Who We Are

Ameriana Bancorp (the "Company") is an Indiana chartered bank holding company organized in 1987 by Ameriana Savings Bank, FSB (the "Bank"). The Company is subject to regulation and supervision by the Federal Reserve Bank. The Bank began banking operations in 1890. On June 29, 2002, the Bank converted to an Indiana savings bank and adopted the name, Ameriana Bank and Trust, SB. On July 31, 2006, the Bank closed its Trust Department and adopted its present name on September 12, 2006. The Bank is subject to regulation and supervision by the Federal Deposit Insurance Corporation (the "FDIC"), and the Indiana Department of Financial Institutions (the "DFI"). Our deposits are insured to applicable limits by the Deposit Insurance Fund administered by the FDIC. References in this Form 10-K to "we," "us," and "our" refer to Ameriana Bancorp and/or the Bank, as appropriate.

We are headquartered in New Castle, Indiana. We conduct business through our main office at 2118 Bundy Avenue, New Castle, Indiana, through 11 branch offices located in New Castle, Middletown, Knightstown, Morristown, Greenfield, Anderson, Avon, McCordsville, Fishers, Carmel and New Palestine, Indiana, and through our loan production office in Carmel, Indiana.

The Bank has three wholly owned subsidiaries, Ameriana Insurance Agency ("AIA"), Ameriana Financial Services, Inc. ("AFS") and Ameriana Investment Management, Inc. ("AIMI"). AIA provides insurance sales from offices in New Castle, Greenfield and Avon, Indiana. AFS offers debt protection products through its ownership of an interest in Family Financial Holdings, Incorporated, Columbus, Indiana. In 2002, AFS acquired a 20.9% ownership interest in Indiana Title Insurance Company, LLC ("ITIC") through which it offers title insurance. In December 2008, the Company sold its interest in ITIC. See Item 1.
"Business-Subsidiaries." AFS also operates a brokerage facility in conjunction with LPL Financial. AIMI manages the Bank's investment portfolio. The Company holds a minority interest in a limited partnership, House Investments, organized to acquire and manage real estate investments which qualify for federal tax credits.

What We Do

The Bank is a community-oriented financial institution. Our principal business consists of attracting deposits from the general public and investing those funds primarily in mortgage loans on single-family residences, multi-family, construction loans, commercial real estate loans, and, to a lesser extent, commercial and industrial loans, small business lending, home improvement, and consumer loans. We have from time to time purchased loans and loan participations in the secondary market. We also invest in various federal and government agency obligations and other investment securities permitted by applicable laws and regulations, including mortgage-backed, municipal and equity securities. We offer customers in our market area time deposits with terms from three months to seven years, interest-bearing and non interest-bearing checking accounts, savings accounts and money market accounts. Our primary source of borrowings is Federal Home Loan Bank ("FHLB") advances. Through our subsidiaries, we engage in insurance and investment and brokerage activities.

Our primary source of income is net interest income, which is the difference between the interest income earned on our loan and investment portfolios and the interest expense incurred on our deposits and borrowing portfolios. Our loan portfolio typically earns more interest than the investment portfolio, and our deposits typically have a lower average rate than FHLB advances. Several factors affect our net interest income. These factors include the loan, investment, deposit, and borrowing portfolio balances, their composition, the length of their maturity, re-pricing characteristics, liquidity, credit, and interest rate risk, as well as market and competitive conditions.

Financial Challenges, Strategies and Results in Recent Years

In 2006, the Company incurred a net loss of $1.0 million, which represented a $3.0 million decline from the prior year and was due primarily to four factors. First, a flattening of the U.S. Treasury yield curve and the related impact on other market interest rates resulted in new rates for the Bank's loans and deposits that further narrowed our net interest margin. Second, in the fourth quarter, management implemented a balance sheet restructuring strategy that involved the sale of $34.0 million of low-yielding U.S. Government Agency securities, which resulted in a loss of $821,000. Third, also in the fourth quarter, a $514,000 loss was recorded due to $13.3 million in investment securities being classified as other than temporarily impaired. Fourth, the drop in net income from the prior year was also the result of 2005 earnings being inflated by the after-tax benefit of $3.3 million in lease settlements during that year.

Although the loss on sales of investment securities from the balance sheet restructuring strategy had a negative impact on 2006 earnings, positive results associated with the strategy were realized throughout 2007 and 2008. Additionally, the loan portfolio expansion of $31.0 million, 14.2%, in 2006 did not have a full year impact on 2006 earnings, but it established a stronger base for future earnings growth.

In 2007, the Company produced net income of $1.2 million, which represented a $2.2 million improvement over the $1.0 million loss recorded in 2006. Net income in 2007 benefited from a $2.8 million settlement related to our litigation against RLI Insurance Co. ("RLI") over surety guarantees for certain lease pools in which Ameriana Bank had previously invested. The positive impact from the RLI settlement in 2007 was offset in part by $1.1 million in charge-offs, most of which occurred later in the year when the economic climate worsened.

During 2007, the Bank continued its balance sheet restructuring strategy that was initiated in late 2006 and involved principally the redeployment of funds from lower-yielding investment securities into higher-yielding loans, and it was the primary reason that net interest margin on a fully-taxable equivalent basis improved 45 basis points from 2.29% for 2006 to 2.74% for 2007. As a result of this improvement in net interest margin, we were able to grow net interest income on a fully-taxable equivalent basis by $1.2 million without the benefit of balance sheet growth, as total assets actually were reduced by $10.5 million, or 2.4%.

As part of the Bank's efforts to expand its commercial lending capabilities, we opened a commercial lending center in the fast growing suburban area of Carmel, Indiana. This office and the Bank's continued emphasis on commercial lending contributed to the loan growth realized during the year. Also in 2007, our re-branding of the Company included the roll-out of a new logo and image campaign. These new initiatives continue to provide significant value to the Company moving forward.

Executive Overview of 2008

The Company recorded net income of $741,000, or $0.25 per share for 2008, which followed net income of $1.2 million, or $0.39 per share for 2007 that benefited from the $2.8 million settlement of litigation related to lease pools. Financial results for 2008 included the following:

• Quarterly dividends totaled $0.16 per share, a payout ratio of 64.6%.

• The Company's tangible common equity ratio at December 31, 2008 was 7.17%.

• Net interest income for of 2008 was $11.8 million, a $2.0 million, or 20.0%, improvement over 2007, primarily a result of a 35 basis point improvement in net interest margin to 3.08%, on a fully tax-equivalent basis.

• Total non-performing loans of $6.2 million, or 1.9% of total net loans at December 31, 2008, represented a $3.6 million increase from December 31, 2007. The increase in non-performing loans was primarily due to the classification of a multi-family loan of $1.7 million in Anderson, Indiana, the classification of two land development loans totaling $1.1 million, and an increase in

• The provision for loan losses for 2008 was $1.3 million, compared to a credit of $1.6 million for 2007 that resulted from the loss recovery realized with the third quarter 2007 settlement of the RLI litigation involving pools of leases.

• Other income for 2008 was $307,000, or 8.8%, higher than the total for 2007. This increase was primarily a result of net losses of only $67,000 on other real estate owned compared to net losses of $573,000 in the prior year, which was offset in part by $328,000 in losses from unconsolidated subsidiaries compared to $30,000 of income in 2007. $227,000 of the 2008 loss resulted from the sale of a title insurance company that the Bank had jointly owned with two other financial institutions.

• Other expense for 2008 increased $406,000, or 2.9%, over the total for 2007, and resulted primarily from costs associated with two new banking centers, and increases in retirement benefits and OREO expense. The overall increase was offset partially by a $255,000 reduction in legal and professional fees, which was due primarily to a significant decline of legal fees as a result of the settlement of the RLI litigation involving pools of leases.

• The income tax benefit of $781,000 for 2008 was related primarily to a total of $2.0 million of tax-exempt income from municipal securities and bank-owned life insurance, and a $150,000 reversal of an income tax liability recorded in prior years that resulted from a favorable tax ruling related to income earned by the Bank's investment subsidiary.

For 2008, the balance sheet grew by $36.7 million, or 8.6%, to $463.5 million:

• Loan portfolio growth in 2008 of $28.6 million, or 9.6%, to $325.5 million, followed portfolio growth of $45.1 million, or 17.9%, in 2007.

• An $8.7 million increase in the investment portfolio in 2008, resulted primarily from the purchase of $30.0 million of Ginnie Mae and Fannie Mae mortgage-backed securities, reduced by sales of $9.2 million of municipal securities, maturities of $5.0 million of U.S. Government agency securities, and $7.3 million of principal payments received on mortgage-backed securities.

• As of December 31, 2008, the Company did not own Fannie Mae or Freddie Mac preferred stock, and did not own private-label mortgage-backed securities. As a matter of policy, the Company has not originated or purchased sub-prime loans.

• During 2008, total deposits increased by $9.7 million, or 3.1%, to $324.4 million, primarily due to a new deposit relationship with the State of Indiana. The State's total investment of $15.0 million in certificate accounts is expected to provide stable deposits for the Bank, based on the prior history of the related investment program as administered by the State. No brokered certificates of deposit were held at December 31, 2008.

• The growth in the investment portfolio and in the loan portfolio, and the addition of new properties for banking centers in 2008 was funded with a combination of deposit growth, borrowings from the Federal Home Loan Bank, and a $7.5 million long-term repurchase agreement involving one of two new Ginnie Mae mortgage-backed securities.

Strategic Summary

The current economic downturn has created a challenging operating environment for all businesses, and, in particular, the financial services industry. Management continues its focus on maintaining and improving overall credit quality, liquidity and capital. Earnings pressure is expected to continue as the deterioration in credit quality resulting from the weak economy is likely to continue. Competition for deposits continues to be intense resulting in higher deposit rates while yields on interest earning assets continue to experience downward pressure. Management is also focused on reducing non-interest expense through aggressive cost control measures including freezing hiring, job restructuring and eliminating certain discretionary expenditures.

Achievement of the Company's financial objectives will require obtaining new loans and deposits in our traditional markets, generating significant loan and deposit growth from our new offices in Hamilton County and continuing the expansion of our commercial lending strategy in the greater Indianapolis metropolitan area.

We believe the long-term success of the Company is dependent on its ability to provide its customers with financial advice and solutions that assist them in achieving their goals. We will accomplish this mission by:

• being our customer's first choice for financial advice and solutions;

• informing and educating customers on the basics of money management; and

• understanding and meeting customer's financial needs throughout their life cycle.

Serving customers requires the commitment of all Ameriana associates to provide exceptional service and sound advice. We believe these qualities will differentiate us from our competitors and increase profitability and shareholder value.

To meet our goals, we have undertaken the following strategies:

Build Relationships With Our Customers. Banking is essentially a transaction business. Nevertheless, numerous industry studies have shown that customers want a relationship with their bank and banker based on trust and sound advice. Based on this information, we are focusing our efforts on building relationships and improving our products per household.

Achieve Superior Customer Service. We continually measure customer satisfaction through post-transaction surveys. Our evaluations include telephone and in-person customer surveys, as well as other in-store performance metrics. We have enhanced our efforts to improve our service by establishing a training department and formalizing our service standards.

Develop and Deliver Fully Integrated Financial Advice and Comprehensive Solutions to Meet Customer Life Events. We are re-packaging our products around customer "life events" such as planning for retirement, buying a home and saving for college education rather than traditional transaction accounts, savings and consumer loan products.

Establish Strong Brand Awareness. We believe it is important to create a value proposition that is relevant, understood and valued by our customers. Accordingly, we are continuing our efforts through our marketing, customer communications, training, and design of our Banking Centers to position Ameriana Bank as a premier service brand.

Use Technology to Expand Our Customer Base. We continue to enhance our electronic delivery of products and services to our customers. Our technology-based services include business sweep products and cash management services, business remote item capture and on-line consumer loan and account opening. These services will allow us to reach more customers effectively and conveniently.

Develop an Innovative Delivery System. We believe our banking centers must evolve into "Financial Stores" that showcase our financial products and offer our customers an environment that is conducive to interacting with knowledgeable Ameriana associates and with our technology-based products.

Increase Market Share in Existing Markets and Expand into New Markets. We believe there is significant opportunity to increase our products per household with existing customers and attract new customers in our existing and new markets. Further, we believe there are opportunities to gain market share in new markets and have developed an expansion strategy to accomplish this. As part of our expansion strategy, the Company opened two new full-service banking centers in Hamilton County, which lies just north of Marion County and Indianapolis. The new offices in Fishers and Carmel opened in October and December 2008, respectively. A full-service banking center in Westfield is under construction and is expected to open during the second quarter of 2009. In addition, the Company has purchased a site in Plainfield, which will enhance our presence on the west side of Indianapolis and our existing office in Avon. We plan to begin construction of the Plainfield office in 2010. We continue to evaluate additional locations for development of full-service banking centers in order to increase our footprint in Marion County and surrounding Indianapolis metropolitan area and to boost our visibility in this market.

Critical Accounting Policies

The accounting and reporting policies of the Company are maintained in accordance with accounting principles generally accepted in the United States and conform to general practices within the banking industry. The Company's significant accounting policies are described in detail in the Notes to the Company's Consolidated Financial Statements. The preparation of financial statements in conformity with generally accepted accounting principles ("GAAP") requires management to make estimates and assumptions. The financial position and results of operations can be affected by these estimates and assumptions, and such estimates and assumptions are integral to the understanding of reported results. Critical accounting policies are those policies that management believes are the most important to the portrayal of the Company's financial condition and results, and they require management to make estimates that are difficult, subjective or complex.

Allowance for Loan Losses. The allowance for loan losses provides coverage for probable losses in the Company's loan portfolio. Management evaluates the adequacy of the allowance for credit losses each quarter based on changes, if any, in underwriting activities, the loan portfolio composition (including product mix and geographic, industry or customer-specific concentrations), trends in loan performance, regulatory guidance and economic factors. This evaluation is inherently subjective, as it requires the use of significant management estimates. Many factors can affect management's estimates of specific and expected losses, including volatility of default probabilities, rating migrations, loss severity and economic and political conditions. The allowance is increased through provisions charged to operating earnings and reduced by net charge-offs.

The Company determines the amount of the allowance based on relative risk characteristics of the loan portfolio. The allowance recorded for commercial loans is based on reviews of individual credit relationships and an analysis of the migration of commercial loans and actual loss experience. The allowance recorded for non-commercial loans is based on an analysis of loan mix, risk characteristics of the portfolio, fraud loss and bankruptcy experiences and historical losses, adjusted for current trends, for each loan category or group of loans. The allowance for loan losses relating to impaired loans is based on the loan's observable market price, the collateral for certain collateral-dependent loans, or the discounted cash flows using the loan's effective interest rate.

Regardless of the extent of the Company's analysis of customer performance, portfolio trends or risk management processes, certain inherent but undetected losses are probable within the loan and lease portfolio. This is due to several factors, including inherent delays in obtaining information regarding a customer's financial condition or changes in their unique business conditions, the judgmental nature of individual loan evaluations, collateral assessments and the interpretation of economic trends. Volatility of economic or customer-specific conditions affecting the identification and estimation of losses for larger, non-homogeneous credits and the sensitivity of assumptions utilized to establish allowances for homogenous groups of loans are among other factors. The Company estimates a range of inherent losses related to the existence of these exposures. The estimates are based upon the Company's evaluation of risk associated with the commercial and consumer allowance levels and the estimated impact of the current economic environment.

Mortgage Servicing Rights. Mortgage servicing rights ("MSRs") associated with loans originated and sold, where servicing is retained, are capitalized and included in other intangible assets in the consolidated balance sheet. The value of the capitalized servicing rights represents the present value of the future servicing fees arising from the right to service loans in the portfolio. Critical accounting policies for MSRs relate to the initial valuation and subsequent impairment tests. The methodology used to determine the valuation of MSRs requires the development and use of a number of estimates, including anticipated principal amortization and prepayments of that principal balance. Events that may significantly affect the estimates used are changes in interest rates, mortgage loan prepayment speeds and the payment performance of the underlying loans. The carrying value of the MSRs is periodically reviewed for impairment based on a determination of fair value. Impairment, if any, is recognized through a valuation allowance and is recorded as amortization of intangible assets.

Valuation Measurements. Valuation methodologies often involve a significant degree of judgment, particularly when there are no observable active markets for the items being valued. Investment securities and residential mortgage loans held for sale are carried at fair value, as defined in SFAS No. 157 "Fair Value Measurement" ("SFAS No. 157"), which requires key judgments affecting how fair value for such assets and liabilities is determined. In addition, the outcomes of valuations have a direct bearing on the carrying amounts for goodwill and intangibles assets. To determine the values of these assets and liabilities, as well as the extent to which related assets may be impaired, management makes assumptions and estimates related to discount rates, asset returns, prepayment rates and other factors. The use of different discount rates or other valuation assumptions could produce significantly different results, which could affect the Corporation's results of operations.

FINANCIAL CONDITION

Total assets increased $36.7 million, or 8.6%, to $463.5 million at December 31, 2008 from $426.8 million at December 31, 2007 primarily due to growth in investment securities and the loan portfolio, and the addition of properties for new banking centers.

Cash and Cash Equivalents

Total cash and cash equivalents decreased $8.8 million to $8.4 million at December 31, 2008 from $17.2 million at December 31, 2007. Cash on hand and in other institutions decreased $635,000, or 14.3%, to $3.8 million at December 31, 2008. This change was due to a $728,000 decrease in our book balance for the noninterest-earning piece of our Federal Reserve Bank account, which primarily represents deposits in transit. Interest-bearing deposits decreased $8.1 million, or 63.6%, to $4.6 million at December 31, 2008. The higher balance as of December 31, 2007 was due primarily to proceeds realized by the Bank's investment subsidiary from sales and maturities of investment securities. These funds were transferred to the Bank in January 2008 in the form of a dividend, and were used to fund new loans and pay off short-term borrowings from the Federal Home Loan Bank.

Securities

Investment securities increased $8.7 million to $75.4 million at December 31, 2008, from $66.7 million at December 31, 2007 and there was a material change in the investment mix. Mortgage-backed securities increased $23.8 million to $55.3 million, while municipal securities declined $9.1 million to $18.6 million, primarily through a second quarter sale of $9.2 million designed to support the Bank's income tax and liquidity strategies. The growth in mortgage-backed securities resulted primarily from a first quarter purchase of $15.0 million of Fannie Mae securities and a third quarter purchase of $15.1 million of Ginnie Mae Securities The third quarter purchase was funded with FHLB borrowings and a $7.5 million repurchase agreement embedded with two interest rate caps totaling $15.0 million in notional value. The interest rate caps are designed to provide protection against a negative impact on the Company's net interest income that could result from rising interest rates. These interest rate caps are considered to be clearly and closely related to the host instrument. All mortgage-backed securities at December 31, 2008 are insured by either Ginnie Mae, Fannie Mae or Freddie Mac.

At December 31, 2008, all investments remained classified as available for sale. All of our investments are evaluated for other-than-temporary impairment, and such impairment, if any, is recognized as a charge to earnings. There were no other than temporarily impaired investment securities as of December 31, 2008.

The following table identifies changes in the investment securities carrying values:

                                                 (Dollars in thousands)
                                        2008       2007     $ Change      % Change
         December 31:
         Mortgage-backed securities   $ 55,289   $ 31,509   $  23,780        75.47 %
         Federal agencies                   -       6,011      (6,011 )    (100.00 )
         Municipal securities           18,557     27,654      (9,097 )     (32.90 )
         Equity securities               1,525      1,518           7         0.46

         Totals                       $ 75,371   $ 66,692   $   8,679        13.01 %

The following table identifies the percentage composition of the investment securities:

                                                            2008       2007      2006
 December 31:
 Mortgage-backed and collateralized mortgage obligations     73.4 %     47.2 %    28.9 %
 Federal agencies                                              -         9.0      34.4
 Municipal securities                                        24.6       41.5      26.5
 Equity securities                                            2.0        2.3       9.8
 Trust preferred                                               -          -        0.4

 Totals                                                    100.00 %   100.00 %   100.0 %

See Note 3 to the "Consolidated Financial Statements" for more information on investment securities.

Loans

Net loans receivable totaled $322.5 million at December 31, 2008, an increase of $28.2 million, or 9.6%, from $294.3 million at December 31, 2007. The portfolio growth was primarily a result of the Bank's increased emphasis on commercial real estate and residential investment property lending, and a decision in 2008 to put most originations of single-family loans into the portfolio to take advantage of the historically wide spreads to funding costs.

Residential real estate loans increased $20.6 million to $160.6 million at December 31, 2008, from $140.0 million at December 31, 2007. The growth involved . . .