Exhibit 13

2006 Annual Report

Dear Shareholders,

     The Bancorp reported another solid performance for the year 2006 with net income of $6.5 million. Statistically our performance was very strong: our return on assets (ROA), which measures net income as a percentage of average assets, was 1.04% and our return on equity (ROE), which measures the return on invested capital, was 13.42%. Our capital, or shareholders equity, finished the year at $50 million or 8.1% of total assets.

     The year 2006 proved to be a challenging year for the entire banking industry, as well as your Bank. The increase in short-term rates, the persistent inverted yield curve and continued consolidation through mergers has made it difficult for many to sustain prior year earnings results. Although 2006 was a good year, our results were not as robust as reports from prior periods. 2006 marked the first time in ten years that the Bancorp reported a decline in income from the previous year.

     Over the past two years, the Federal Reserve has taken action to raise interest rates in an effort to fight inflationary trends in the national economy. The result has been good news for our deposit customers because interest rates paid on deposits have risen substantially. At the same time, yields on the Bancorp’s earning assets, loans and investments, have not risen as dramatically.

     The Federal Reserve’s policy to raise short-term interest rates in the current operating environment has resulted in an inverted yield curve, a term that describes short-term interest rates having yields higher than long-term rates. Under such conditions, the increase in yields on loans and investments generally lag the increases in rates paid to depositors as well as the rates the Bancorp pays on Federal Home Loan Bank borrowings.

     During 2006, loan and investment yields lagged the higher rates paid to depositors resulting in a negative impact on the Bancorp’s core earnings. Net interest income, the difference between interest received from loans and investments and interest paid to fund providers, totaled $19.2 million for 2006 compared to $20.3 million for 2005, a decrease of 5.1%. The compression of our net interest margin, which began during 2005, accelerated throughout the current year with funding pressure continuing to be exerted through the fourth quarter of 2006.

     Market forces worked to contain asset growth during the year. Management determined that the persistence of the high short-term rate environment was not conducive to smart growth. Offering excessive deposit rates could have attained market share, but not market value. Such a strategy could not be executed in an environment that did not offer matching high rate and high quality loans and investments.

     Throughout the year, our balance sheet was actively managed to sustain long-term market value rather than short-term market share. At December 31, 2006, our assets totaled $619 million, a decrease of 1.3% for the year. Deposits totaled $513 million, a decrease of $12.8 million from the end of 2005. The decrease in deposits can be attributed to market forces as well as a planned withdrawal by a local government unit.

     Consolidation of the local community banks in 2005 reverberated into 2006 with implications on the Bancorp’s lending portfolio. Loan participations that the Bancorp had acquired from two former community banks were repurchased by the successors of those financial institutions resulting in decreases in the Bancorp’s loan portfolio that exceeded $20 million. As a result, the Bancorp’s lending portfolio totaled $471.7 million, an increase of $2.7 million.

     Despite the strains on the core earnings of the Bancorp in 2006, there were notable successes in our performance that offer a sturdy base for long-term earnings growth.

	n		Core deposits, which include checking, savings, and money market accounts totaled $299.6 million or 58.4% of all deposits at year-end
	n		Investment Securities totaled $99.0 million, an increase of $8.9 million
	n		Asset quality remains strong with non-performing loans to total assets at the manageable level of 0.50% at the end of the year
	n		Operating expenses were held to a 3.8% increase during the year
	n		Income from banking operations, including Wealth Management, totaled $4.2 million, an increase of 19.2%
	n		$9.2 million of long-term fixed rate loans originated during the year were sold to minimize interest rate risk at a gain of $157 thousand
	n		Home Equity Loans, a key part of our strategy to add interest sensitive loans to our portfolio, grew $2.2 million or 14.6%

     As the Bancorp builds long-term shareholder value, we will continue to seek new opportunities to expand our commitment to deliver the best banking, lending, and wealth management experience to our customers and community. In the near term, the Bancorp will work harder to produce earning assets that can adjust more rapidly to an increase in interest rates. We are committed to achieving our growth goals while improving our balance sheet with interest sensitive loans and investments funded by core accounts.

     Customer preferences have changed the competitiveness of banking while providing new opportunities to serve our customers. The coming retirement of the baby boomer generation, along with the conversion of bank customers from depositors to investors, is re-shaping the financial landscape.

     In the latter part of 2006, Terry Quinn, a well-respected financial advisor, joined the Peoples team as a Senior Vice-President of Wealth Management and has become an integral part of our effort to deliver a wide range of investment vehicles to our customers. Our goal to offer a full array of financial products will enable the Bancorp to become a partner in our customers’ prosperity.

     Bank consolidation has brought a number of new banking companies to our trade territory with new forms of competition. As a community Bank, we have the advantage of not only knowing our customers, but also being able to meet directly with them and tailor a response to their banking needs. This year we will expand our offices to include a new Banking Center in Crown Point and we continue to seek other locations that will profitably build value for the Bancorp.

     Your Bank continues to take an active role in the community. We provided support to over 225 community organizations in 2006. Notable among them was our success again this year with our Holiday Project. The Peoples team — directors and employees — contributed $8,550 to the project, an amount that was matched by your company. These funds were distributed between Habitat for Humanity to support affordable housing and the Boys and Girls Club of Northwest Indiana to provide clothing essentials for worthy youth in our community. Since its inception in 1994, our Holiday Project has contributed over $121,000 to these two community organizations.

     In both the near and long-term, our value as a community bank will be determined by the market’s response to our brand. “Friendly People for Today’s Banking” describes a financially educated, motivated, and well-trained team that is committed to building trust, excellence, and exceptional customer service. Our goal for 2007 is to put in place a training and marketing plan that will give new definition and new energy to “Friendly People for Today’s Banking.”

     On behalf of the Bancorp’s directors and employees, thank you for your support.

Financial Highlights

Selected Consolidated Financial Data
in thousands of dollars, except per share data

		December 31,				December 31,				December 31,				December 31,				December 31,				December 31,
Fiscal Year Ended		2006				2005				2004				2003				2002				2001
Statement of Income:
Total interest income		$	34,979			$	30,024			$	26,614			$	26,357			$	27,781			$	28,425
Total interest expense			15,737				9,758				6,858				7,521				10,107				13,222
Net interest income			19,241				20,266				19,756				18,836				17,674				15,203
Provision for loan losses			15				245				385				420				720				230
Net interest income after provision for loan losses			19,226				20,021				19,371				18,416				16,954				14,973
Noninterest income			4,219				3,540				3,312				2,968				2,675				2,402
Noninterest expense			14,296				13,771				13,174				12,037				10,859				9,911
Net noninterest expense			10,077				10,231				9,862				9,069				8,184				7,509
Income tax expenses			2,674				3,118				3,219				3,411				3,277				2,754
Net income		$	6,475			$	6,672			$	6,290			$	5,936			$	5,493			$	4,710
Basic earnings per common share		$	2.32			$	2.40			$	2.28			$	2.16			$	2.01			$	1.73
Diluted earnings per common share		$	2.30			$	2.37			$	2.24			$	2.13			$	1.99			$	1.71
Cash dividends declared per common share		$	1.40			$	1.32			$	1.24			$	1.20			$	1.12			$	1.04
		December 31,				December 31,				December 31,				December 31,				December 31,				December 31,
		2006				2005				2004				2003				2002				2001
Balance Sheet:
Total assets		$	618,982			$	627,439			$	557,393			$	508,775			$	488,002			$	440,710
Loans receivable			471,716				469,043				433,790				409,808				380,428				342,642
Investment securities			99,012				90,093				79,979				63,733				56,571				67,260
Deposits			512,931				525,731				451,573				421,640				406,673				355,215
Borrowed funds			51,501				51,152				57,201				40,895				36,065				44,989
Total stockholders’ equity			50,010				46,433				44,097				41,554				39,148				35,882
		December 31,				December 31,				December 31,				December 31,				December 31,				December 31,
Fiscal Year Ended		2006				2005				2004				2003				2002				2001
Interest Rate Spread During Period:
Average effective yield on loans and investment securities			6.02	%			5.50	%			5.31	%			5.65	%			6.26	%			7.29	%
Average effective cost of deposits and borrowings			2.77	%			1.82	%			1.40	%			1.67	%			2.38	%			3.55	%
Interest rate spread			3.25	%			3.68	%			3.91	%			3.98	%			3.88	%			3.74	%
Net interest margin			3.31	%			3.71	%			3.94	%			4.04	%			3.99	%			3.90	%
Return on average assets			1.04	%			1.14	%			1.17	%			1.20	%			1.18	%			1.15	%
Return on average equity			13.42	%			14.67	%			14.64	%			14.65	%			14.58	%			13.49	%
		December 31,				December 31,				December 31,				December 31,				December 31,				December 31,
		2006				2005				2004				2003				2002				2001
Total capital to risk-weighted assets			12.0	%			11.6	%			12.2	%			12.5	%			13.1	%			13.6	%
Tier 1 capital to risk-weighted assets			11.1	%			10.7	%			11.2	%			11.5	%			11.9	%			12.5	%
Tier 1 capital to adjusted average assets			8.0	%			7.9	%			8.0	%			8.0	%			7.6	%			8.3	%
Allowance for loan losses to total loans			0.90	%			0.89	%			0.90	%			0.92	%			0.96	%			0.92	%
Allowance for loan losses to non-performing loans			153.95	%			198.00	%			371.00	%			220.31	%			152.43	%			108.64	%
Non-performing loans to total loans			0.58	%			0.45	%			0.24	%			0.42	%			0.63	%			0.85	%
Total loan accounts			5,392				5,422				5,370				5,213				5,049				4,964
Total deposit accounts			32,435				33,963				32,866				32,502				31,385				30,433
Total Banking Centers (all full service)			8				8				8				8				8				8

		December 31,				December 31,				December 31,				December 31,
		2000				1999				1998				1997
		$	28,077			$	25,607			$	25,235			$	23,669
			13,386				11,281				12,310				11,721
			14,691				14,326				12,925				11,948
			175				200				110				221
			14,516				14,126				12,815				11,727
			1,995				1,659				1,347				1,066
			9,449				8,774				7,938				7,154
			7,454				7,115				6,591				6,088
			2,691				2,775				2,461				2,223
		$	4,371			$	4,236			$	3,763			$	3,416
		$	1.61			$	1.53			$	1.36			$	1.24
		$	1.60			$	1.52			$	1.35			$	1.23
		$	0.96			$	0.84			$	0.74			$	0.64
		December 31,				December 31,				December 31,				December 31,
		2000				1999				1998				1997
		$	392,313			$	361,719			$	345,417			$	319,609
			326,207				295,813				273,433				272,213
			38,128				41,931				36,350				29,362
			324,310				306,647				293,222				272,090
			30,599				18,607				17,320				14,628
			33,529				32,471				31,316				29,482
		December 31,				December 31,				December 31,				December 31,
		2000				1999				1998				1997
			7.88	%			7.61	%			8.00	%			8.16	%
			3.95	%			3.54	%			4.16	%			4.32	%
			3.93	%			4.07	%			3.84	%			3.84	%
			4.12	%			4.26	%			4.10	%			4.12	%
			1.17	%			1.20	%			1.14	%			1.13	%
			13.30	%			13.17	%			12.35	%			11.87	%
		December 31,				December 31,				December 31,				December 31,
		2000				1999				1998				1997
			13.6	%			14.8	%			15.3	%			15.0	%
			12.3	%			13.5	%			14.1	%			13.8	%
			8.6	%			9.0	%			9.2	%			9.2	%
			1.02	%			1.12	%			1.14	%			1.13	%
			183.54	%			412.08	%			213.06	%			257.84	%
			0.55	%			0.27	%			0.54	%			0.44	%
			4,762				4,676				4,625				4,764
			28,906				27,712				26,172				25,443
			8				7				7				7

Business

     NorthWest Indiana Bancorp (the Bancorp) is a bank holding company registered with the Board of Governors of the Federal Reserve System. Peoples Bank SB (the Bank), an Indiana savings bank, is a wholly owned subsidiary of the Bancorp. The Bancorp has no other business activity other than being the holding company for Peoples Bank SB.

     The Bancorp conducts business from its Corporate Center in Munster and its eight full-service offices located in East Chicago, Hammond, Merrillville, Dyer, Munster, Schererville and Hobart, Indiana. The Bancorp is primarily engaged in the business of attracting deposits from the general public and the origination of loans secured by single family residences and commercial real estate, as well as, construction loans, various types of consumer loans and commercial business loans. In addition, the Bancorp’s Wealth Management Group provides estate and retirement planning, guardianships, land trusts, profit sharing and 401(k) retirement plans, IRA and Keogh accounts, investment agency accounts. The Wealth Management Group may also serve as the personal representative of estates and act as trustee for revocable and irrevocable trusts.

     The Bancorp’s common stock is traded in the over-the-counter market and is quoted on the OTC Bulletin Board. On February 23, 2007, the Bancorp had 2,801,265 shares of common stock outstanding and 409 stockholders of record. This does not reflect the number of persons or entities who may hold their stock in nominee or “street” name through brokerage firms.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

General

     The Bancorp’s earnings are dependent upon the earnings of the Bank. The Bank’s earnings are primarily dependent upon net interest margin. The net interest margin is the difference between interest income earned on loans and investments and interest expense paid on deposits and borrowings stated as a percentage of average interest earning assets. The net interest margin is perhaps the clearest indicator of a financial institution’s ability to generate core earnings. Fees and service charges, wealth management operations income, gains and losses from the sale of assets, provisions for loan losses, income taxes and operating expenses also affect the Bancorp’s profitability.

     A summary of our significant accounting policies is detailed in Note 1 to the Bancorp’s consolidated financial statements included in this report. The preparation of our financial statements requires management to make estimates and assumptions that affect our financial condition and operating results. Actual results could differ from those estimates. Estimates associated with the allowance for loan losses, fair values of financial instruments and status of contingencies are particularly susceptible to material change in the near term as further information becomes available and future events occur.

     At December 31, 2006, the Bancorp had total assets of $619.0 million and total deposits of $512.9 million. The Bancorp’s deposit accounts are insured up to applicable limits by the Deposit Insurance Fund (DIF) that is administered by the Federal Deposit Insurance Corporation (FDIC), an agency of the federal government. At December 31, 2006, stockholders’ equity totaled $50.0 million, with book value per share at $17.86. Net income for 2006 was $6.5 million, or $2.32 basic earnings per common share and $2.30 diluted earnings per common share. The return on average assets (ROA) was 1.04%, while the return on average stockholders’ equity (ROE) was 13.42%.

Asset/Liability Management and Market Risk

     Asset/liability management involves the funding and investment strategies necessary to maintain an appropriate balance between interest sensitive assets and liabilities as well as to assure adequate liquidity. These strategies determine the characteristics and mix of the balance sheet. They affect the interest margins, maturity patterns, interest rate sensitivity and risk, as well as resource allocation. For the Bancorp, the key components of asset/liability management are loans, investments, deposits and borrowed funds. Over the years, the Bancorp has directed its lending efforts toward construction and land development loans, adjustable rate residential loans, equity lines of credit, adjustable rate commercial real estate loans, commercial business loans tied to the prime rate of interest and loans to local governmental agencies. Consumer loans are generally made for terms of five years or less. Fixed rate residential real estate loans are generally made for contractual terms of thirty years or less. The actual cash flows from these loans generally result in a duration which is less than the contractual maturity, providing protection against possible changes in interest rates.

     The Bancorp is primarily a portfolio lender. Mortgage banking activities are generally limited to the sale of fixed rate mortgage loans with contractual maturities exceeding fifteen years. These loans are identified as held for sale when originated and sold, on a case-by-case basis, in the secondary market as part of the Bancorp’s efforts to manage interest rate risk.

     The primary objectives of the investment portfolio are to provide liquidity, modify and manage interest rate risk, meet pledging requirements, and optimize portfolio earnings by implementing strategies that are consistent with the Bancorp’s strategic goals. The investment portfolio includes securities, an overnight open time account at the Federal Home Loan Bank of Indianapolis, and federal funds sold. Management of the investment portfolio focuses on a laddered approach to portfolio management. Daily funds are invested in either federal funds or in the Bancorp’s overnight open time account. Investments in non-callable and callable securities are made with maturities ranging from one day to seven years. Investments in callable securities will generally focus on bonds with one time calls and at least one year of call protection. In addition, purchases of municipal securities, mortgage-backed securities, and collateralized mortgage obligations are made to reduce the Bank’s tax liability, enhance portfolio yield, and increase monthly cash flows. Securities are classified as either held-to-maturity or available-for-sale. Held-to-maturity securities are those that the Bancorp has the positive intent and ability to hold to maturity. Available-for-sale securities are those the Bancorp may decide to sell if needed for liquidity, asset-liability management or other reasons. The Bancorp does not have a trading portfolio. During 2006, the Bancorp did not have any derivative instruments and was not involved in hedging activities as defined by SFAS 133.

     The Bancorp’s cost of funds reacts rapidly to changes in market interest rates due to the relatively short term nature of its deposit liabilities. Consequently, the levels of short-term interest rates have influenced the Bancorp’s results of operations. In order to reduce exposure to interest rate risk, core deposits (checking, NOW accounts, savings and money market accounts) have been marketed and certificate accounts have been competitively priced. Core deposits provide a very stable flow of funds and have been promoted by offering competitive interest rates, quality service and competitive service charges. Certificates with maturities ranging from ten days to forty-two months are offered. In addition, the Bank utilizes borrowings, i.e. repurchase agreements and advances from the Federal Home Loan Bank of Indianapolis, as a source of funds. Advances with maturities ranging from one to five years are used to fund securities and loans of comparable duration, as well as, to reduce the impact that movements in short-term interest rates have on the Bancorp’s overall cost of funds. The Bancorp does not obtain funds through brokers.

     The Bancorp’s primary market risk exposure is interest rate risk. Interest rate risk is the risk that the Bancorp’s earnings and capital will be adversely affected by changes in interest rates. The primary approach to interest rate risk management is one that focuses on adjustments to the

Bancorp’s asset/liability mix in order to limit the magnitude of interest rate risk. The Asset, Liability, Capital & Technology Management Committee of the Board is responsible for monitoring activity, approving initiatives, reviewing reports, and recommending strategies related to interest rate risk. The Bancorp’s Asset/Liability Management Committee (ALCO) is responsible for developing and implementing an interest rate risk (IRR) management strategy, establishing and maintaining a system of limits and controls, and establishing and utilizing an IRR measurement system. The ALCO generally meets monthly with board presentations occurring quarterly.

     Performance from an interest rate risk perspective can be measured in different ways. Methodologies used by the Bancorp focus on net interest income and the net economic value of equity. Net interest income is defined as interest income less interest expense. Variability in net interest income arises because its components, interest income and interest expense, do not change equally as rates vary. This mismatch occurs because individual assets and liabilities reprice differently as rates change. Factors which affect net interest income include changes in the level of interest rates, changes in the relationship between earning asset yields and the cost of interest bearing liabilities, changes in the volume of assets and liabilities outstanding, and changes in the composition or mix of assets and liabilities. Management uses rate shock (i.e. instantaneous and sustained parallel shifts in the yield curve in 1% increments up and down 2%) for stress testing the net interest income under several rate change levels. In order to simulate activity, maturing balances are replaced with new balances at the new rate level and repricing balances are adjusted to the new rate shock level. The results are compared to limits set by the Board of Directors and are monitored to identify unfavorable trends.

     Net economic value of equity is the net present value of the Bancorp’s portfolio of assets and liabilities. By marking-to-market the components of the balance sheet, management can compute the net economic value of equity. As rates change over time, the market values of Bancorp assets and liabilities will change, with longer-term products fluctuating more than shorter-term products. In most cases, rate-sensitive assets and liabilities will not have the same maturity characteristics. Therefore, as rates vary, the market value of the rate-sensitive assets will not change equally with the market value of rate-sensitive liabilities. This will cause the net economic value of equity to vary. The focus of the net economic value of equity is to determine the percentage decline in the net economic value of equity caused by a 2% increase or decrease in interest rates, whichever produces the larger decline. A large value indicates a large percentage decline in the net economic value of equity due to changes in interest rates and, thus, high interest rate sensitivity. A low value indicates a small percentage decline in the net economic value of equity due to changes in interest rates and, thus, low interest rate sensitivity. As with net interest income, the results are compared to limits set by the Board of Directors and are monitored to identify unfavorable trends.

     Presented in the following tables is forward-looking information about the Bancorp’s sensitivity to changes in interest rates as of December 31, 2006 and 2005. The tables incorporate the Bancorp’s internal system generated data as related to the maturity and repayment/withdrawal of interest earning assets and interest bearing liabilities. Prepayment assumptions are based on published data. Present value calculations use current published market interest rates. For core deposits that have no contractual maturity, the table presents principal cash flows and, as applicable, related weighted-average interest rates based on the Bancorp’s historical experience, management’s judgment, statistical analysis, and their most likely withdrawal behaviors.

Interest Rate Risk at December 31, 2006

Net Interest Income																		Net Economic Value of Equity
Change														Policy												Policy
in rates						Amount				Change				Limit				Amount				Change				Limit
	2	%				$	15,707				-8.93	%			-20.00	%		$	53,318				-14.13	%			-35	%
	1	%				$	16,502				-4.32	%			- 7.50	%		$	57,950				- 6.67	%			-15	%
	0	%				$	17,247				0.00	%						$	62,089				0.00	%
	-1	%				$	17,656				-2.37	%			- 7.50	%		$	64,115				3.26	%			-15	%
	-2	%				$	17,740				-2.86	%			-20.00	%		$	63,713				2.62	%			-35	%

Interest Rate Risk at December 31, 2005

Net Interest Income																		Net Economic Value of Equity
Change														Policy												Policy
in rates						Amount				Change				Limit				Amount				Change				Limit
	2	%				$	20,849				-2.90	%			-20.00	%		$	54,700				-14.50	%			-35	%
	1	%				$	21,206				-1.20	%			- 7.50	%		$	59,368				- 7.20	%			-15	%
	0	%				$	21,464				0.00	%						$	64,004				0.00	%
	-1	%				$	21,014				-2.10	%			- 7.50	%		$	66,431				3.80	%			-15	%
	-2	%				$	19,988				-6.90	%			-20.00	%		$	65,242				1.90	%			-35	%

     The tables show that the Bancorp has managed interest rate risk within the policy limits set by the Board of Directors. At December 31, 2006, an increase in interest rates of 2% would have resulted in a 8.9% decrease in net interest income and a 14.1% decrease in the net economic value of equity, compared to a 2.9% decrease in net interest income and a 14.5% decrease in the net economic value of equity at December 31, 2005. During 2006, the Bancorp has managed interest rate risk by generally selling residential fixed rate loans with contractual maturities exceeding 15 years, maintaining the short duration of the securities portfolio, and implementing deposit pricing strategies.

Financial Condition

     During the year ended December 31, 2006, total assets decreased by $8.5 million (1.3%), to $619.0 million, with interest-earning assets decreasing by $7.9 million (1.4%). At December 31, 2006, interest earning assets totaled $574.3 million and represented 92.8% of total assets. Loans totaled $471.7 million and represented 82.1% of interest-earning assets, 76.2% of total assets and 92.0% of total deposits. The loan portfolio, which is the Bancorp’s largest asset, is a significant source of both interest and fee income. The Bancorp’s lending strategy stresses quality growth, product

diversification, and competitive and profitable pricing. The loan portfolio includes $234.0 million (49.6%) in residential real estate loans, $111.3 million (23.6%) in commercial real estate loans, $48.7 million (10.3%) in construction and land development loans, $46.8 million (9.9%) in commercial business loans, $15.7 million (3.3%) in multifamily loans, $12.3 million (2.6%) in government and other loans, and $2.9 million (0.7%) in consumer loans. During 2006, loans increased by $2.7 million (0.6%), with increases taking place in loans secured by real estate. Adjustable rate loans comprised 57.2% of total loans at year-end. Management believes a general slowdown in the national and local economies may result in a softening in loan demand in all categories.

     During 2006, the Bancorp sold $9.2 million in fixed rate mortgages originated for sale compared to $5.6 million in 2005 and $3.9 million in 2004. Net gains realized from the sales totaled $157 thousand, $102 thousand and $234 thousand for 2006, 2005 and 2004. The current year increase in gain on sale of loans is a result of the current interest rate environment and an increase of loans originated for sale. Net mortgage loan servicing fees totaled $12 thousand for 2006, $1 thousand for 2005 and $9 thousand for 2004. At December 31, 2006, the Bancorp had no loans that were held for sale. During 2007, the Bancorp expects to continue selling fixed rate mortgage loans, with contractual maturities exceeding fifteen years, on a case-by-case basis, as part of its efforts to manage interest rate risk.

     Non-performing loans include those loans that are 90 days or more past due and those loans that have been placed on non-accrual status. Non-performing loans totaled $3.1 million at December 31, 2006 compared to $2.1 million at December 31, 2005, an increase of $967 thousand or 46%. The increase in non-performing loans at December 31, 2006 is related to two borrowers. The first borrower has one commercial business loan and two loans secured by real estate totaling $1.2 million that were placed in non-accrual status during the first quarter of 2006. These loans have been considered impaired at both December 31, 2006 and December 31, 2005. As a result, the impaired loan balances were included in the allowance for loan loss analysis at December 31, 2006 and December 31, 2005, and no additional provisions were required for these loans during 2006. The second borrower has one commercial real estate and one commercial business loan totaling $725 thousand that was placed in non-accrual status during the third quarter of 2006. The ratio of non-performing loans to total loans was 0.65% at December 31, 2006, compared to 0.45% at December 31, 2005. The ratio of non-performing loans to total assets was 0.50% at December 31, 2006, compared to 0.34% at December 31, 2005. The December 31, 2006 non-performing loan balances include $2.9 million in loans accounted for on a non-accrual basis and $182 thousand in accruing loans which were contractually past due 90 days or more. Loans internally classified as substandard totaled $6.9 million at December 31, 2006, compared to $3.2 million at December 31, 2005. The increase in substandard loans is primarily related to an increase in loans secured by residential and commercial real estate loans. No loans were classified as doubtful or loss. Substandard loans include non-performing loans and potential problem loans, where information about possible credit issues or other conditions causes management to question the ability of such borrowers to comply with loan covenants or repayment terms. In addition to identifying and monitoring non-performing and other classified loans, management maintains a list of watch loans. Watch loans represent loans management is more closely monitoring due to one or more factors that may cause the loan to become classified. Watch loans totaled $7.6 million at December 31, 2006, compared to $8.7 million at December 31, 2005.

     At December 31, 2006, impaired loans totaled $1.9 million, compared to $1.7 million at December 31, 2005. The impaired loan balances were also classified as non-performing loans at the end of both periods. The December 31, 2006 impaired loan balances consist of five impaired loans to two commercial borrowers that are secured by business assets and real estate, and are personally guaranteed by the owner of the business. Impaired loans are loans where full payment under the loan terms is not expected. There were no other loans considered to be impaired loans as of, or for the quarter ended, December 31, 2006.

     At December 31, 2006, management is of the opinion that there are no loans, except those discussed above, where known information about possible credit problems of borrowers causes management to have serious doubts as to the ability of such borrowers to comply with the present loan repayment terms and which may result in disclosure of such loans as non-accrual, past due or restructured loans. Also, at December 31, 2006, there were no other interest bearing assets that would be required to be disclosed as non-accrual, past due, restructured or potential problems if such assets were loans. Management does not presently anticipate that any of the non-performing loans or classified loans would materially impact future operations, liquidity or capital resources.

     Notwithstanding the above, the Bancorp has a $1.1 million participation in a $6.4 million letter of credit, which acts as payment support to bondholders. Bancorp’s management currently believes that the principal of the borrower has the financial capacity to meet future bond repayment obligations. Cash flows from the security collateralizing the letter of credit have been negatively impacted due to the closing of a major tenant. Management will continue to monitor the letter of credit and bond repayments.

     Because some loans may not be repaid in accordance with contractual agreements, an allowance for loan losses (ALL) has been maintained. While management may periodically allocate portions of the allowance for specific problem loans, the entire allowance is available to absorb probable incurred losses that arise from the loan portfolio and is not segregated for, or allocated to, any particular loan or group of loans. For the twelve months ended December 31, 2006, $15 thousand in additions to the ALL account were required, compared to $245 thousand for the twelve months ended December 31, 2005. The December 31, 2005 ALL contained a specific allowance for the collateral deficiency associated with three loans totaling $1.4 million,

which had been classified as impaired at December 31, 2006 and December 31, 2005, and placed in non-accrual status during the first quarter of 2006. Recoveries, net of charge-offs, totaled $71 thousand for the current twelve months, compared to recoveries, net of charge-offs of $44 thousand for the twelve months ended December 31, 2005. Changes in the provision take into consideration management’s current judgments about the credit quality of the loan portfolio, loan portfolio growth, changes in the portfolio mix and local economic conditions. In determining the provision for loan loss for the current period, management has given consideration to increased risks associated within the local economy, changes in loan mix and asset quality.

     The determination of the amount of the ALL and provisions for loan losses is based on management’s current judgments about the credit quality of the loan portfolio with consideration given to all known relevant internal and external factors that affect loan collectibility as of the reporting date. The appropriateness of the current year provision and the overall adequacy of the ALL are determined through a disciplined and consistently applied quarterly process that combines a review of the current position with a risk assessment worksheet. The risk assessment worksheet covers the residential, commercial real estate, commercial business, and consumer loan portfolios. Management uses a risk rating system to assist in determining the appropriate level for the ALL. Management assigns risk factors to non-performing loans; loans that management has internally classified as impaired; loans that management has internally classified as substandard, doubtful, loss, or watch; and performing loans.

     Risk factors for non-performing and internally classified loans are based on an analysis of the estimated collateral liquidation value for individual loans defined as substandard, doubtful, loss or watch. Estimated collateral liquidation values are based on established loan underwriting standards and adjusted for current mitigating factors on a loan-by-loan basis. Aggregate substandard loan collateral deficiencies are determined for residential, commercial real estate, commercial business, and consumer loan portfolios. These deficiencies are then stated as a percentage of the classified loan category to determine the appropriate risk factors.

     Risk factors for performing and non-classified loans are based on the average net charge-offs for the most recent five years, which are then stated as a percentage of average loans for the same period. Historical risk factors are calculated for residential, commercial real estate, commercial business, and consumer loans. The historical factors are then adjusted for current subjective risks attributable to: local and national economic factors; loan growth and changes in loan composition; organizational structure; composition of loan staff; loan concentrations; policy changes and out of market lending activity.

     The ALL to total loans was 0.90% at December 31, 2006, compared to 0.89% at December 31, 2005, while the ALL to non-performing loans (coverage ratio) was 138.6% at December 31, 2006, compared to 198.1% at December 31, 2005. A consistently strong coverage ratio is an indicator that sufficient provisions for loan losses have been established. The December 31, 2006 balance in the ALL account of $4.3 million is considered adequate by management after evaluation of the loan portfolio, past experience and current economic and market conditions. While management may periodically allocate portions of the allowance for specific problem loans, the whole allowance is available for any loan charge offs that occur. The allocation of the ALL reflects performance and growth trends within the various loan categories, as well as consideration of the facts and circumstances that affect the repayment of individual loans, and loans which have been pooled as of the evaluation date, with particular attention given to non-performing loans and loans which have been classified as substandard, doubtful or loss. Management has allocated general reserves to both performing and non-performing loans based on current information available.

     At December 31, 2006, the Bancorp’s investment portfolio totaled $99.0 million and was invested as follows: 40.9% in U.S. government agency debt securities, 39.2% in U.S. government agency mortgage-backed securities and collateralized mortgage obligations, and 19.9% in municipal securities. At December 31, 2006, securities available-for-sale totaled $83.8 million or 84.6% of total securities. Available-for-sale securities are those the Bancorp may decide to sell if needed for liquidity, asset-liability management or other reasons. During 2006, securities increased by $8.9 million (9.9%). In addition, at December 31, 2006, the Bancorp had $3.5 million in FHLB stock.

     Deposits are a fundamental and cost-effective source of funds for lending and other investment purposes. The Bancorp offers a variety of products designed to attract and retain customers, with the primary focus on building and expanding relationships. At December 31, 2006, deposits totaled $512.9 million. During 2006, deposits decreased by $12.8 million (2.4%). Savings accounts decreased by $7.4 million (12.1%), money market deposit accounts (MMDA’s) decreased by $5.8 million (4.1%), certificates of deposit decreased by $1.4 million (0.6%), while checking accounts increased by $1.8 million (1.6%). The decrease in savings account and certificate of deposit balances was a result of the changing customer preference for alternative market investments. The decrease in MMDA’s was a result of a planned withdrawal by a local governmental unit. At December 31, 2006, the deposit base was comprised of 21.1% checking, 26.8% MMDA’s, 10.6% savings accounts, and 41.5% certificates of deposit.

     Borrowings are primarily used to fund asset growth not supported by deposit generation. At December 31, 2006, borrowed funds totaled $51.5 million compared to $51.2 million at December 31, 2005, an increase of $349 thousand (0.7%). Retail repurchase agreements totaled $14.7 million at December 31, 2006, compared to $12.1 million at December 31, 2005, an increase of $2.6 million (21.9%). FHLB advances totaled $32.0 million, decreasing $5.5 million, as the Bancorp used excess liquidity to repay maturing advances. In addition, the Bancorp’s FHLB line of credit carried a balance of $3.1 million at December 31, 2006, compared to $0 at December 31, 2005. Other short-term borrowings totaled $1.7 million at December 31, 2006, compared to $1.6 million at December 31, 2005.

Liquidity and Capital Resources

     The Bancorp’s primary goal for funds and liquidity management is to ensure that at all times it can meet the cash demands of its depositors and its loan customers.

     A secondary purpose of funds management is profit management. Because profit and liquidity are often conflicting objectives, management will maximize the Bank’s net interest margin by making adequate, but not excessive, liquidity provisions. Furthermore, funds are managed so that future profits will not be significantly impacted because management uses expensive ways of raising cash.

     Changes in the liquidity position result from operating, investing and financing activities. Cash flows from operating activities are generally the cash effects of transactions and other events that enter into the determination of net income. The primary investing activities include loan originations, loan repayments, investments in interest bearing balances in financial institutions, dividend receipts and the purchase and maturity of investment securities. Financing activities focus almost entirely on the generation of customer deposits. In addition, the Bancorp utilizes borrowings (i.e., repurchase agreements and advances from the FHLB) as a source of funds.

     During 2006, cash and cash equivalents decreased $24.1 million, compared to an increase of $23.4 million for 2005, and an increase of $328 thousand for 2004. During 2006, the primary sources of cash and cash equivalents were from the maturities and sales of securities, loan sales and prepayments, FHLB advances and cash from operating activities. The primary uses of cash and cash equivalents were loan originations and loan participations purchased, the purchase of securities, deposit withdrawals and the payment of common stock dividends. During 2006, cash from operating activities decreased to $6.6 million, compared to $7.1 million for 2005 and $7.9 million for 2004. The 2006 decrease in cash provided by operating activities was a result of the net change in other assets. Cash outflows from investing activities totaled $14.6 million during 2006, compared to $48.4 million during 2005 and $50.8 million for 2004. The decrease during 2006 was due primarily to a reduction in loan originations. The net change in loans receivable and loan participations purchased totaled $2.9 million during 2006, compared to $35.2 million during 2005 and $36.7 million for 2004. Cash outflows from financing activities totaled $16.1 million in 2006, compared to $64.7 million in 2005 and $43.2 million in 2004. The change during 2006 was primarily due to a net decrease in deposit balances. Deposits decreased by $12.8 million during 2006, compared to an increase of $74.2 million for 2005 and $29.9 million for 2004. The 2006 decrease in deposits was a result of a planned withdrawal of a short-term local government deposit. FHLB advances decreased by $5.5 million during 2006, compared to a decrease of $2.0 million during 2005, and an increase of $13.0 million during 2004. The Bancorp paid dividends on common stock of $3.8 million during 2006, compared to $3.6 million during 2005 and $3.4 million for 2004.

     Management strongly believes that safety and soundness is enhanced by maintaining a high level of capital. During 2006, stockholders’ equity increased by $3.6 million (7.7%). The increase resulted primarily from earnings of $6.5 million for 2006. Additional items increasing stockholders’ equity were $246 thousand from the issuance of 15,348 shares of common stock from stock-based compensation plans, $107 thousand from the recognition of the overfunded status of the Bank’s postretirement medical plan, $67 thousand from stock-based compensation expense and $593 thousand from the net change in unrealized loss on available-for-sale securities. Decreasing stockholders’ equity was the Bancorp’s declaration of $3.9 million in cash dividends. At December 31, 2006, book value per share was $17.86 compared to $16.67 at December 31, 2005.

     The Bancorp is subject to risk-based capital guidelines adopted by the Board of Governors of the Federal Reserve System (the FRB), and the Bank is subject to risk-based capital guidelines adopted by the FDIC. As applied to the Bancorp and the Bank, the FRB and FDIC capital requirements are substantially the same. These regulations divide capital into two tiers. The first tier (Tier 1) includes common equity, certain non-cumulative perpetual preferred stock and minority interests in equity accounts of consolidated subsidiaries, less goodwill and certain other intangible assets. Supplementary (Tier 2) capital includes, among other things, cumulative perpetual and long-term limited-life preferred stock, mandatory convertible securities, certain hybrid capital instruments, term subordinated debt and the allowance for loan losses, subject to certain limitations, less required deductions. The Bancorp and the Bank are required to maintain a total risk-based capital ratio of 8%, of which 4% must be Tier 1 capital. In addition, the FRB and FDIC regulations provide for a minimum Tier 1 leverage ratio (Tier 1 capital to adjusted average assets) of 3% for financial institutions that meet certain specified criteria, including that they have the highest regulatory rating and are not experiencing or anticipating significant growth. All other financial institutions are required to maintain a Tier 1 leverage ratio of 3% plus an additional cushion of at least one to two percent.

     The following table shows that, at December 31, 2006, the Bancorp’s capital exceeded all regulatory capital requirements. At December 31, 2006, the Bancorp’s and the Bank’s regulatory capital ratios were substantially the same. The dollar amounts are in millions.

										Required for								To Be Well
		Actual								Adequate Capital								Capitalized
		Amount				Ratio				Amount				Ratio				Amount				Ratio
Total capital to risk-weighted assets		$	54,665				12.0	%		$	36.4				8.0	%		$	45.5				10.0	%
Tier 1 capital to risk-weighted assets		$	50,398				11.1	%		$	18.2				4.0	%		$	27.3				6.0	%
Tier 1 capital to adjusted average assets		$	50,398				8.0	%		$	19.0				3.0	%		$	31.7				5.0	%

Contractual Obligations, Commitments, Contingent Liabilities, and Off-balance Sheet Arrangements

     The following table presents the Bancorp’s consolidated long term contractual obligations, as well as commitments to extend credit to our borrowers, in aggregate and by payment due dates at December 31, 2006. Dollar amounts are in thousands.

		Less than				One through				Four through				After
		One Year				Three Years				Five Years				Five Years				Total
Long-term contractual obligations:
Time deposits		$	202,256			$	11,076			$	—			$	—			$	213,332
FHLB advances			20,000				12,000				—				—				32,000
Limited partnership obligation			60				—				—				—				60
Total long-term contractual obligations			222,316				23,076				—				—				245,392
Commitments to extend credit:
Performance standby letters of credit			2,268				885				699				174				4,026

     At December 31, 2006, outstanding commitments to fund loans totaled $95.3 million. Approximately 80% of the commitments were at variable rates. Management believes that the Bancorp has sufficient cash flow and borrowing capacity to fund all outstanding commitments and to maintain proper levels of liquidity. Except for the items disclosed in the table above, the Bancorp has no other off-balance sheet arrangements, which will have a current or future effect on results of operations, liquidity, capital expenditures or resources.

     At December 31, 2006, management is not aware of any current recommendations by the regulatory authorities, which if they were to be implemented, would have a material effect on the Bancorp’s liquidity, capital resources or operations.

Results of Operations - Comparison of 2006 to 2005

     Net income for 2006 was $6.5 million, compared to $6.7 million for 2005, a decrease of $197 thousand (3.0%). The Bancorp’s earnings were impacted by challenges that constrained revenue growth, one from persistent high short-term interest rates, the persistent inverted yield curve and continued consolidation through mergers that negatively impacted lending activity. Contributing to the Bancorp’s earnings were asset quality, increased noninterest income from banking activities and stable operating expenses. The earnings represent a return on average assets of 1.04% for 2006 compared to 1.14% for 2005. The return on average equity was 13.42% for 2006 compared to 14.67% for 2005.

     Net interest income for 2006 was $19.2 million, a decrease of $1.0 million (5.1%) from $20.3 million for 2005. The decrease in net interest income was affected by the Federal Reserve’s action to raise interest rates and the subsequent inverted yield curve, a term that describes short-term interest rates having yields higher than long-term rates. Under such conditions, the increase in yields earned on loans and investments generally lag the increases in rates paid to depositors as well as the rates on bank borrowings. The weighted-average yield on interest-earning assets was 6.02% for 2006 compared to 5.50% for 2005. The weighted-average cost of funds was 2.77% for 2006 compared to 1.82% for 2005. The impact of the 6.02% return on interest earning assets and the 2.77% cost of funds resulted in a net interest spread of 3.25% for 2006 compared to 3.68% for 2005. During 2006, total interest income increased by $5.0 million (16.5%) while total interest expense increased by $6.0 million (61.3%). The net interest margin was 3.31% for 2006 compared to 3.71% for 2005. During 2006, the Bancorp continued to focus on reducing its effective tax rate by investing in tax-exempt securities and loans. As a result, the Bancorp’s tax equivalent net interest margin for 2006 was 3.41% compared to 3.80% for 2005.

     During 2006, interest income from loans increased by $4.2 million (15.8%) compared to 2005. The increase was due to an increase in average loan balances and increased yields. The weighted-average yield on loans outstanding was 6.44% for 2006 compared to 5.92% for 2005. Loan balances averaged $472.2 million for 2006, up $28.7 million (6.5%) from $443.5 million for 2005. During 2006, interest income from securities and other interest earning assets increased by $794 thousand (21.1%) compared to 2005. The increase was due to higher average balances and an increase in portfolio yields. The weighted-average yield on securities and other interest earning assets was 4.19% for 2006 compared to 3.67% for 2005. Securities and other interest earning assets averaged $108.8 million for 2006, up $6.4 million (6.3%) from $102.4 million for 2005.

     Interest expense for deposits increased by $5.5 million (69.4%) during 2006 compared to 2005. The change was due to an increase in the weighted-average rate paid on deposits and increased average balances. The weighted-average rate paid on deposits for 2006 was 2.65% compared to 1.82% for 2005. The higher cost of funds was a result of MMDA and certificates of deposit growth in a higher rate environment, and a decrease in savings account average balances. Total deposit balances averaged $507.8 million for 2006, up $24.9 million (5.2%) from $482.9 million for 2005. Interest expense on borrowed funds increased by $466 thousand (25.7%) during 2006 due to an increase in average daily balances and an increase in cost of borrowing. The weighted-average cost of borrowed funds was 3.78% for 2006 compared to 3.34% for 2005. Borrowed funds averaged $60.2 million during 2006, up $5.9 million (10.9%) from $54.3 million for 2005. The lower marginal cost of acquiring borrowed funds provides a cost-effective supplement to deposits for funding interest-earning asset growth.

     Noninterest income was $4.2 million for 2006, up $679 thousand (19.2%) from $3.5 million during 2005. During 2006, fees and service charges from account related services increased $541 thousand (22.5%). The increase was primarily due to fees from deposit accounts. Fees from wealth management operations totaled $657 thousand for 2006, compared to $601 thousand for 2005, an increase of $56 thousand (9.3%). Income from increases in the cash

value of bank owned life insurance totaled $365 thousand for 2006, compared to $310 for 2005, an increase of $55 thousand (17.7%). During 2006, the Bancorp reported $157 thousand in gains on sales of loans compared to $102 thousand for 2005, an increase of $55 thousand (54.0%). Gain on sale of foreclosed real estate totaled $43 thousand during 2006, compared to $8 thousand for 2005, an increase of $35 thousand (437.5%). In addition, the Bancorp reported $3 thousand in gains on the sale of securities during 2006, compared to gains of $70 thousand for 2005.

     Noninterest expense for 2006 was $14.3 million, up $525 thousand (3.8%) from $13.8 million for 2005. During the current year, compensation and benefits totaled $7.3 million, an increase of $150 thousand (2.1%) compared to $7.2 million for 2005. The increase was primarily due to increased compensation, due to annual salary increases and the recognition of stock-based employee compensation in accordance with Financial Accounting Standards No. 123(R), “Share-based Payment,” which was adopted in 2006. Occupancy and equipment totaled $2.4 million for 2006, an increase of $156 thousand (7.0%) compared to $2.2 million for 2005. The increase was a result of additional depreciation expense for equipment and technology expenditures. Data processing totaled $827 thousand for 2006, an increase of $53 thousand (6.8%), compared to $774 thousand for 2005. The change was a result of increased utilization and transaction volume with the Bancorp’s core data processing system. Statement and check processing totaled $348 thousand for 2006, compared to $368 thousand for 2005. Marketing expense totaled $325 thousand for 2006, an increase of $55 thousand (20.2%), compared to $270 thousand for 2005. The marketing expense change was a result of increased market communication of the Bancorp’s brand. Professional services expense related to the utilization of third parties totaled $378 thousand for 2006, an increase of $136 thousand (56.0%), compared to $242 for 2005. The increase was a result of the formation of the Bancorp’s real estate investment trust. Other expense totaled $2.7 million for 2006 and 2005. The Bancorp’s efficiency ratio for 2006 was 60.9% compared to 57.9% for 2005. The ratio is determined by dividing total noninterest expense by the sum of net interest income and total noninterest income for the period.

     Income tax expenses for 2006 totaled $2.7 million compared to $3.1 million for 2005, a decrease of $444 thousand (14.2%). The combined effective federal and state tax rates for the Bancorp were 29.3% for 2006 and 31.8% for 2005. The decrease was due to an increased investment in tax-exempt investments, loans, bank owned life insurance and the formation of a real estate investment trust.

Results of Operations - Comparison of 2005 to 2004

     Net income for 2005 was $6.7 million, compared to $6.3 million for 2004, an increase of $382 thousand (6.1%), principally due to consistent core earnings, asset quality, increased noninterest income from banking activities and stable operating expenses. The earnings represent a return on average assets of 1.14% for 2005 compared to 1.17% for 2004. The return on average equity was 14.67% for 2005 compared to 14.64% for 2004.

     Net interest income for 2005 was $20.3 million, up $510 thousand (2.6%) from $19.8 million for 2004. The increase in net interest income was due to an increase in average loan and core deposit balances. The rising interest rate environment during 2005 resulted in increased yields for investments and loans, as maturing securities were reinvested at higher rates and new loan production carried higher yields. During 2005, the cost of funds increased faster than earning asset yields due to the maturity structure of the Bancorp’s certificates of deposit, growth in MMDA’s, and a reduction in checking and savings account balances. The weighted-average yield on interest-earning assets was 5.50% for 2005 compared to 5.31% for 2004. The weighted-average cost of funds was 1.82% for 2005 compared to 1.40% for 2004. The impact of the 5.50% return on interest earning assets and the 1.82% cost of funds resulted in a net interest spread of 3.68% for 2005 compared to 3.91% for 2004. During 2005, total interest income increased by $3.4 million (12.8%) while total interest expense increased by $2.9 million (42.3%). The net interest margin was 3.71% for 2005 compared to 3.94% for 2004. During 2005, the Bancorp continued to focus on reducing its effective tax rate by investing in tax-exempt securities and loans. As a result, the Bancorp’s tax equivalent net interest margin for 2005 was 3.80% compared to 3.97% for 2004.

     During 2005, interest income from loans increased by $2.6 million (10.8%) compared to 2004. The increase was due to an increase in average loan balances and increased yields. The weighted-average yield on loans outstanding was 5.92% for 2005 compared to 5.71% for 2004. Loan balances averaged $443.5 million for 2005, up $28.4 million (6.8%) from $415.1 million for 2004. During 2005, interest income from securities and other interest earning assets increased by $855 thousand (29.4%) compared to 2004. The increase was due to higher average balances and an increase in portfolio yields. The weighted-average yield on securities and other interest earning assets was 3.67% for 2005 compared to 3.37% for 2004. Securities and other interest earning assets averaged $102.4 million for 2005, up $16.3 million (18.9%) from $86.1 million for 2004.

     Interest expense for deposits increased by $2.6 million (48.8%) during 2005 compared to 2004. The change was due to an increase in the weighted-average rate paid on deposits and increased average balances. The weighted-average rate paid on deposits for 2005 was 1.82% compared to 1.40% for 2004. The higher cost of funds was a result of MMDA and certificates of deposit growth in a rising rate environment, and a decrease in low cost checking and savings account average balances. Total deposit balances averaged $482.9 million for 2005, up $42.1 million (9.6%) from $440.8 million for 2004. Interest expense on borrowed funds increased by $293 thousand (19.3%) during 2005 due to an increase in average daily balances and an increase in the

cost of borrowing. The weighted-average cost of borrowed funds was 3.34% for 2005 compared to 3.10% for 2004. Borrowed funds averaged $54.3 million during 2005, up $5.3 million (10.8%) from $49.0 million for 2004. Borrowed funds have provided a cost-effective supplement to deposits for funding interest-earning asset growth.

     Noninterest income was $3.5 million for 2005, up $228 thousand (6.9%) from $3.3 million during 2004. During 2005, fees and service charges increased $287 thousand (13.5%). The increase was primarily due to fees from deposit accounts and an increase in the cash value of bank owned life insurance. Fees from wealth management operations totaled $601 thousand for 2005, compared to $498 thousand for 2004, an increase of $103 thousand (20.7%). During 2005, the Bancorp reported $102 thousand in gains on sales of loans compared to $234 thousand for 2004, a decrease of $132 thousand (54.4%). Gains on securities totaled $70 thousand during 2005 compared to $284 thousand for 2004, a decrease of $214 thousand (75.4%). The decrease in gains on sales of loans and securities was a result of fewer sales due to the current interest rate environment. Income from the increase in the cash value of bank owned life insurance totaled $310 thousand during the current year, compared to $147 thousand in 2004, an increase of $163 thousand (110.9%). In addition, the Bancorp reported $8 thousand in gains on the sale of foreclosed real estate during 2005 compared to gains of $1 thousand for 2004.

     Noninterest expense for 2005 was $13.8 million, up $597 thousand (4.5%) from $13.2 million for 2004. During the current year, compensation and benefits totaled $7.2 million, an increase of $342 thousand (5.0%) compared to $6.8 million for 2004. The increase was primarily due to increased compensation, due to annual salary increases, and additional staffing for current banking operations. Occupancy and equipment totaled $2.23 million for 2005, an increase of $30 thousand (1.4%) compared to $2.20 million for 2004. Marketing expense totaled $270 thousand for 2005, an increase of $37 thousand (15.9%), compared to $233 thousand for 2004. The marketing expense change was a result of increased market communication of the Bancorp’s brand, while selling its products and services. Data processing totaled $774 thousand for 2005, an increase of $51 thousand (7.1%), compared to $723 thousand for 2004. The change was a result of increased transaction volume with the Bancorp’s core data processing system. Other expense totaled $3.1 million for 2005, an increase of $193 thousand (6.7%) from $2.9 million for 2004. The increase was primarily due to expense associated with the imaging of customer checks and account statements, which was implemented during August 2004. The Bancorp’s efficiency ratio for 2005 was 57.9% compared to 57.1% for 2004.

     Income tax expenses for 2005 totaled $3.1 million compared to $3.2 million for 2004, a decrease of $101 thousand (3.1%). The combined effective federal and state tax rates for the Bancorp were 31.8% for 2005 and 33.9% for 2004. The decrease was due to an increased investment in tax-exempt investments, loans and bank owned life insurance.

Critical Accounting Policies

     Critical accounting policies are those accounting policies that management believes are most important to the portrayal of the Bancorp’s financial condition and that require management’s most difficult, subjective or complex judgments. The Bancorp’s most critical accounting policy is summarized below. Other accounting policies, including those related to the fair values of financial statements and the status of contingencies, are summarized in Note 1 to the Bancorp’s consolidated financial statements.

     Allowance for Loan Losses – The Bancorp maintains an Allowance for Loan Losses (ALL) to absorb probable incurred credit losses that arise from the loan portfolio. The ALL is increased by the provision for loan losses, and decreased by charge-offs net of recoveries. The determination of the amounts of the ALL and provisions for loan losses is based upon management’s current judgments about the credit quality of the loan portfolio with consideration given to all known relevant internal and external factors that affect loan collectibility. The methodology used to determine the current year provision and the overall adequacy of the ALL includes a disciplined and consistently applied quarterly process that combines a review of the current position with a risk assessment worksheet. Factors that are taken into consideration in the analysis include an assessment of national and local economic trends, a review of current year loan portfolio growth and changes in portfolio mix, and an assessment of trends for loan delinquencies and loan charge-off activity. Particular attention is given to non-accruing loans and accruing loans past due 90 days or more, and loans that have been classified as substandard, doubtful, or loss. Changes in the provision are directionally consistent with changes in observable data.

     Commercial and industrial, and commercial real estate loans that exhibit credit weaknesses and loans that have been classified as impaired are subject to an individual review. Where appropriate, ALL allocations are made to these loans based on management’s assessment of financial position, current cash flows, collateral values, financial strength of guarantors, industry trends, and economic conditions. ALL allocations for homogeneous loans, such as residential mortgage loans and consumer loans, are based on historical charge-off activity and current delinquency trends. Management has allocated general reserves to both performing and non-performing loans based on historical data and current information available.

     Risk factors for non-performing and internally classified loans are based on an analysis of the estimated collateral liquidation value for individual loans defined as substandard or doubtful. Estimated collateral liquidation values are based on established loan underwriting standards and adjusted for current mitigating factors on a loan-by-loan basis. Aggregate substandard loan collateral deficiencies are determined for residential, commercial real estate, commercial business, and consumer loan portfolios. These deficiencies are then stated as a percentage of the total substandard balances to determine the appropriate risk factors.

     Risk factors for performing and non-classified loans are based on the average net charge-offs for the most recent five years, which are then stated as a percentage of average loans

for the same period. Historical risk factors are calculated for residential, commercial real estate, commercial business, and consumer loans. The historical factors are then adjusted for current subjective risks attributable to: local and national economic factors; loan growth and changes in loan composition; organizational structure; composition of loan staff; loan concentrations; policy changes and out of market lending activity.

     The risk factors are applied to these types of loans to determine the appropriate level for the ALL. Adjustments may be made to these allocations that reflect management’s judgment on current conditions, delinquency trends, and charge-off activity.

     The Bancorp has not made any significant changes to its overall approach in the determination of the ALL for all periods reported. There have been no material changes in assumptions or estimation techniques. Based on the above discussion, management believes that the ALL is currently adequate, but not excessive, given the risk inherent in the loan portfolio.

Impact of Inflation and Changing Prices

     The financial statements and related data presented herein have been prepared in accordance with accounting principles generally accepted in the United States of America, which require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation. The primary assets and liabilities of the Bancorp are monetary in nature. As a result, interest rates have a more significant impact on the Bancorp’s performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or magnitude as the prices of goods and services.

Forward-Looking Statements

     Statements contained in this report that are not historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The words or phrases “would be,” “will allow,” “intends to,” “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimate,” “project,” or similar expressions are also intended to identify “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act. The Bancorp cautions readers that forward-looking statements, including without limitation, those relating to the Bancorp’s future business prospects, interest income and expense, net income, liquidity, and capital needs are subject to certain risks and uncertainties that could cause actual results to differ materially from those indicated in the forward-looking statements, due to, among other things, factors identified in this report, including the following:

     Regulatory Risk. The banking industry is heavily regulated. As discussed above, the Bancorp and Bank are subject to regulation and supervision by the DFI, FDIC, FRB, and SEC (Securities and Exchange Commission). The burden imposed by federal and state regulations puts banks at a competitive disadvantage compared to less regulated competitors such as finance companies, mortgage banking companies and leasing companies. The banking industry continues to lose market share to competitors.

     Legislation. Because of concerns relating to the competitiveness and the safety and soundness of the industry, Congress continues to consider a number of wide-ranging proposals for altering the structure, regulation, and competitive relationships of the nation’s financial institutions. Among such bills are proposals to combine banks and thrifts under a unified charter, to combine regulatory agencies, and to further expand the powers of depository institutions, bank holding companies, and competitors of depository institutions. Management cannot predict whether or in what form any of these proposals will be adopted or the extent to which the business of the Bancorp or the Bank may be affected thereby.

     Credit Risk. One of the greatest risks facing lenders is credit risk, that is, the risk of losing principal and interest due to a borrower’s failure to perform according to the terms of a loan agreement. While management attempts to provide an allowance for loan losses at a level adequate to cover probable incurred losses based on loan portfolio growth, past loss experience, general economic conditions, information about specific borrower situations, and other factors, future adjustments to reserves may become necessary, and net income could be significantly affected, if circumstances differ substantially from assumptions used with respect to such factors.

     Exposure to Local Economic Conditions. The Bank’s primary market area for deposits and loans encompasses Lake County, in northwest Indiana, where all of its offices are located. Ninety-five percent of the Bank’s business activities are within this area. This concentration exposes the Bank to risks resulting from changes in the local economy. A dramatic drop in local real estate values would, for example, adversely affect the quality of the Bank’s loan portfolio.

     Interest Rate Risk. The Bancorp’s earnings depend to a great extent upon the level of net interest income, which is the difference between interest income earned on loans and investments and the interest expense paid on deposits and other borrowings. Interest rate risk is the risk that the earnings and capital will be adversely affected by changes in interest rates. Further discussion of interest rate risk can be found under the caption “Asset/Liability Management and Market Risk” in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section of this document.

     Competition. The activities of the Bancorp and the Bank in the geographic market served involve competition with other banks as well as with other financial institutions and enterprises, many of which have substantially greater resources than those available to the Bancorp. In addition, non-bank competitors are generally not subject to the extensive regulation applicable to the Bancorp and the Bank.

Report of Independent Registered Public Accounting Firm

Board of Directors
NorthWest Indiana Bancorp
Munster, Indiana

We have audited the accompanying consolidated balance sheets of NorthWest Indiana Bancorp (“Company”) as of December 31, 2006 and 2005 and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2006. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of NorthWest Indiana Bancorp as of December 31, 2006 and 2005, and the results of their operations and its cash flows for each of the three years in the period ended December 31, 2006 in conformity with U.S. generally accepted accounting principles.

As disclosed in Note 1, during 2006 the Company adopted new accounting guidance for post-retirement benefits.

South Bend, Indiana
March 13, 2007

Consolidated Balance Sheets

		December 31,
(Dollars in thousands)		2006				2005
ASSETS
Cash and noninterest bearing balances in financial institutions		$	15,764			$	19,772
Interest bearing balances in financial institutions			—				20,059
Total cash and cash equivalents			15,764				39,831
Securities available-for-sale			83,765				76,382
Securities held-to-maturity; fair value: December 31, 2006 - $15,380 December 31, 2005 - $13,668			15,247				13,711
Loans receivable			471,716				469,043
Less: allowance for loan losses			(4,267	)			(4,181	)
Net loans receivable			467,449				464,862
Federal Home Loan Bank stock			3,544				2,987
Accrued interest receivable			3,331				2,986
Premises and equipment			14,603				14,510
Foreclosed real estate			323				260
Cash value of bank owned life insurance			10,822				8,457
Investment in real estate limited partnerships			696				808
Other assets			3,438				2,645
Total assets		$	618,982			$	627,439
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits:
Noninterest bearing		$	43,889			$	49,204
Interest bearing			469,042				476,527
Total			512,931				525,731
Borrowed funds			51,501				51,153
Accrued expenses and other liabilities			4,540				4,122
Total liabilities			568,972				581,006
Stockholders’ Equity:
Preferred stock, no par or stated value; 10,000,000 shares authorized, none outstanding			—				—
Common stock, no par or stated value; 10,000,000 shares authorized;
shares issued: December 31, 2006 - 2,870,437 December 31, 2005 - 2,856,539
shares outstanding: December 31, 2006 - 2,799,814 December 31, 2005 - 2,785,916			359				357
Additional paid-in capital			4,610				4,299
Accumulated other comprehensive loss			(389	)			(1,089	)
Retained earnings			46,952				44,388
Treasury stock, common shares at cost: December 31, 2006 and 2005 - 70,623			(1,522	)			(1,522	)
Total stockholders’ equity			50,010				46,433
Total liabilities and stockholders’ equity		$	618,982			$	627,439

See accompanying notes to consolidated financial statements.

Consolidated Statements of Income

		Year Ended December 31,
(Dollars in thousands, except per share data)		2006				2005				2004
Interest income:
Loans receivable
Real estate loans		$	25,819			$	22,364			$	21,007
Commercial loans			4,356				3,633				2,371
Consumer loans			250				267				331
Total loan interest			30,425				26,264				23,709
Taxable securities			3,342				2,758				2,517
Tax exempt securities			715				531				305
Other interest earning assets			497				471				83
Total interest income			34,979				30,024				26,614
Interest expense:
Deposits			13,460				7,946				5,339
Borrowed funds			2,278				1,812				1,519
Total interest expense			15,738				9,758				6,858
Net interest income			19,241				20,266				19,756
Provision for loan losses			15				245				385
Net interest income after provision for loan losses			19,226				20,021				19,371
Noninterest income:
Fees and service charges			2,950				2,409				2,122
Wealth management operations			657				601				498
Increase in cash value of bank owned life insurance			365				310				147
Gain on sale of loans, net			157				102				234
Gain on securities, net			3				70				284
Gain on sale of foreclosed real estate			43				8				1
Other			44				40				26
Total noninterest income			4,219				3,540				3,312
Noninterest expense:
Compensation and benefits			7,329				7,179				6,837
Occupancy and equipment			2,381				2,225				2,195
Data processing			827				774				723
Statement and check processing			348				368				195
Marketing			325				270				233
Professional services			378				242				298
Other			2,708				2,713				2,693
Total noninterest expense			14,296				13,771				13,174
Income before income tax expenses			9,149				9,790				9,509
Income tax expenses			2,674				3,118				3,219
Net income		$	6,475			$	6,672			$	6,290
Earnings per common share:
Basic		$	2.32			$	2.40			$	2.28
Diluted		$	2.30			$	2.37			$	2.24
Dividends declared per common share		$	1.40			$	1.32			$	1.24

See accompanying notes to consolidated financial statements.

Consolidated Statements of Changes in Stockholders’ Equity

										Accumulated
						Additional				Other
		Common				Paid-in				Comprehensive				Retained				Treasury				Total
(Dollars in thousands, except per share data)		Stock				Capital				Income (Loss)				Earnings				Stock				Equity
Balance at January 1, 2004		$	353			$	3,567			$	540			$	38,534			$	(1,440	)		$	41,554
Comprehensive income:
Net income			—				—				—				6,290				—				6,290
Net unrealized gain/(loss) on securities available-for-sale, net of reclassification and tax effects			—				—				(720	)			—				—				(720	)
Comprehensive income			—				—				—				—				—				5,570
Issuance of 18,747 shares of common stock at $10.63 - $30.00 per share, under stock-based compensation plans			2				403				—				—				—				405
Cash dividends, $1.24 per share			—				—				—				(3,432	)			—				(3,432	)
Balance at December 31, 2004			355				3,970				(180	)			41,392				(1,440	)			44,097
Comprehensive income:
Net income			—				—				—				6,672				—				6,672
Net unrealized gain/(loss) on securities available-for-sale, net of reclassification and tax effects			—				—				(909	)			—				—				(909	)
Comprehensive income			—				—				—				—				—				5,763
Issuance of 15,560 shares of common stock at $10.63 - $35.50 per share, under stock-based compensation plans, including related tax effects			2				329				—				—				—				331
Purchase of treasury stock			—				—				—				—				(82	)			(82	)
Cash dividends, $1.32 per share			—				—				—				(3,676	)			—				(3,676	)
Balance at December 31, 2005			357				4,299				(1,089	)			44,388				(1,522	)			46,433
Comprehensive income:
Net income			—				—				—				6,475				—				6,475
Net unrealized gain/(loss) on securities available-for-sale, net of reclassification and tax effects			—				—				593				—				—				593
Comprehensive income			—				—				—				—				—				7,068
Adjustment to initially apply SFAS No. 158, net of tax effects			—				—				107				—				—				107
Issuance of 15,348 shares of common stock at $10.63 - $35.50 per share, under stock-based compensation plans, including related tax effects			2				244				—				—				—				246
Stock-based compensation expense			—				67				—				—				—				67
Cash dividends, $1.40 per share			—				—				—				(3,911	)			—				(3,911	)
Balance at December 31, 2006		$	359			$	4,610			$	(389	)		$	46,952			$	(1,522	)		$	50,010

See accompanying notes to consolidated financial statements.

Consolidated Statements of Cash Flows

		Year Ended December 31,
(Dollars in thousands)		2006				2005				2004
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	6,475			$	6,672			$	6,290
Adjustments to reconcile net income to net cash provided by operating activities:
Origination of loans for sale			(9,141	)			(5,499	)			(3,835	)
Sale of loans originated for sale			9,234				5,591				3,921
Depreciation and amortization, net of accretion			1,310				1,466				1,425
Amortization of mortgage servicing rights			84				97				71
Amortization of investment in real estate limited partnerships			132				125				50
Equity in (gain)/loss of investments in limited partnership, net of interest received			89				11				39
Stock-based compensation			67				—				—
Federal Home Loan Bank stock dividend			—				(83	)			(129	)
Net gains on sale of securities			(3	)			(70	)			(284	)
Net gains on sale of loans			(157	)			(102	)			(234	)
Net gain on sale of foreclosed real estate			(43	)			(8	)			(1	)
Provision for loan losses			15				245				385
Net change in:
Interest receivable			(345	)			(527	)			(210	)
Cash value of bank owned life insurance			(365	)			(310	)			(147	)
Other assets			(1,324	)			(23	)			732
Accrued expenses and other liabilities			542				(459	)			(198	)
Total adjustments			95				454				1,585
Net cash from operating activities			6,570				7,126				7,875
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities and paydowns of securities available-for-sale			13,352				8,703				21,849
Proceeds from sales of securities available-for-sale			3,290				8,777				8,305
Purchase of securities available-for-sale			(23,137	)			(26,126	)			(39,500	)
Purchase of securities held-to-maturity			(1,561	)			(2,939	)			(7,925	)
Proceeds from maturities and paydowns of securities held-to-maturity			13				14				12
Proceeds from sale of loans transferred to held for sale			—				—				12,166
Loan participations purchased			(12,354	)			(23,121	)			(17,756	)
Net change in loans receivable			9,413				(12,084	)			(18,985	)
Proceeds from sale of Federal Home Loan Bank Stock			164				—				—
Purchase of Federal Home Loan Bank Stock			(721	)			—				—
Purchase of premises and equipment, net			(1,360	)			(1,687	)			(994	)
Proceeds from sale of foreclosed real estate			319				28				35
Purchase of bank owned life insurance			(2,000	)			—				(8,000	)
Net cash from investing activities			(14,582	)			(48,435	)			(50,793	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Change in deposits			(12,800	)			74,158				29,933
Proceeds from FHLB advances			26,000				12,000				20,000
Repayment of FHLB advances			(31,500	)			(14,000	)			(7,000	)
Change in other borrowed funds			5,848				(4,048	)			3,306
Tax effect of nonqualified stock option exercise			15				1				—
Proceeds from issuance of common stock			231				330				405
Dividends paid			(3,849	)			(3,617	)			(3,398	)
Treasury stock purchased			—				(82	)			—
Net cash from financing activities			(16,055	)			64,742				43,246
Net change in cash and cash equivalents			(24,067	)			23,433				328
Cash and cash equivalents at beginning of period			39,831				16,398				16,070
Cash and cash equivalents at end of period		$	15,764			$	39,831			$	16,398
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid during the period for:
Interest		$	7,560			$	9,612			$	6,868
Income taxes		$	3,230			$	2,965			$	2,450
SUPPLEMENTAL NONCASH INFORMATION:
Transfers from loans to foreclosed real estate		$	339			$	307			$	314
Transfers from loans to loans held for sale		$	—			$	—			$	12,202

See accompanying notes to consolidated financial statements.

Notes to Consolidated Financial Statements
Years ended December 31, 2006, 2005 and 2004

NOTE 1 — Summary of Significant Accounting Policies

     Principles of Consolidation — The consolidated financial statements include NorthWest Indiana Bancorp (the Bancorp), its wholly owned subsidiary, Peoples Bank SB (the Bank), and the Bank’s wholly owned subsidiaries, Peoples Service Corporation and NWIN, LLC. The Bancorp has no other business activity other than being a holding company for the Bank. The Bancorp’s earnings are dependent upon the earnings of the Bank. Peoples Service Corporation provides insurance and annuity investments to the Bank’s wealth management customers. NWIN, LLC is located in Las Vegas, Nevada and serves as the Bank’s investment subsidiary and parent of a real estate investment trust, NWIN Funding, Inc.

     NWIN Funding, Inc. was formed on September 1, 2006 as an Indiana Real Estate Investment Trust. The formation of NWIN Funding, Inc. provides the Bancorp with a vehicle that may be used to raise capital, utilizing portfolio mortgages as collateral, without diluting stock ownership. In addition, NWIN Funding, Inc. will receive favorable state tax treatment for income generated by its operations. All significant inter-company accounts and transactions have been eliminated in consolidation.

     Use of Estimates — Preparing financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period, as well as the disclosures provided. Actual results could differ from those estimates. Estimates associated with the allowance for loan losses, loan servicing rights, fair values of financial instruments and status of contingencies are particularly susceptible to material change in the near term.

     Concentrations of Credit Risk — The Bancorp grants residential, commercial real estate, commercial business and installment loans to customers primarily of Lake County, in northwest Indiana. Substantially all loans are secured by specific items of collateral including residences, commercial real estate, business assets and consumer assets.

     Cash Flow Reporting — For purposes of the statement of cash flows, the Bancorp considers cash on hand, noninterest bearing balances in financial institutions, all interest-bearing balances in financial institutions with original maturities of ninety days or less and federal funds sold to be cash and cash equivalents. The Bancorp reports net cash flows for customer loan and deposit transactions and short-term borrowings with maturities of 90 days or less.

Interest-bearing Deposits in Other Financial Institutions - Interest bearing deposits in other financial institutions mature within one year and are carried at cost.

     Securities — The Bancorp classifies securities into held-to-maturity, available-for-sale, or trading categories. Held-to-maturity securities are those which management has the positive intent and the Bancorp the ability to hold to maturity, and are reported at amortized cost. Available-for-sale securities are those the Bancorp may decide to sell if needed for liquidity, asset-liability management or other reasons. Available-for-sale securities are reported at fair value, with unrealized gains and losses reported in other comprehensive income. The Bancorp does not have a trading portfolio. Realized gains and losses resulting from the sale of securities recorded on the trade date are computed by the specific identification method. Interest and dividend income, adjusted by amortization of premium or discount on a level yield method are included in earnings. Securities are written down to fair value when a decline in fair value is not temporary.

     Declines in the fair value of securities below their cost that are other than temporary are reflected as realized losses. In estimating other than temporary losses, management considers: (1) the length of time and extent that fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, and (3) the Bancorp’s ability and intent to hold the security for a period sufficient to allow for any anticipated recovery in fair value.

     Loans Held for Sale — Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or market, as determined by outstanding commitments from investors. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings.

     Mortgage loans held for sale are generally sold with servicing rights retained. The carrying value of mortgage loans sold is reduced by the cost allocated to the servicing rights. Gains and losses on sales of mortgage loans are based on the difference between the selling price and the carrying value of the related loan sold.

     Loans and Loan Income — Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of unearned interest, deferred loan fees and costs, and an allowance for loan losses. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using the level yield method without anticipating prepayments.

     Interest income on mortgage and commercial loans is discontinued at the time the loan is 90 days delinquent unless the loan is well-secured and in process of collection. Consumer loans are typically charged off no later than 120 days past due. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on non-accrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.

     All interest accrued but not received for loans placed on non-accrual is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

     Allowance for Loan Losses — The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off.

     A loan is considered impaired when, based on current information and events, it is probable that the Bancorp will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case by case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Bancorp does not separately identify individual consumer and residential loans for impairment disclosures.

     Federal Home Loan Bank Stock — The Bank is a member of the FHLB system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. FHLB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on ultimate recovery of par value. Both cash and stock dividends are reported as income.

     Premises and Equipment — Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Premises and related components are depreciated using the straight-line method with useful lives ranging from 26 to 39 years. Furniture and equipment are depreciated using the straight-line method with useful lives ranging from 3 to 10 years.

     Foreclosed Real Estate — Assets acquired through or instead of loan foreclosure are initially recorded at fair value when acquired, establishing a new cost basis. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Operating costs after acquisition are expensed.

     Servicing Rights — Servicing assets represent the allocated value of retained servicing rights on loans sold. Servicing assets are expensed in proportion to, and over the period of, estimated net servicing revenues. Impairment is evaluated based on the fair value of the assets, using groupings of the underlying loans as to interest rates. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market based assumptions. Any impairment of a grouping is reported as a valuation allowance, to the extent that fair value is less than the capitalized amount for a grouping.

     Investment in Real Estate Limited Partnerships — Investment in real estate limited partnerships represent the Bancorp’s investments in affordable housing projects for the primary purpose of available tax benefits. The method of accounting used for each investment is based on ownership percentage in the investment. One investment is accounted for using the cost method of accounting. The excess of the carrying amount of the investment over its estimated residual value is amortized during the periods in which associated tax credits are allocated to the investor. The annual amortization of the investment is based on the proportion of tax credits received in the current year to total estimated tax credits to be allocated to the Bancorp. The other investment is accounted for using the equity method of accounting. Under the equity method of accounting, the Bancorp records its share of the partnership’s earnings or losses in its income statement and adjusts the carrying amount of the investments on the balance sheet. These investments are reviewed for impairment when events indicate their carrying amounts may not be recoverable from future undiscounted cash flows. If impaired, the investments are reported at fair value. The Bancorp’s involvement in these types of investments is for tax planning purposes only and, as such, the Bancorp is not involved in the management or operation of such investments.

     Long-term Assets — Premises and equipment, core deposit and other intangible assets, and other long term assets are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value.

     Bank Owned Life Insurance — The Bank has purchased life insurance policies on certain key management personnel. Bank owned life insurance is recorded at its cash surrender value, or the amount that can be realized.

     Repurchase Agreements — Substantially, all repurchase agreement liabilities represent amounts advanced by various customers that are not covered by federal deposit insurance and are secured by securities owned by the Bancorp.

     Postretirement Benefits Other Than Pensions — The Bancorp sponsors a defined benefit postretirement plan that provides comprehensive major medical benefits to all eligible

retirees. Postretirement benefits are accrued based on the expected cost of providing postretirement benefits to employees during the years the employees have rendered service to the Bancorp.

     Stock Compensation — Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-based Payment,” using the modified prospective transition method. Accordingly, the Company has recorded stock-based employee compensation cost using the fair value method starting in 2006. For 2006, adopting this standard resulted in a reduction of income before income taxes of $37 thousand, a reduction in net income of $22 thousand, a decrease in basic and diluted earnings per share of $0.01 and a decrease in cash flow from operations of $37 thousand.

     During 2006, the exercising of stock options increased cash flows from financing activities by $231 thousand. In addition, the tax effect from the exercising of nonqualified stock options increased cash flows from financing activities by $15 thousand.

     As of December 31, 2006, there was $30 thousand of total unrecognized compensation cost related to nonvested stock options granted under the Plan. The cost is expected to be recognized over a weighted-average period of 2.0 years.

     Prior to January 1, 2006, employee compensation expense under stock options was reported using the intrinsic value method; therefore, no stock based compensation cost is reflected in net income for the years ending December 31, 2005 and 2004, as all options granted had an exercise price equal to or greater than the market price of the underlying common stock at date of grant.

     The following table illustrates the effect on net income and earnings per share if expense was measured using the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock Based Compensation, for the years ending December 31:

		(Dollars in thousands)
		2005				2004
Net income as reported		$	6,672			$	6,290
Deduct: Stock-based compensation expense determined under fair value based method			(45	)			(51	)
Pro forma net income		$	6,627			$	6,239
Basic earnings per common share as reported		$	2.40			$	2.28
Pro forma basic earnings per common share		$	2.38			$	2.26
Diluted earnings per common share as reported		$	2.37			$	2.24
Pro forma diluted earnings per common share		$	2.35			$	2.22

     Income Taxes — Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.

     Loan Commitments and Related Financial Instruments — Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and standby letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded.

     Earnings Per Common Share — Basic earnings per common share is net income divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per common share includes the dilutive effect of additional potential common shares issuable under stock options.

     Comprehensive Income — Comprehensive income consists of net income and other comprehensive income. Other comprehensive income for the Bancorp includes unrealized gains and losses on securities available-for-sale.

     Loss Contingencies — Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there now are such matters that will have a material effect on the financial statements.

     Restrictions on Cash — Cash on hand or on deposit with the Federal Reserve Bank of $345,000 and $5,398,000 was required to meet regulatory reserve and clearing requirements at year-end 2006 and 2005. These balances do not earn interest.

     Fair Value of Financial Instruments — Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.

     Operating Segments — While the Bancorp’s executive management monitors the revenue streams of the various products and services, the identifiable segments are not material and operations are managed and financial performance is evaluated on a company-wide basis. Accordingly, all of the Bancorp’s financial service operations are considered by management to be aggregated in one reportable operating segment.

     Reclassification — Certain amounts appearing in the consolidated financial statements and notes thereto for the years ended December 31, 2004 and December 31, 2005, may have been reclassified to conform to the December 31, 2006 presentation.

     Adoption of New Accounting Standards — Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-based Payment.” See “Stock Compensation” above for further discussion of the effect of adopting this standard.

     In September 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans –an amendment of FASB Statements No. 87, 88, 106 and 132(R). This Statement requires an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan (other than a multiemployer plan) as an asset or liability in its balance sheet, beginning with year end 2006, and to recognize changes in the funded status in the year in which the changes occur through comprehensive income beginning in 2007. Additionally, defined benefit plan assets and obligations are to be measured as of the date of the employer’s fiscal year-end, starting in 2008.

     Adoption had the following effect on individual line items in the 2006 balance sheet:

		(Dollars in thousands)
		Before								After
		Application								Application
		of								of SFAS
		SFAS No. 58				Adjustments				No. 58
Liability for postretirement benefits		$	207			$	(185	)		$	22
Deferred income taxes			(1,464	)			78				(1,503	)
Total assets			619,060				(78	)			618,982
Total liabilities			569,157				(185	)			568,972
Accumulated other comprehensive loss			(496	)			107				(389	)
Total stockholders’ equity		$	49,903			$	107			$	50,010