General

As the holding company for the Bank, the Company conducts its business primarily through the Bank. The Bank's results of operations depend primarily on net interest income, which is the difference between the income earned on its interest-earning assets, such as loans and investments, and the cost of its interest-bearing liabilities, consisting primarily of deposits, retail repurchase agreements and borrowings from the Federal Home Loan Bank of Indianapolis. The Bank's net income is also affected by, among other things, fee income, provisions for loan losses, operating expenses and income tax provisions. The Bank's results of operations are also significantly affected by general economic and competitive conditions, particularly changes in market interest rates, government legislation and policies concerning monetary and fiscal affairs, housing and financial institutions and the intended actions of the regulatory authorities.

Management's discussion and analysis of financial condition and results of operations is intended to assist in understanding the financial condition and results of operations of the Company and the Bank. The information contained in this section should be read in conjunction with the consolidated financial statements and the accompanying notes to consolidated financial statements included elsewhere in this report.

Operating Strategy

The Company is the parent company of an independent community-oriented financial institution that delivers quality customer service and offers a wide range of deposit, loan and investment products to its customers. The commitment to customer needs, the focus on providing consistent customer service, and community service and support are the keys to the Bank's past and future success. The Company has no other material income other than that generated by the Bank and its subsidiaries.

The Bank's primary business strategy is attracting deposits from the general public and using those funds to originate one-to-four-family residential mortgage loans, multi-family residential loans, commercial real estate and business loans and consumer loans. The Bank invests excess liquidity primarily in interest-bearing deposits with the Federal Home Loan Bank of Indianapolis and other financial institutions, federal funds sold, U.S. government and agency securities, local municipal obligations and mortgage-backed securities.

In recent years, the Company's operating strategy has also included strategies designed to enhance profitability by increasing sources of noninterest income and improving operating efficiency while managing its capital and limiting its credit risk and interest rate risk exposures. To accomplish these objectives, the Company has focused on the following:

• Control credit risk by focusing on the origination of one-to-four-family residential mortgage loans and consumer loans, consisting primarily of home equity loans and lines of credit, while increasing the market share of commercial real estate and small business loans.

• Focus on growth at the branch offices in commercial deposit and loan relationships.

• Capitalize on our branch locations to further expand our market share in Southern Indiana.

• Increase fee income from secondary market mortgage originations by having dedicated originators serving each office.

• Continue to invest in technology to increase productivity and efficiency, increase growth of our Internet banking service, bill payment service, and the Company's ability to provide customer information at our teller lines in minutes versus days.

Critical Accounting Policies and Estimates

The accounting and reporting policies of the Company comply with accounting principles generally accepted in the United States of America and conform to general practices within the banking industry. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. The financial position and results of operations can be affected by these estimates and assumptions, which are integral to understanding reported results. Critical accounting policies are those policies that require management to make assumptions about matters that are highly uncertain at the time an accounting estimate is made; and different estimates that the Company reasonably could have used in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, would have a material impact on the Company's financial condition, changes in financial condition or results of operations. Most accounting policies are not considered by management to be critical accounting policies. Several factors are considered in determining whether or not a policy is critical in the preparation of financial statements. These factors include, among other things, whether the estimates are significant to the financial statements, the nature of the estimates, the ability to readily validate the estimates with other information including third parties or available prices, and sensitivity of the estimates to changes in economic conditions and whether alternative accounting methods may be utilized under generally accepted accounting principles.

Significant accounting policies, including the impact of recent accounting pronouncements, are discussed in Note 1 of the Notes to Consolidated Financial Statements. Those policies considered to be critical accounting policies are described below.

Allowances for Loan Losses. Management's evaluation of the adequacy of the allowance for loan losses is the most critical of accounting estimates for a financial institution. The methodology for determining the allowance for loan losses and the related provision for loan losses is described below in "Allowance for Loan Losses." This accounting estimate is highly subjective and requires a significant amount of judgment because a multitude of factors can influence the ultimate collection of a loan. The methodology for determining the allowance for loan losses attempts to identify the amount of probable losses in the loan portfolio. However, there can be no assurance that the methodology will successfully identify all probable losses as the factors and conditions that influence the estimate are subject to significant change and management's judgments. As a result, additional provisions for loan losses may be required that would adversely impact earnings in future periods.

Valuation Methodologies. In the ordinary course of business, management applies various valuation methodologies to assets and liabilities that often involve a significant degree of judgment, particularly when active markets do not exist for the items being valued. Generally, in evaluating various assets for potential impairment, management compares the fair value to the carrying value. Quoted market prices are referred to when estimating fair values for certain assets, such as investment securities. However, for those items for which market-based prices do not exist, management utilizes significant estimates and assumptions to value such items. Examples of these items include goodwill and other intangible assets, estimated present value of impaired loans, deferred compensation plans, value ascribed to stock-based compensation and certain other financial investments. The use of different assumptions could produce significantly different results, which could have material positive or negative effects on the Company's results of operations.

Year Ended December 31, 2008 Compared to Year Ended December 31, 2007

Net Income. Net income was $3.6 million ($1.27 per share diluted; weighted average common shares outstanding of 2,815,276, as adjusted) for the year ended December 31, 2008 compared to $3.4 million ($1.20 per share diluted; weighted average common shares outstanding of 2,836,601, as adjusted) for the year ended December 31, 2007.

Net Interest Income. Net interest income increased $1.6 million, or 11.6%, from $13.4 million in 2007 to $14.9 million in 2008 primarily due to an increase in the interest rate spread.

Total interest income decreased 5.2% from $27.1 million in 2007 to $25.7 million in 2008. This decrease was primarily a result of lower yields due to lower market interest rates. Interest on loans decreased

$1.3 million as a result of the average tax-equivalent yield on those loans decreasing from 7.03% in 2007 to 6.72% in 2008 and the average balance of loans decreasing from $333.7 million in 2007 to $329.9 million in 2008. Interest on investment securities decreased $8,000 during 2008 due to the average balance of investment securities decreasing from $78.1 million in 2007 to $77.0 million in 2008, partially offset by the average tax-equivalent yield of those investments increasing from 4.81% in 2007 to 4.96% in 2008. The average balance of total interest-earning assets increased from $419.0 million in 2007 to $420.3 million in 2008. The average tax equivalent yield on interest-earning assets decreased from 6.58% in 2007 to 6.24% in 2008. Management continued to focus loan origination efforts on commercial and consumer loans. The majority of the new commercial loans are adjustable-rate loans. Adjustable-rate loans now comprise 40% of the total loan portfolio, compared to 38% at the end of 2007. As the Federal Open Market Committee (FOMC) of the Federal Reserve lowered interest rates by 400 basis points during 2008, the yield on variable-rate loans scheduled to reprice during the year decreased as did the yield on new originations.

Total interest expense decreased $3.0 million, from $13.7 million for 2007 to $10.7 million for 2008. This decrease was primarily due to an decrease in the average cost of funds from 3.76% in 2007 to 2.94% in 2008. The decrease was primarily due to the average cost of interest-bearing demand deposits which decreased from 2.41% in 2007 to 1.19% in 2008 primarily due to the FOMC rate reductions. The average balances of deposits and borrowed funds were $300.4 million and $65.4 million, respectively, for 2008. In 2007, those average balances were $291.7 million and $72.9 million. For further information, see "Average Balance Sheets" below. The changes in interest income and interest expense resulting from changes in volume and changes in rates for 2008 and 2007 are shown in the schedule captioned "Rate/Volume Analysis" included herein.

Provision for Loan Losses. The provision for loan losses was $1.6 million for 2008 compared to $558,000 for 2007. The consistent application of management's allowance methodology resulted in an increase in the provision for loan losses during 2008 due to increased specific allowances due to deteriorating commercial real estate values and an increase in the general allowances due to deteriorating economic conditions such as depreciating collateral values, job losses and continued pressures on household budgets in the Bank's market area. Nonperforming loans decreased from $5.7 million at December 31, 2007 to $5.5 million at December 31, 2008. Net charge offs increased when comparing the two periods, from $646,000 during 2007 to $1.1 million during 2008. The provisions were recorded to bring the allowance to the level determined in applying the allowance methodology after reduction for net charge-offs during the year. See "Asset Quality."

Provisions for loan losses are charges to earnings to maintain the total allowance for loan losses at a level considered reasonable by management to provide for probable known and inherent loan losses based on management's evaluation of the collectibility of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specified impaired loans and economic conditions. Although management uses the best information available, future adjustments to the allowance may be necessary due to changes in economic, operating, regulatory and other conditions that may be beyond the Bank's control. While the Bank maintains the allowance for loan losses at a level that it considers adequate to provide for estimated losses, there can be no assurance that further additions will not be made to the allowance for loan losses and that actual losses will not exceed the estimated amounts.

Noninterest income. Noninterest income increased $49,000 to $3.6 million for 2008 compared to 2007. Service charges on deposit accounts and the earnings from bank-owned life insurance increased $83,000 and $78,000, respectively, when comparing the two periods. The increase in cash surrender value of bank-owned life insurance was due to the purchase of $3.6 million of bank-owned life insurance in May 2007. Mortgage brokerage fees decreased $114,000 for 2008 compared to 2007 as the Bank emphasized originating loans for its portfolio rather than for third parties.

Noninterest expense. Noninterest expense increased $497,000, or 4.4%, to $11.8 million for 2008 compared to $11.3 million in 2007. The increase results primarily from increases of $212,000 in other operating expenses and $205,000 in compensation and benefits. The increase in other operating expenses was primarily due to an increase in Federal Deposit Insurance Corporation (FDIC) insurance assessments due to the Bank exhausting its one-time FDIC credit assessment on deposits in existence as of December 31, 1996. FDIC insurance assessments are expected to increase substantially in 2009 as the FDIC has announced plans to increase assessments to compensate for recent and expected bank failures. The increase in compensation and benefits is attributable to normal salary increases.

Income tax expense. Income tax expense for the year ended December 31, 2008 was $1.5 million compared to $1.6 million for the year ended December 31, 2007. The effective tax rate for 2007 was 31.8% compared to 30.0% for 2008. The decrease in the effective tax rate for 2008 compared to 2007 was primarily the result of increases in tax-exempt income due to increases in municipal securities and bank-owned life insurance. See Note 12 in the accompanying Notes to Consolidated Financial Statements.

Year Ended December 31, 2007 Compared to Year Ended December 31, 2006

Net Income. Net income was $3.4 million ($1.20 per share diluted; weighted average common shares outstanding of 2,836,601, as adjusted) for the year ended December 31, 2007 compared to $3.7 million ($1.30 per share diluted; weighted average common shares outstanding of 2,848,229, as adjusted) for the year ended December 31, 2006.

Net Interest Income. Net interest income decreased $84,000, or 0.6%, from $13.5 million in 2006 to $13.4 million in 2007 primarily due to a decrease in the interest rate spread.

Total interest income increased 3.3% from $26.2 million in 2006 to $27.1 million in 2007. This increase was primarily a result of higher yields due to higher market interest rates. Interest on loans increased $544,000 as a result of the average tax-equivalent yield on those loans increasing from 6.82% in 2006 to 7.03% in 2007. Interest on investment securities increased $181,000 during 2007 due to the average tax-equivalent yield of those investments increasing from 4.56% in 2006 to 4.81% in 2007. The average balance of interest-earning assets changed little, increasing from $417.9 million in 2006 to $419.0 million in 2007. The average tax equivalent yield on interest-earning assets increased from 6.38% in 2006 to 6.58% in 2007. Management has focused loan origination efforts on commercial and consumer loans. The majority of the new commercial loans are adjustable-rate loans. Adjustable-rate loans now comprise 38% of the total loan portfolio compared to 36% at the end of 2006. Market interest rates increased during 2006, resulting in scheduled upward repricing of variable-rate loans during 2007, increasing the overall yield on these loans in 2007.

Total interest expense increased $958,000, from $12.7 million for 2006 to $13.7 million for 2007. This increase was primarily due to an increase in the average cost of funds from 3.48% in 2006 to 3.76% in 2007. The increase was primarily due to the average cost of time deposits which increased from 4.05% in 2006 to 4.54% in 2007 primarily due to low cost accounts maturing and repricing at higher current rates. The average balances of deposits and borrowed funds were $291.7 million and $72.9 million, respectively, for 2007. In 2006, those average balances were $290.4 million and $75.4 million. For further information, see "Average Balance Sheets" below. The changes in interest income and interest expense resulting from changes in volume and changes in rates for 2007 and 2006 are shown in the schedule captioned "Rate/Volume Analysis" included herein.

Provision for Loan Losses. The provision for loan losses was $558,000 for 2007 compared to $810,000 for 2006. The consistent application of management's allowance methodology resulted in a decrease in the provision for loan losses during 2007 due to the net loan portfolio growth of $888,000, compared to $11.1 million in 2006. Nonperforming loans increased from $4.4 million at December 31, 2006 to $5.7 million at December 31, 2007. Net charge offs increased slightly comparing the two periods, from $594,000 during 2006 to $646,000 during 2007. The provisions were recorded to bring the allowance to the level determined in applying the allowance methodology after reduction for net charge-offs during the year. See "Asset Quality."

Provisions for loan losses are charges to earnings to maintain the total allowance for loan losses at a level considered adequate by management to provide for probable known and inherent loan losses based on management's evaluation of the collectibility of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specified impaired loans and economic conditions. Although management uses the best information available, future adjustments to the allowance may be necessary due to changes in economic, operating, regulatory and other conditions that may be beyond the Bank's control. While the Bank maintains the allowance for loan losses at a level that it considers adequate to provide for estimated losses, there can be no assurance that further additions will not be made to the allowance for loan losses and that actual losses will not exceed the estimated amounts.

Noninterest income. Noninterest income increased $53,000 to $3.5 million for 2007 compared to 2006. Service charges on deposit accounts and the earnings on bank-owned life insurance increased $163,000 and $108,000, respectively, when comparing the two periods. The increase in cash surrender value of life insurance was due to the purchase of $3.6 million of bank-owned life insurance in May 2007. Other income and commission income decreased $168,000 and $140,000, respectively, primarily due to the sale of the Company's insurance agency in December 2006.

Noninterest expense. Noninterest expense increased $798,000, or 7.6%, to $11.3 million for 2007 compared to $10.6 million in 2006. The increase resulted primarily from increases of $361,000 in compensation and benefits and $212,000 in other operating expenses. The increase in compensation and benefits is attributable to normal salary increases and the increased staff with the opening of the new office in Salem, Indiana during November 2007. The increase in other operating expenses is primarily due to losses on the sale of foreclosed assets and other expenses associated with those assets.

Income tax expense. Income tax expense for the year ended December 31, 2007 was $1.6 million compared to $1.9 million for the year ended December 31, 2006. The effective tax rate for 2006 was 33.5% compared to 31.8% for 2007. The decrease in the effective tax rates for 2007 compared to 2006 was primarily the result of an increase in tax-exempt income due to increases in municipal securities and bank-owned life insurance held in 2007 compared to 2006. See Note 12 in the accompanying Notes to Consolidated Financial Statements.

The following table sets forth certain information for the periods indicated regarding average balances of assets and liabilities, as well as the total dollar amounts of interest income from average interest-earnings assets and interest expense on average interest-bearing liabilities and average yields and costs. Such yields and costs for the periods indicated are derived by dividing income or expense by the average historical cost balances of assets or liabilities, respectively, for the periods presented and do not give effect to changes in fair value that are included as a separate component of stockholders' equity. Average balances are derived from daily balances. Tax-exempt income on loans and investment securities has been adjusted to a tax equivalent basis using the federal marginal tax rate of 34%.

                                                                                 Year Ended December 31,
                                                      2008                                2007                                2006
                                                                 Average                             Average                             Average
                                          Average                Yield/       Average                Yield/       Average                Yield/
(Dollars in thousands)                    Balance    Interest     Cost        Balance    Interest     Cost        Balance    Interest     Cost
Interest-earning assets:
Loans (1) (2):
Taxable (3)                              $ 327,698   $  22,013      6.72 %   $ 331,077   $  23,282      7.03 %   $ 331,210   $  22,644      6.84 %
Tax-exempt                                   2,220         149      6.71 %       2,636         173      6.56 %       5,276         314      5.95 %

Total loans                                329,918      22,162      6.72 %     333,713      23,455      7.03 %     336,486      22,958      6.82 %


Investment securities:
Taxable (3)                                 53,478       2,420      4.53 %      57,193       2,509      4.39 %      59,502       2,454      4.12 %
Tax-exempt                                  23,475       1,397      5.95 %      20,873       1,248      5.98 %      18,046       1,080      5.98 %

Total investment securities                 76,953       3,817      4.96 %      78,066       3,757      4.81 %      77,548       3,534      4.56 %


Federal funds sold and
interest-bearing deposits with banks        13,436         233      1.73 %       7,210         359      4.98 %       3,913         192      4.91 %

Total interest-earning assets              420,307      26,212      6.24 %     418,989      27,571      6.58 %     417,947      26,684      6.38 %


Noninterest-earning assets                  31,823                              27,919                              26,119

Total assets                             $ 452,130                           $ 446,908                           $ 444,066


Interest-bearing liabilities:
Interest-bearing demand deposits         $ 108,230   $   1,283      1.19 %   $  92,843   $   2,242      2.41 %   $  92,016   $   2,021      2.20 %
Savings accounts                            33,183         247      0.74 %      30,440         242      0.80 %      31,603         247      0.78 %
Time deposits                              159,012       6,404      4.03 %     168,387       7,642      4.54 %     166,810       6,751      4.05 %

Total deposits                             300,425       7,934      2.64 %     291,670      10,126      3.47 %     290,429       9,019      3.11 %


Retail repurchase agreements                11,759         248      2.11 %      13,137         632      4.81 %      16,821         841      5.00 %
FHLB advances                               53,639       2,563      4.78 %      59,722       2,941      4.92 %      58,562       2,881      4.92 %

Total interest-bearing liabilities         365,823      10,745      2.94 %     364,529      13,699      3.76 %     365,812      12,741      3.48 %


Noninterest-bearing liabilities:
Noninterest-bearing deposits                37,069                              35,026                              33,015
Other liabilities                            2,611                               3,250                               2,323

Total liabilities                          405,503                             402,805                             401,150
Stockholders' equity                        46,627                              44,103                              42,916

Total liabilities and Stockholders'
equity                                   $ 452,130                           $ 446,908                           $ 444,066


Net interest income                                  $  15,467                           $  13,872                           $  13,943


Interest rate spread                                                3.30 %                              2.82 %                              2.90 %


Net interest margin                                                 3.68 %                              3.31 %                              3.34 %


Ratio of average interest - earning
assets to average interest-bearing
liabilities                                                       114.89 %                            114.94 %                            114.25 %

(1) Interest income on loans includes fee income of $620,000, $485,000, and $480,000 for the years ended December 31, 2008, 2007, and 2006, respectively.

(2) Average loan balances include loans held for sale and nonperforming loans.

(3) Includes taxable debt and equity securities and Federal Home Loan Bank Stock.

The following table sets forth the effects of changing rates and volumes on net interest income and interest expense computed on a tax-equivalent basis. Information is provided with respect to (i) effects on interest income attributable to changes in volume (changes in volume multiplied by prior rate);
(ii) effects attributable to changes in rate (changes in rate multiplied by prior volume); and (iii) effects attributable to changes in rate and volume (change in rate multiplied by changes in volume). Tax exempt income on loans and investment securities has been adjusted to a tax-equivalent basis using the federal marginal tax rate of 34%.

                                               2008 Compared to 2007                            2007 Compared to 2006
                                            Increase (Decrease) Due to                        Increase (Decrease) Due to
                                                             Rate/                                            Rate/
                                     Rate       Volume      Volume        Net         Rate       Volume       Volume        Net
                                                                           (In thousands)
Interest-earning assets:
Loans:
Taxable                            $ (1,038 )   $  (241 )   $    10     $ (1,269 )   $   647     $    (9 )   $     -      $   638
Tax-exempt                                4         (27 )        (1 )        (24 )        32        (157 )        (16 )      (141 )

Total investment
securities                           (1,034 )      (268 )         9       (1,293 )       679        (166 )        (16 )       497


. . .