubled Debt Restructurings:

The Company has allocated $1.0 million and $485,000 of specific reserves to customers whose loan terms have been modified in troubled debt restructurings as of June 30, 2011 and December 31, 2010.  The Company has committed to lend additional amounts totaling up to $497 and $8,962 as of June 30, 2011 and December 31, 2010, respectively, to customers with outstanding loans that are classified as troubled debt restructurings.

Credit Quality Indicators:

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as:  current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors.  The Company analyzes loans individually by classifying the loans as to credit risk.  This analysis includes non-homogeneous loans, such as commercial and commercial real estate loans.  This analysis is performed on a quarterly basis.  The Company uses the following definitions for risk ratings:

26

Special Mention:  Loans classified as special mention have a potential weakness that deserves management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution's credit position at some future date.

Substandard:  Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

Doubtful:  Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans.  Loans listed as not rated are included in groups of homogeneous loans.  As of June 30, 2011 and December 31, 2010, and based on the most recent analysis performed, the risk category of the recorded investment of loans by class of loans is as follows:

June 30, 2011	Not Rated		Pass		Special Mention		Substandard		Doubtful
Commercial	$	-	$	198,539,235	$	11,605,036	$	13,044,198	$	5,981,459
Commercial Real Estate
Construction		-		5,681,725		3,221,267		9,984,226		1,802,431
Other		-		95,932,824		3,424,051		4,256,475		1,232,914
Residential Real Estate
Traditional		53,727,876		-		-		-		-
Jumbo		30,728,052		-		-		-		-
Home Equity		37,009,426		-		-		-		-
Consumer		14,086,359		-		-		-		-
Total	$	135,551,713	$	300,153,784	$	18,250,354	$	27,284,899	$	9,016,804

December 31, 2010	Not Rated		Pass		Special Mention		Substandard		Doubtful
Commercial	$	-	$	197,230,795	$	15,507,296	$	15,459,634	$	6,309,465
Commercial Real Estate
Construction		-		5,725,698		3,104,775		12,345,774		3,476,644
Other		-		79,158,412		8,485,742		4,364,067		2,208,204
Residential Real Estate
Traditional		54,373,838		-		-		-		-
Jumbo		25,899,046		-		-		-		-
Home Equity		38,620,639		-		-		-		-
Consumer		16,186,219		-		-		-		-
Total	$	135,079,742	$	282,114,905	$	27,097,813	$	32,169,475	$	11,994,313

The Company considers the performance of the loan portfolio and its impact on the allowance for loan losses.  For residential, home equity, and consumer classes, the Company also evaluates the credit quality based on the aging status of the loan, which was previously presented, and by activity.  The following table presents the recorded investment in residential, home equity, and consumer loans based on aging status as of June 30, 2011 and December 31, 2010:

June 30, 2011	Not Past Due		30 - 89 Days Past Due		Greater than 90 Days Past Due Still Accruing		Nonaccrual
Residential Real Estate
Traditional	$	52,833,612	$	47,155	$	249,997	$	597,112
Jumbo		30,728,052		-		-		-
Home Equity		36,232,479		659,194		69,422		48,331
Consumer		13,887,657		193,712		4,990		-
Total	$	133,681,800	$	900,061	$	324,409	$	645,443

27

December 31, 2010	Not Past Due		30 - 89 Days Past Due		Greater than 90 Days Past Due Still Accruing		Nonaccrual
Residential Real Estate
Traditional	$	52,459,174	$	860,019	$	229,213	$	825,432
Jumbo		24,715,658		1,183,388		-		-
Home Equity		38,554,735		48,433		179		17,292
Consumer		15,812,711		345,665		27,843		-
Total	$	131,542,278	$	2,437,505	$	257,235	$	842,724

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

	June 30, 2011			December 31, 2010
Loans past due over 90 days and still accruing	$	2,123,235		$	2,688,135
Nonperforming restructured loans		1,822,379			7,501,958
Nonaccrual loans		9,663,137			12,939,331
Total nonperforming loans	$	13,608,751		$	23,129,424
Other real estate owned		3,728,845			4,284,263
Impaired Securities		386,067			421,529
Total nonperforming assets	$	17,723,663		$	27,835,216
Nonperforming assets to total assets		2.68	%		4.22	%
Nonperforming loans to total loans		2.78	%		4.75	%

Note:Loan balances disclosed in the chart above are reported at unpaid principal.

Note 10 – Federal Home Loan Bank

Advances from the Federal Home Loan Bank (“FHLB”) were:

	June 30, 2011		December 31, 2010
3.19% bullet advance, principal due at maturity March 28, 2011	$	-	$	2,000,000
3.60% bullet advance, principal due at maturity April 28, 2011		-		1,500,000
0.47% variable rate advance, principal due at maturity December 5, 2011		3,500,000		-
0.47% variable rate advance, principal due at maturity December 12, 2011		3,500,000		-
0.47% variable rate advance, principal due at maturity December 13, 2011		2,000,000		-
0.47% variable rate advance, principal due at maturity December 19, 2011		6,000,000		-
0.47% variable rate advance, principal due at maturity December 20, 2011		2,000,000		-
0.47% variable rate advance, principal due at maturity December 27, 2011		8,000,000		-
3.55% bullet advance, principal due at maturity March 26, 2012		2,000,000		2,000,000
0.31% bullet advance, principal due at maturity May 21, 2012		5,000,000		-
3.81% bullet advance, principal due at maturity March 26, 2013		2,000,000		2,000,000
	$	34,000,000	$	7,500,000

Of the total FHLB borrowings at June 30, 2011 and December 31, 2010, no advances had callable options.

At June 30, 2011 scheduled principal reductions on these FHLB advances were as follows:

Year	Advances
2011	$	25,000,000
2012		7,000,000
2013		2,000,000
	$	34,000,000

28

Note 11 – Fair Value Measurement

The fair value hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

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 reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The Company used the following methods and significant assumptions to estimate fair value:

Investment Securities:  The fair values for investment securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2), which include our agencies, municipal bonds, and the majority of our mortgage-backed securities. In certain cases where market data is not readily available because of lack of market activity or little public disclosure, values may be based on unobservable inputs and classified in Level 3 of the fair value hierarchy, which include our collateralized debt obligations and some mortgage-backed securities.  Collateralized debt obligations, such as Trust Preferred Securities, which are issued by financial institutions and insurance companies have seen a decline in the level of observable inputs and market activity in this class of investments has been significant and resulted in unreliable external pricing.  Broker pricing and bid/ask spreads, when available, vary widely.  The once active market has become comparatively inactive.  The same is true for the mortgage-backed securities that are categorized as Level 3.  As such, these investments are priced at June 30, 2011 and December 31, 2010 using Level 3 inputs.  Due to current market conditions as well as the limited trading activity of these securities, the fair value is highly sensitive to assumption changes and market volatility.

Impaired Loans:  The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent collateral appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

Other Real Estate Owned:  Nonrecurring adjustments to certain commercial and residential real estate properties classified as other real estate owned (OREO) are measured at fair value, less costs to sell. Fair values are based on recent real estate appraisals. These appraisals may use a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

29

The following tables present for each of the fair-value hierarchy levels our assets that are measured at fair value on a recurring basis.

			June 30, 2011
	Level 1		Level 2		Level 3		Total
Available for sale securities:
U.S. Government agency debt obligations	$	-	$	1,340,787	$	-	$	1,340,787
Obligations of states and political subdivisions		-		50,419,837		-		50,419,837
Mortgage-backed securities (residential)		-		58,156,892		6,366,304		64,523,196
Mortgage-backed securities (commercial)		-		4,604,711		-		4,604,711
Collateralized debt obligations		-		-		-		-
Total	$	-	$	114,522,227	$	6,366,304	$	120,888,531

			December 31, 2010
	Level 1		Level 2		Level 3		Total
Available for sale securities:
U.S. Government agency debt obligations	$	-	$	4,172,667	$	-	$	4,172,667
Obligations of states and political subdivisions		-		45,759,402		-		45,759,402
Mortgage-backed securities (residential)		-		47,097,328		8,391,642		55,488,970
Mortgage-backed securities (commercial)		-		4,683,017		-		4,683,017
Collateralized debt obligations		-		-		4,600		4,600
Total	$	-	$	101,712,414	$	8,396,242	$	110,108,656

The following table represents the changes in the Level 3 fair-value category for the periods ended June 30, 2011 and June 30, 2010.  We classify financial instruments in Level 3 of the fair-value hierarchy when there is reliance on at least one significant unobservable input in the valuation model.  In addition to these unobservable inputs, the valuation models for Level 3 financial instruments typically also rely on a number of inputs that are readily observable either directly or indirectly.  Thus, the gains and losses presented below include changes in the fair value related to both observable and unobservable inputs.

	Available-for-sale securities					Available-for-sale securities
	June 30, 2011					June 30, 2010
For the three months ended	Collateralized Debt Obligation		Mortgage Backed Securities (residential)			Collateralized Debt Obligation			Mortgage Backed Securities (residential)
Beginning Balance, April 1	$	-	$	7,650,172		$	10,028		$	6,130,027
Principal paydowns		-		(429,744	)		-			(287,037	)
Net realized/unrealized gains (losses) Included in earnings:
Interest income on securities		-		11,267			-			32,612
Credit loss recognized in earnings		-		(1,288	)		-			(14,278	)
Included in other comprehensive income		-		(33,429	)		(28	)		(96,045	)
Purchases of Level 3 securities		-		-			-			493,904
Transfers in (out) of Level 3		-		(830,674	)		-			-
Ending Balance, June 30	$	-	$	6,366,304		$	10,000		$	6,259,183

30

	Available-for-sale securities						Available-for-sale securities
	June 30, 2011						June 30, 2010
For the six months ended	Collateralized Debt Obligation			Mortgage Backed Securities (residential)			Collateralized Debt Obligation		Mortgage Backed Securities (residential)
Beginning Balance, January 1	$	4,600		$	8,391,642		$	10,000	$	5,091,556
Principal paydowns		-			(1,177,300	)		-		(542,980	)
Net realized/unrealized gains (losses)Included in earnings:
Interest income on securities		-			9,287			-		57,236
Credit loss recognized in earnings		(110,000	)		(16,287	)		-		(24,868	)
Included in other comprehensive income		105,400			(10,364	)		-		71,562
Purchases of Level 3 securities		-			-			-		1,606,677
Transfers in (out) of Level 3		-			(830,674	)		-		-
Ending Balance, June 30	$	-		$	6,366,304		$	10,000	$	6,259,183

The fair value for one mortgage backed security with a fair value of $830,674 as of June 30, 2011 was transferred out of Level 3 and into Level 2 because of the availability of observable market data for this investment due to an increase in the market activity for this security.  The Company’s policy is to recognize transfers as of the end of the reporting period.  As a result, the fair value for this collateralized debt obligation was transferred on June 30, 2010.

The table below summarizes changes in unrealized gains and losses recorded in earnings for the three-month and six-month periods ending June 30 for Level 3 assets that are still held at June 30.

	Changes in Unrealized Gains (Losses) Relating to Assets Held at Reporting Date  for the Quarter Ended June 30
Collateralized Debt Obligation	2011	2010
Impairment recognized in earnings	$                       -	$                     -

	Changes in Unrealized Gains (Losses) Relating to Assets Held at Reporting Date  for the Quarter Ended June 30
Mortgage backed securities (residential)	2011	2010
Impairment recognized in earnings	$                     1,288	$                   14,278

	Changes in Unrealized Gains (Losses) Relating to Assets Held at Reporting Date for the Six Months Ended June 30
Collateralized Debt Obligation	2011	2010
Impairment recognized in earnings	$                   110,000	$                    -

	Changes in Unrealized Gains (Losses) Relating to Assets Held at Reporting Date for the Six Months Ended June 30
Mortgage backed securities (residential)	2011	2010
Impairment recognized in earnings	$                    16,287	$                    24,868

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Assets Measured at Fair Value on a Non-recurring Basis

Other certain assets and liabilities are measured at fair value on a non-recurring basis and are therefore not included in the tables above.  These include impaired loans, which are measured at fair value based on the fair value of the underlying collateral, and other real estate owned.  Fair value is determined, where possible, using market prices derived from an appraisal or evaluation.  However, certain assumptions and unobservable inputs are used many times by the appraiser, therefore, qualifying the assets as Level 3 in the fair-value hierarchy.

The following tables present for each of the fair-value hierarchy levels our assets that are measured at fair value on a non-recurring basis.

			June 30, 2011
	Level 1		Level 2		Level 3		Total
Impaired loans:
Commercial	$	-	$	-	$	3,193,048	$	3,193,048
Commercial Real Estate
Construction		-		-		2,499,947		2,499,947
Other		-		-		4,026,125		4,026,125
Other real estate owned:
Commercial Real Estate
Construction	$	-	$	-	$	51,700	$	51,700
Other		-		-		329,000		329,000
Residential Real Estate
Traditional		-		-		391,130		391,130
Jumbo		-		-		-		-

			December 31, 2010
	Level 1		Level 2		Level 3		Total
Impaired loans:
Commercial	$	-	$	-	$	5,491,859	$	5,491,859
Commercial Real Estate Construction		-		-		763,986		763,986
Other		-		-		4,617,865		4,617,865
Other real estate owned:
Commercial Real Estate Construction	$	-	$	-	$	1,878,255	$	1,878,255
Other		-		-		917,000		917,000
Residential Real Estate
Traditional		-		-		279,000		279,000
Jumbo		-		-		-		-

Impaired loans with specific allocations which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $14.1 million, with a valuation allowance of $4.4 million at June 30, 2011, resulting in an additional provision for loan losses of $3.1 million for the three months and $3.0 million for the six months ended June 30, 2011.  Offsetting these additional provisions was a decrease in the general reserve allocations, as calculated per ASC 450-2, which was the result of an improvement, quarter-over-quarter, in our nonperforming assets, delinquency ratios, and two-year historical look-back. Additional provision expense was recorded in the amounts of $448,000 for the three months and $1.0 million recorded for the six months ended June 30, 2010.  Impaired loans with a carrying amount totaling $2.3 million at June 30, 2011 and $5.4 million at December 31, 2010 were excluded from the chart above as these were measured using the present value of expected future cashflows, which is not considered fair value. At December 31, 2010, impaired loans had a carrying amount of $12.5 million, with a valuation allowance of $1.6 million.

Our internal policy on OREO properties requires an updated appraisal once every 12 months.  Several appraisals were received during the fourth quarter of 2010 at which time those properties were written down to fair value.  Based on receiving new appraisals on a few OREO properties over the last six months, we have marked four of them to fair value.  At June 30, 2011, the carrying value of those properties was $857,830, with a valuation allowance of $86,000, resulting in additional OREO expense of approximately $25,000 for the three months and $78,780 for the six months ended June 30, 2011.  We added two residential real estate properties and three commercial real estate properties totaling $1.7 million, which was offset by five sales with a carrying value that totaled $2.0 million.  At December 31, 2010 the carrying value was $3.5 million, with a valuation allowance of $446,043, resulting in additional OREO expense of approximately $446,000 for the year ended December 31, 2010.

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In accordance with accounting standards the carrying values and estimated fair values of our financial instruments at June 30, 2011 and December 31, 2010 are as follows:

	June 30, 2011						December 31, 2010
	Carrying			Fair			Carrying			Fair
	Value			Value			Value			Value
Financial assets:
Cash and cash equivalents	$	17,361,219		$	17,361,219		$	29,679,382		$	29,679,382
Long-term interest earning deposits		996,000			996,000			996,000			996,000
Securities available for sale		120,888,531			120,888,531			110,108,656			110,108,656
FHLBI and FRB stock		3,807,700			N/A			4,075,100			N/A
Loans held for sale		1,367,988			1,367,988			2,140,872			2,140,872
Loans, net		476,677,116			478,924,215			474,424,715			477,931,195
Accrued interest receivable		2,444,535			2,444,535			2,391,953			2,391,953
Financial liabilities:
Deposits	$	(547,895,614	)	$	(550,951,305	)	$	(576,356,136	)	$	(579,132,112	)
FHLB advances		(34,000,000	)		(34,147,800	)		(7,500,000	)		(7,716,450	)
Junior subordinated debt		(17,527,000	)		(16,991,892	)		(17,527,000	)		(16,537,065	)
Accrued interest payable		(1,794,934	)		(1,794,934	)		(1,415,713	)		(1,415,713	)

Estimated fair value for securities available for sale is consistent with the hierarchy regarding fair value measurements.  For securities where quoted market prices are not available, fair values are estimated based on market prices of similar securities and in some cases on unobservable inputs due to inactive market activity.  Estimated fair value of FHLBI and FRB stock cannot be determined due to restrictions placed on its transferability.  Estimated fair value for loans is based on the rates charged at period-end for new loans with similar maturities, applied until the loan is assumed to reprice or be paid and the allowance for loan losses is considered to be a reasonable estimate of discount for credit quality concerns. Estimated fair value for IRAs, CDs, short-term borrowings, fixed rate advances from the FHLB and the junior subordinated debt is based on the rates at period-end for new deposits or borrowings, applied until maturity. Estimated fair value for other financial instruments and off-balance-sheet loan commitments is considered to approximate carrying value.

Note 12 – Reclassifications

Certain items in the financial statements and notes thereto were reclassified to conform to the current presentation.  The reclassifications had no effect on net income or stockholders’ equity as previously reported.

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

The following presents management’s discussion and analysis of the consolidated financial condition of the Company as of June 30, 2011 and December 31, 2010 and results of operations for the three- and six-month periods ended June 30, 2011 and June 30, 2010.  This discussion should be read in conjunction with the Company’s consolidated condensed financial statements and the related notes appearing elsewhere in this report and the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.

Executive Overview

Net income for the first six months of 2011 was $1.9 million, an increase of $637,346 from the first six months of 2010.  The increase in net income was primarily due to an increase in net interest income of $203,066, an increase in noninterest income of $387,618, and a decrease in noninterest expense of $162,524.  Net interest income increased primarily due to a drop in our cost of funds.  Interest expense decreased by $1.1 million compared to the same six-month period in 2010 ending June 30.  Noninterest income also increased in 2011 compared to 2010 primarily due to an increase in the gain on the sale of securities by $402,957 and an increase in our net debit card interchange income by $100,518.  Operating expenses decreased primarily due to a decrease of $643,873 in Other Real Estate Owned (OREO) expenses and write-downs and a decrease in FDIC insurance premiums of $135,901.  These decreases were offset by an increase in employment expenses of $592,215 due to normal increases in salaries, new incentive plans, and an increase in payroll taxes.  Most of the other expense categories remained the same or showed a slight decrease from the first six months of 2010 to the first six months of 2011, each of which was less than or around $100,000, including loan and professional costs, office supplies and occupancy and equipment expenses.

Total assets increased by $1.1 million from December 31, 2010 to June 30, 2011.  The increase in total assets was primarily due to an increase in long-term investments and bank owned life insurance totaling $13.8 million offset by a decrease in cash and cash equivalents by $12.3 million.  We also experienced an increase of $1.8 million in total loans, which primarily came from our residential real estate and commercial real estate portfolios.

Total deposits decreased by $28.5 million to $547.9 million as of June 30, 2011, primarily due to decreases of $11.4 million, $10.9 million, $5.7 million and $5.0 million in certifcates of deposit, money market accounts, noninterest bearing checking accounts, and brokered deposits, respectively.  These decreases were slightly offset by increases of $6.5 million in our interest bearing checking.  Core deposits decreased by $18.8 million, and now comprise 75.3% of total deposits.

Financial Condition

Total assets were $661.0 million at June 30, 2011 compared to total assets at December 31, 2010 of $659.9 million.  The 0.2% increase in assets was primarily due to an increase in long-term investments and bank owned life insurance of $13.8 million, which was offset by a decrease in cash and cash equivalents by $12.3 million.

Cash and Investments.   Cash and cash equivalents, which include federal funds sold, were $17.4 million at June 30, 2011, a decrease of $12.3 million, or 41.5%, from December 31, 2010.  The excess cash was used to purchase securities available for sale, which increased by $10.8 million from December 31, 2010 to $120.9 million at the end of the second quarter of 2011.  The increase in long-term investments was primarily in municipal bonds and residential mortgage-backed securities, which increased by $4.7 million and $9.0 million, respectively.  Long-term investments now comprise 18.9% of total assets, as we continue to focus on liquidity and repositioning of the balance sheet.

Loans.  Total loans were $488.7 million at June 30, 2011 reflecting a 0.4% increase from total loans of $486.9 million at December 31, 2010.   The increase in loans during the first six months of 2011 occurred mainly in the commercial real estate and residential real estate loan categories, which reported increases of $6.7 million and 4.2 million, respectively. These increases were offset by a decrease in the commercial loan category of $5.3 million.

Nonperforming Assets.  Nonperforming assets include impaired securities, nonperforming loans, and other real estate owned (OREO).  Nonperforming loans include loans past due over 90 days and still accruing interest, nonperforming restructured loans, and all nonaccrual loans.  Nonperforming assets have decreased from $27.8 million, or 4.2% of total assets, at December 31, 2010 to $17.7 million, or 2.7% of total assets, at June 30, 2011.  The decrease was primarily attributable to three restructured loans totaling $7.5 million moving to performing status.  These three relationships have demonstrated their ability to consistently make scheduled payments for six or more months based on the restructured terms. Included in delinquencies greater than 90 days as of June 30, 2011 and December 31, 2010 is an accruing $1.8 million loan that has matured.  The Bank has elected not to renew the loan and is seeking collection via legal process.  The loan remains in accruing status because it is further supported by the unlimited guaranty of a third party whose guaranty is fully secured by a mortgage on a performing commercial real estate property that is unrelated to the borrower’s enterprise and cash collateral of $750,000 on deposit in the Bank’s name.  This loan is expected to remain nonperforming during the pendency of our legal collection efforts but ultimate collection is not currently in doubt.   We expect this loan to be resolved during the second half of 2011.  Without this item, non-performing assets would have totaled $15.9 million, or 2.4% of total assets and $26.0 million, or 3.9% of total assets at June 30, 2011 and December 31, 2010, respectively.

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Nonaccrual loans decreased by $3.3 million during the first six months of 2011 primarily due to the sale of a $1.9 million commercial loan, the sale of a $1.9 million commercial real estate loan, charging off $1.7 million of loan balances, and the transfer of five loans to OREO in the amount of $1.7 million.  The reductions to nonaccruals were offset by adding three commercial and two commercial real estate relationship totaling $3.9 million.  These additions to nonaccruals resulted in $622,000 of additional provision expense for the six months ending June 30, 2011.

The decrease in OREO of $555,418 was a direct result of the sale of one residential real estate property and one commercial real estate property totaling $664,000 since December 31, 2010.  In addition to these sales, two other properties added during the first quarter of 2011 totaling $1.3 million were sold during the second quarter of 2011.  Offsetting the sales was the addition of two commercial real estate properties and one residential real estate property, which added $385,476 to other real estate owned.

Loans are deemed impaired when it is probable that we will not be able to collect all principal and interest amounts due according to their contractual terms, which includes most nonperforming loans.  Total impaired loans at June 30, 2011 were $27.2 million, compared to $31.6 million at December 31, 2010.  At June 30, 2011, management believes it has allocated adequate specific reserves for these risks.

Allowance for Loan Losses.   In each quarter the allowance for loan loss is adjusted to the amount management believes is necessary to maintain the allowance at adequate levels. Management allocates specific portions of the allowance for loan losses to specific problem loans.  Problem loans are identified through a loan risk rating system and monitored through watchlist reporting.  Specific reserves are determined for each identified problem loan based on delinquency rates, collateral and other risk factors specific to that problem loan.  Management’s allocation of the allowance to other loan pools considers various factors including historical loss experience, the present and prospective financial condition of borrowers, industry concentrations within the loan portfolio, general economic conditions, and peer industry data of comparable banks.

The allowance for loan losses at June 30, 2011 was $12.0 million, or 2.46% of total loans outstanding, a decrease of $472,398 from $12.5 million, or 2.57% of total loans outstanding, at December 31, 2010.   The provision for loan losses during the first six months of 2011 was $2.3 million compared to $2.4 million in the first six months of 2010.

For the first six months of 2011, we were in a net charge-off position of $2.8 million compared to a net charge-off position of $1.3 million for the first six months of 2010.  The increase in the charge-offs from the first six months of 2010 compared to the first six months of 2011 was a result of management’s decision to aggressively reduce classified assets.  The reduction occurred through the sale of loans, discounts taken on loans to allow the customer to refinance through other institutions or payoff, and write-downs to fair value.  Nonperforming loans decreased by $9.5 million during the first six months of 2011.  The specific allowance allocations increased by $1.2 million to $4.9 million in the first six months of 2011 primarily due to moving two commercial real estate relationships to impaired with specific allowances totaling $2.7 million. These additions were offset by charging down one commercial real estate relationship by $1.0 million that was previously reserved and did not require additional reserves as of June 30, 2011.  An additional offset to the increases in specific allocations was a decrease in our general reserve allocations for commercial loans, as calculated per ASC 450-2.  This decrease was primarily due to a steady improvement in our nonperforming assets, delinquency ratios, and our two year historical look-back period.

Other Assets.   Other assets, which includes bank owned life insurance and prepaid FDIC insurance, increased by $2.0 million, primarily from the $3.0 million purchase of bank owned life insurance in first quarter of 2011.  Prepaid FDIC insurance decreased $827,177 and will continue to decrease as the quarterly amounts are expensed.

Deposits.   Total deposits were $547.9 million at June 30, 2011 compared to total deposits at December 31, 2010 of $576.4 million. The decrease of $28.5 million during the first six months of 2011 was a combination of decreases of $10.9 million, $6.7 million, $5.7 million and $5.0 million in money market accounts, certifcates of deposit under $100,000, noninterest bearing accounts, and brokered deposits, respectively, which were offset by an increase in interest bearing deposits, primarily in health savings accounts, of $6.5 million.  Core deposits decreased by $18.8 million over the first six months of 2011, but remain at 75.3% of total deposits.  Total brokered deposits were $100.5 million at June 30, 2011, which includes brokered certificates of deposit of $88.5 million and brokered money market accounts of $12.0 million.  Brokered deposits were $105.5 million at December 31, 2010.  In 2010, we strategically increased our brokered deposits, in both certificates of deposit for the long-term funding and money market accounts for the short-term funding.  We were able to lock in rates on brokered certificates of deposits over a period ranging from two to ten years, which has been the primary reason for maintaining our net interest margin over the past several quarters.

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

	June 30, 2011					December 31, 2010
	Balance		%			Balance		%
Core deposits:
Noninterest-bearing demand	$	87,171,004		15.9	%	$	92,872,957		16.1	%
Interest-bearing checking		107,637,677		19.6	%		101,158,162		17.6	%
Money market		148,476,775		27.1	%		159,336,066		27.7	%
Savings		20,677,415		3.8	%		22,672,555		3.9	%
Time, under $100,000		48,768,179		8.9	%		55,450,402		9.6	%
Total core deposits		412,731,050		75.3	%		431,490,142		74.9	%
Non-core deposits:
In-market non-core deposits:
Time, $100,000 and over		34,687,476		6.3	%		39,356,777		6.8	%
Out-of-market non-core deposits:
Money market		12,026,078		2.2	%		12,015,936		2.1	%
Brokered certificate of deposits		88,451,010		16.2	%		93,493,281		16.2	%
Total out-of-market deposits		100,477,088		18.4	%		105,509,217		18.3	%
Total non-core deposits		135,164,564		24.7	%		144,865,994		25.1	%
Total deposits	$	547,895,614		100.0	%	$	576,356,136		100.0	%

Borrowings.   The Company had borrowings in the amount of $34.0 million in FHLB advances at June 30, 2011 and $7.5 million at December 31, 2010.  Of the outstanding FHLB advances at June 30, 2011, $9.0 million are bullet advances and mature in a range from March 2012 through March 2013.  The remaining $25.0 million are variable rate advances that mature in December 2011.

Other Liabilities.  Other liabilities and accrued interest payable increased $161,086 from $5.4 million at December 31, 2010 to $5.6 million at June 30, 2011.  Accrued interest payable increased by $379,221, primarily from the deferral of our interest payments related to our Junior Subordinated debt.

Results of Operations

For The Three-Month Periods Ended June 30

Results of operations for the three-month period ended June 30, 2011 reflected net income of $1.1 million, or $0.22 per diluted share.  This was a $575,739 increase from 2010’s second quarter net income of $514,090, or $0.12 per diluted share.   The increase in net income for the three-month period ended June 30, 2011was primarily attributable to an increase in our net interest income of $123,378, an increase of $338,099 in our noninterest income, and decreases of $25,000 and $350,065 in both our loan loss provision and noninterest expenses, respectively.

Performance Ratios	June 30
	2011	2010
Return on average assets *	0.66%	0.31%
Return on average equity *	7.92%	4.26%
Net interest margin (TEY) *	3.83%	3.72%
Efficiency ratio	67.91%	76.96%

* annualized

Net Interest Income.   Interest income for the three-month periods ended June 30, 2011 and 2010 was $7.3 million and $7.8 million, respectively, while interest expense for the second quarter was $1.6 million in 2011 and $2.2 million in 2010, resulting in net interest income of  $5.7 million and $5.6 million for the same three-month period in 2011 and 2010.  The tax equivalent net interest margin for the second quarter of 2011 was 3.83%, while the tax equivalent net interest margin for the second quarter of 2010 was 3.72%.  The improvement in our net interest margin was two-fold.  First, $8 million of our Junior Subordinated Debt moved to a variable rate of three month LIBOR plus 134 basis points, or 1.64% at June 30, 2011, which is a significant decrease from 6.21% at June 30, 2010.  Second, we aggressively reduced our cost of funding during 2010, which was consistent with our strategy to decrease higher cost deposits and replace them with lower cost out-of-market deposits that can be structured to reduce interest rate risk in the future.  The increase in our average earning assets of $3.7 million from the second quarter of 2010 added to the increase in our net interest income for the quarter.  Over the last twelve months, we have been able to reposition our balance sheet by adding $31.5 million to our average long-term investments, with $18.4 million of that increase coming from tax-exempt municipal bonds that yielded 5.69% in the second quarter of 2011 compared to loans, which yielded 5.18% for the same period.  While we estimate the interest rates will remain relatively flat into the first or second quarter of 2012, we expect some minimal margin compression to occur over the next few quarters as deposit rates have started to flatten and reinvestment rates on loans and deposits continue to decline.

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

	As of and For The Three-Month Period Ended
	June 30, 2011								June 30, 2010
				Interest		Annualized						Interest		Annualized
	Average			Earned		Yield			Average			Earned		Yield
($ in thousands)	Balance			or Paid		or Cost			Balance			or Paid		or Cost
Assets
Short-term investments and interest-earning deposits	$	1,917		$	6		1.26	%	$	2,115		$	5		0.95	%
Federal funds sold		3,213			1		0.12	%		2,006			1		0.20	%
Securities - taxable		84,181			640		3.05	%		71,059			663		3.74	%
Securities - tax exempt (1)		44,004			624		5.69	%		25,623			386		6.04	%
Loans held for sale		1,048			-		0.00	%		1,294			-		0.00	%
Loans		486,360			6,277		5.18	%		514,962			6,827		5.32	%
Total interest-earning assets		620,723			7,548		4.88	%		617,059			7,882		5.12	%
Allowance for loan losses		(11,828	)							(12,606	)
Cash and due from banks		11,576								16,057
Other assets		40,389								43,314
Total assets	$	660,860							$	663,824
Liabilities and Stockholders' Equity
Interest-bearing checking	$	112,346		$	39		0.14	%	$	105,376		$	88		0.33	%
Savings		21,307			9		0.17	%		19,870			20		0.40	%
Money market		147,811			164		0.45	%		146,963			313		0.85	%
Certificates of deposit		86,493			391		1.81	%		123,992			581		1.88	%
Brokered deposits		104,204			748		2.88	%		90,403			726		3.22	%
Short-term borrowings		72			-		0.00	%		24,078			143		2.38	%
FHLB advances		24,817			63		1.02	%		36			-		0.00	%
Junior subordinated debt		17,527			201		4.60	%		17,527			283		6.48	%
Total interest-bearing liabilities		514,577			1,615		1.26	%		528,245			2,154		1.64	%
Noninterest-bearing checking		86,038								83,155
Other liabilities		5,032								4,020
Stockholders' equity		55,213								48,404
Total liabilities and stockholders' equity	$	660,860							$	663,824
Net interest income				$	5,933							$	5,728
Rate spread							3.62	%							3.48	%
Net interest income as a percent of average earning assets							3.83	%							3.72	%

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

Provision for Loan Losses.   A provision for loan losses was recorded in the amount of $1.1 million, or 93 basis points, annualized, on average loans during the second quarter of 2011 as compared to $1.1 million, or 86 basis points, annualized, on average loans for the second quarter of 2010.  The allowance for loan losses at June 30, 2011 totaled $12.0 million and was 2.46% of total loans outstanding on that date.  For the three-month period ended June 30, 2011 we were in a net charge-off position of $1.0 million, or 84 basis points, annualized, on average loans compared to net charge-off of $531,585, or 41 basis points, annualized, on average loans during the same period a year ago.  The charge-offs taken in 2011 were primarily comprised of four lending relationships.  One commercial real estate and one commercial lending relationship together recorded charge-offs of $1.2 million due to the sale of the loans at a discount.  By selling these loans, we were able to reduce nonperforming assets by $4.1 million.  These charge-offs were offset by a $540,000 recovery on a commercial loan previously charged-off in September of 2010 in the amount of $736,190.

Noninterest Income.   Noninterest income was $2.1 million during the second quarter of 2011. This was a $338,099 increase compared to the second quarter of 2010.  The majority of the increase relates to an increase of $345,128 in the gain on sale of available for sale securities.  We also experienced an increase in our net debit card interchange income of $53,695 primarily due to the increase in the number of debit cards outstanding and the conversion to another service provider in February of 2011.  These increases were offset by a decrease in Trust and Brokerage Fees of $71,297 which was a direct result of a decrease in assets under management by $137.1 million from June 30, 2010.

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Noninterest Expense.   Noninterest expense was $5.3 million for the second quarter of 2011 while noninterest expense for the three-month period ended June 30, 2010 was $5.6 million.  The main components of noninterest expense for the second quarter of 2011 were salaries and benefits of $2.7 million, occupancy and equipment costs of $589,434, loan and professional expenses of $420,213, FDIC insurance premiums of $349,923, and data processing costs of $391,398.  Most noninterest expense categories reported decreases in 2011 compared to the same three-month period in 2010, including decreases in OREO expenses of $779,996, FDIC insurance premiums of $140,544, occupancy and equipment expenses of $40,790, and other expenses of $90,796.  Employee benefits and data processing expenses displayed the largest increases of $420,209 and $275,098, respectively.   The increase in employee benefits was caused by normal increases in salaries, new incentive plans, and an increase in payroll taxes.    A one-time credit received from our new core processor in 2010 lowered the data processing costs in that year compared to prior years and compared to 2011.  Data processing expenses also increased due to increasing the number of services with this core processor.  At the beginning of the second quarter of 2011, the FDIC reduced their assessment rates for determining insurance premiums, which was reflected by the $140,544 decrease in expense from the same three-month period in 2010.  Beginning in the third quarter of 2011, we expect a further reduction in FDIC premiums of approximately $125,000 per quarter compared to the premiums expensed in the second quarter of 2011.  The estimated savings is based on our average quarterly assets less average tangible equity and will vary depending on growth or contraction of the balance sheet.

Income Taxes.    During the quarters ended June 30, 2011 and 2010, the Company recorded $285,788 and $74,985 in income taxes expense, respectively. The effective tax rate recorded was 20.8% for the second quarter of 2011 as compared to 12.7% for the second quarter of 2010.  The increase in the effective tax rate from 2010 was caused by an increase in taxable income compared to the prior year.  We are able to maintain a low effective tax rate through strategic tax planning, which is primarily due to the use of tax-exempt income.

For The Six-Month Periods Ended June 30

Results of operations for the six-month period ended June 30, 2011 reflected net income of $1.9 million, or $0.39 per diluted share.  This was a $637,346 increase from 2010’s first six months of net income of $1.2 million, or $0.28 per diluted share.  The increase in net income for the six-month period ended June 30, 2011 was primarily attributable to an increase in our net interest income of $203,066, an increase of $387,618 in our noninterest income, and decreases of $95,000 and $162,524 in both our loan loss provision noninterest expenses, respectively.

Performance Ratios	June 30
	2011	2010
Return on average assets *	0.57%	0.37%
Return on average equity *	6.94%	5.20%
Net interest margin (TEY) *	3.83%	3.69%
Efficiency ratio	68.85%	72.78%

* annualized

Net Interest Income.   Interest income for the six-month periods ended June 30, 2011 and 2010 was $14.6 million and $15.5 million, respectively, while interest expense for the first six months was $3.2 million in 2011 and $4.4 million in 2010, resulting in net interest income of  $11.4 million and $11.2 million for the same six-month period in 2011 and 2010.  The tax equivalent net interest margin for the first six months of 2011 was 3.83%, while the tax equivalent net interest margin for the first six months of 2010 was 3.69%.  The improvement in our net interest margin came primarily from a decrease in the rates on $8.0 million of our Junior Subordinated Debt, which went to a variable floating rate on December 2, 2010.  The current rate at June 30, 2011, which is subject to change on a quarterly basis, was three-month LIBOR plus 134 basis points, or 1.64%.  The fixed rate prior to December 2, 2010 was 6.21%.  Also positively impacting our net interest margin, was an aggressive reduction in cost of funding during 2010, which was consistent with our strategy to decrease higher cost deposits and replace them with lower cost out-of-market deposits that can be structured to reduce interest rate risk in the future.  We were also able to take advantage of the low interest rate environment in the second half of 2010 by increasing brokered deposits as discussed previously under the section “Financial Condition – Deposits.”  The increase in our net interest margin was offset by a decrease in earning assets of $3.8 million from the first six months of 2010.  Over the last twelve months, we have been able to reposition our balance sheet by adding $28.9 million to our average long-term investments, with $17.8 million of that increase coming from tax-exempt municipal bonds that yielded 5.81% in the first six months of 2011 compared to loans, which yielded 5.19% for the same period.  While we estimate the interest rates will remain relatively flat for the remainder of the year, we expect some minimal margin compression to occur over the next few quarters as deposit rates have started to flatten out and reinvestment rates on loans and long-term investments are not very attractive as we reinvest the monthly amortization we receive from these assets.

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

	As of and For The Six Month Period Ended
	June 30, 2011								June 30, 2010
				Interest		Annualized						Interest		Annualized
	Average			Earned		Yield			Average			Earned		Yield
($ in thousands)	Balance			or Paid		or Cost			Balance			or Paid		or Cost
Assets
Short-term investments and interest-earning deposits	$	2,351		$	19		1.63	%	$	2,274		$	9		0.80	%
Federal funds sold		2,613			2		0.15	%		2,863			3		0.21	%
Securities - taxable		82,146			1,219		2.99	%		71,050			1,302		3.70	%
Securities - tax exempt (1)		42,836			1,220		5.74	%		25,021			758		6.11	%
Loans held for sale		1,369			-		0.00	%		1,225			-		0.00	%
Loans		488,179			12,566		5.19	%		520,888			13,710		5.31	%
Total interest-earning assets		619,494			15,026		4.89	%		623,321			15,782		5.11	%
Allowance for loan losses		(12,396	)							(12,323	)
Cash and due from banks		15,542								17,671
Other assets		40,072								42,227
Total assets	$	662,712							$	670,896
Liabilities and Stockholders' Equity
Interest-bearing checking	$	113,965		$	85		0.15	%	$	106,133		$	194		0.37	%
Savings		22,232			24		0.22	%		19,511			39		0.40	%
Money market		151,579			341		0.45	%		148,356			636		0.86	%
Certificates of deposit		89,003			806		1.83	%		129,996			1,313		2.04	%
Brokered deposits		104,945			1,456		2.80	%		77,310			1,305		3.40	%
Short-term borrowings		69			-		0.00	%		18			-		0.00	%
FHLB advances		17,653			135		1.54	%		34,421			313		1.83	%
Junior subordinated debt		17,527			401		4.61	%		17,527			563		6.48	%
Total interest-bearing liabilities		516,973			3,248		1.27	%		533,272			4,363		1.65	%
Noninterest-bearing checking		86,203								85,693
Other liabilities		5,098								4,018
Stockholders' equity		54,438								47,913
Total liabilities and stockholders' equity	$	662,712							$	670,896
Net interest income				$	11,778							$	11,419
Rate spread							3.62	%							3.46	%
Net interest income as a percent of average earning assets							3.83	%							3.69	%

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

Provision for Loan Losses.   A provision for loan losses was recorded in the amount of $2.3 million, or 97 basis points, annualized, on average loans during the first six months of 2011 as compared to $2.4 million, or 94 basis points, annualized, on average loans for the first six months of 2010.  The allowance for loan losses at June 30, 2011 totaled $12.0 million and was 2.46% of total loans outstanding on that date.  For the six-month period ended June 30, 2011 we were in a net charge-off position of $2.8 million, or 116 basis points, annualized, on average loans compared to net charge-off of $1.3 million, or 51 basis points, annualized, on average loans during the same period a year ago.  The charge-offs taken in 2011 comprised primarily of six lending relationships.  Four commercial lending relationships together recorded charge-offs of $1.7 million and two commercial real estate relationships recorded charge-offs of $1.6 million, of which $2.2 million was previously reserved as of December 31, 2010.  These charge-offs were offset by a $540,000 recovery on a commercial loan previously charged-off in September of 2010 in the amount of $736,190.

Noninterest Income.   Noninterest income was $3.7 million during the first six months of 2011. This was a $387,618 increase compared to the first six months of 2010.  The majority of the increase relates to an increase in the gain on sale of available for sale securities of $402,957.  Through restructuring opportunities within the market, we were able to recognize some gains and reinvest the proceeds with minimal impact to the portfolio yield.  The gains were offset by an increase of $101,419 in the OTTI charge we recorded in the first six months of 2011 compared to the same period in 2010.  An increase of $100,518 in net debit card interchange income also added to the increase in noninterest income.  This increase was primarily due to the increase in the number of debit cards outstanding and the conversion to another service provider, who charges less for debit card transaction processing, in February of 2011.  Trust and Brokerage Fees decreased from the second quarter 2010 by $70,263 primarily due to a decrease in assets under management of $137.1 million from June 30, 2010.

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Noninterest Expense.   Noninterest expense was $10.4 million for the first six months of 2011 while noninterest expense for the six-month period ended June 30, 2010 was $10.5 million.  The main components of noninterest expense for the first six months of 2011 were salaries and benefits of $5.3 million, occupancy and equipment costs of $1.2 million, FDIC insurance premiums of $856,771, loan and professional expenses of $781,655, and data processing costs of $700,703.  Several noninterest expense categories reported decreases in 2011 compared to the same six-month period in 2010, which include decreases in OREO expenses of $643,873, FDIC insurance premiums of $135,901, other expenses of $128,651, and loan and professional costs of $77,782.  These decreases were offset by increases of $592,215 and $275,491 in employment costs and data processing, respectively.  The increase in employee benefits was caused by normal increases in salaries, new incentive plans, and increase in payroll taxes.    Data processing expenses increased primarily due to recognizing a one-time credit in 2010 for our conversion to a new core system service provider.  Effective April 1, 2011, the FDIC reduced their assessment rates for determining insurance premiums, which was reflected by the $135,901 decrease in expense from the same six-month period in 2010.  Beginning in the third quarter of 2011, we expect a further reduction in FDIC premiums of approximately $125,000 per quarter compared to the premiums expensed in the second quarter of 2011.  The estimated savings is based on our average quarterly assets less average tangible equity and will vary depending on growth or contraction of the balance sheet.

Income Taxes.    During the six-month period ended June 30, 2011 and 2010, the Company recorded $480,649 and $269,787 in income taxes expense, respectively. The effective tax rate recorded was 20.4% for 2011 as compared to 17.9% for 2010.  The increase in the effective tax rate from 2010 was caused due to an increase in taxable income.  We continue to have a low effective tax rate through the use of strategic tax planning, which is primarily due to the use of tax-exempt income.

Liquidity and Capital Resources

Liquidity.   Our general liquidity strategy is to fund growth with deposits and to maintain an adequate level of short- and medium-term investments to meet typical daily loan and deposit activity needs.   We experienced a decrease of $28.5 million in total deposits during the first six months of 2011.   While we continue to encourage the growth of in-market deposits, we believe we have positioned ourselves to increase our out-of-market brokered deposits and FHLB advances while allowing higher cost in-market certificates of deposit to leave as they mature.  This strategy has allowed us to reduce interest rate risk by purchasing brokered deposits and maintain an adequate net interest margin.  Currently, $9.0 million of our FHLB advances are fixed rate bullet advances with no callable options; therefore, we must wait until maturity to repay.  The average interest rate on our FHLB advances at June 30, 2011 is 0.82%, which has decreased from an average rate of 3.53% at December 31, 2010.  We also have $25.0 million in variable rate FHLB advances that can be repaid anytime with scheduled maturities in December 2011.  Included in our out-of-market funding base are borrowings from the FHLB, brokered deposits, and trust preferred securities.  In the aggregate these out-of-market deposits and borrowings represented $152.0 million, or 25.3% of our total funding, at June 30, 2011.  This was up from $130.5 million, or 21.7%, at December 31, 2010. Total deposits at June 30, 2011 were $547.9 million and the loan to deposit ratio was 89.2%.   Total borrowings at June 30, 2011 were $34.0 million.  We expect to experience a minimal decline in loan balances over the second half of 2011 primarily due to a planned reduction in nonperforming loans of approximately $10.0 million to $20.0 million.  As loans amortize and payments are received, we will reinvest when appropriate in loans and long-term investments as opportunities arise and/or reduce outstanding debt when excess cash is available.

Capital Resources.    Stockholders’ equity is a noninterest-bearing source of funds, which provides support for asset growth.  Stockholders’ equity was $56.0 million and $53.1 million at June 30, 2011 and December 31, 2010, respectively. Affecting the increase in stockholders’ equity during the first six months of 2011 was $1.9 million in net income and $989,923 in unrealized gains, net of tax, on available for sale securities.  Additionally, we recorded $23,455 of restricted stock compensation expense.

During the first six months of 2011, we made no dividend payments.  We have not made dividend payments since the first quarter of 2008, based on our desire to retain capital and hedge against challenging economic and banking industry conditions as well as to maintain Tower Bank’s current “well capitalized” status within the Federal Reserve System.  Under the terms of our current agreement with our regulatory agencies, we must first be granted permission by the Federal Reserve Bank of Chicago in order to declare and pay any dividends.

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

	June 30, 2011									December 31, 2010
				Well-			Minimum						Well-			Minimum
	Actual			Capitalized			Required			Actual			Capitalized			Required
The Company
Leverage capital		10.82	%		5.00	%		4.00	%		10.55	%		5.00	%		4.00	%
Tier 1 risk-based		13.66	%		6.00	%		4.00	%		13.10	%		6.00	%		4.00	%
Total risk-based		14.92	%		10.00	%		8.00	%		14.30	%		10.00	%		8.00	%
The Bank
Leverage capital		10.41	%		5.00	%		4.00	%		10.08	%		5.00	%		4.00	%
Tier 1 risk-based		13.07	%		6.00	%		4.00	%		12.46	%		6.00	%		4.00	%
Total risk-based		14.33	%		10.00	%		8.00	%		13.72	%		10.00	%		8.00	%

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Commitments and Off-Balance Sheet Risk

The Bank maintains off-balance-sheet instruments in the normal course of business to meet the financing needs of its customers.   These financial instruments include commitments to extend credit and standby letters of credit.  These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized, if any, in the balance sheet.   The Bank’s maximum exposure to loan loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of these instruments.   Such financial instruments are recorded when they are funded.  Fair value of the Bank’s off-balance-sheet instruments (commitments to extend credit and standby letters of credit) is based on rates currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing.   At June 30, 2011, the rates on existing off-balance-sheet instruments were equivalent to current market rates, considering the underlying credit standing of the counterparties.

Tabular disclosure of the Company’s contractual obligations as of the end of our latest fiscal year was provided in our Annual Report on Form 10-K for the year ended December 31, 2010.  There have been no material changes outside the ordinary course of business in such contractual obligations during the first six months of 2011.

Item 4.   CONTROLS AND PROCEDURES

a.  Evaluation of disclosure controls and procedures

As of the end of the period covered by this report, we carried out an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities and Exchange Act of 1934), under the supervision and the participation of management, including our Chief Executive Officer and Chief Financial Officer.  Based upon their evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed by us in reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by Securities and Exchange Commission rules and forms.  Furthermore, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed is accumulated and communicated to our management in an appropriate manner so as to allow timely decisions regarding required disclosures.  In designing and evaluating the disclosure controls and procedures, our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and our management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

c.  Changes in internal control over financial reporting

There were no changes in our internal control over financial reporting or in our procedures during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting, nor were we required to take nor did we take any corrective actions with regard to any significant deficiencies or material weaknesses in internal control over financial reporting.

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PART II.  OTHER INFORMATION

Item 1.    LEGAL PROCEEDINGS

No material litigation

Item 1a.   RISK FACTORS

As reported in our Form 10-K, we are subject to extensive regulation, supervision and examination by the Indiana Department of Financial Institutions (the IDFI), the Federal Reserve and the FDIC, as insurer of its deposits.  Such regulation and supervision govern the activities in which a financial institution and its holding company may engage, and are intended primarily for the protection of the depositors and borrowers of Tower Bank and for the protection of the FDIC insurance fund.  The regulation and supervision by the Federal Reserve, the IDFI and the FDIC are not intended to protect the interests of investors in our common stock.  Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on our operations, the adverse classification of our assets and determination of the level of our allowance for loan losses.  Beginning in 2010, this risk factor increased in importance with the passing of the Dodd-Frank Wall Street Reform and Consumer Protection Act and the uncertainty of the exact impact it will have on financial institutions.

In addition to the information set forth above and throughout this report, you should carefully consider the factors discussed in Part I, Item 1a “Risk Factors” contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2010, which could materially affect our business, financial condition or future results.

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Item 6.   EXHIBITS

(a) Exhibits.

31.1 Certification of Chief Executive Officer required by Item 307 of Regulation S-K as promulgated by the Securities and Exchange Commission and Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*

31.2 Certification of Chief Financial Officer required by Item 307 of Regulation S-K as promulgated by the Securities and Exchange Commission and Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*

32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*

32.2. Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*

101.INS Instance Document

101.SCH XBRL Taxonomy Extension Schema Document

101.CAL XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF XBRL Taxonomy Extension Definition Linkbase Document

101.LAB XBRL Taxonomy Extension Label Linkbase Document

101.PRE XBRL Taxonomy Extension Presentation Linkbase Document

*Filed with concurrently herewith.

SIGNATURES

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

	TOWER FINANCIAL CORPORATION
Dated:  August 5, 2011	/ s /  Michael D. Cahill
	Michael D. Cahill, President
	and Cheif Executive Officer

Dated:  August 5, 2011	/ s /  Richard R. Sawyer
	Richard R. Sawyer
	Chief Financial Officer

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