2011 Annual Report

David A. Bochnowski
Chairman and Chief Executive Officer

Dear Shareholder,

2011 proved to be another year of uncertainty for American households and small business owners, yet hopeful signs for an economic recovery began to take hold in the latter part of the year as employment improved and consumer spending increased. Despite the slow pace of the economic growth that prevailed throughout the year, the Bancorp reported another solid year of performance as income increased 4.0% over the prior year. Once again, your company outpaced the results of the banking industry during the year.

Strategic Focus

In keeping with our mission, we seek ways to provide our customers, shareholders, and the communities we serve with exceptional value and an unparalleled banking experience. Our strategic focus as a community bank has built a sustainable business model capable of absorbing unforeseen shocks to the fabric of the economy, while providing a strong capital base to enable our continued growth as a modern community bank.

The Bancorp enjoys a 101-year tradition of community banking and we recognize that remaining relevant to our customers, shareholders, and communities is our most important task. In addition, the Bancorp’s strategy emphasizes banking fundamentals with core earnings and cost efficient operations leading the way. As a result, our operating margin and efficiency ratio sustained earnings in 2011 as it always has.

Unlike many competitors in the banking sector, the Bancorp has reported income for each of the last twenty-seven years. Additionally, the strength of our financial results permitted the continued payment of dividends to our shareholders throughout the Great Recession. Our consistent performance has provided financial stability to support our growth as a community bank, enabling the Bancorp to invest in a professional team as well as locations and technology that meet customer needs in the 21st century.

Customer Value

Our well-trained team is dedicated to delivering our unique brand of “You First Banking” through our network of banking center locations and access to the bank through 21^st century technology. To measure how effectively we are meeting the needs of our customers, we contracted with a leading financial services research firm to survey our customers. We are pleased to report that overall customer satisfaction stands at 96% along with a very high loyalty index of 78% which was well above the average for the survey. Moreover, 70% of those surveyed consider your bank to be their primary financial institution, underscoring the level of strength of our customer loyalty and satisfaction. The percentage of customers who consider Peoples Bank primary and only use your bank was also significantly higher than the survey average.

Customers continue to demonstrate an increasing preference for electronic banking services. During the year, we enhanced electronic convenience to our menu of services by offering customers the ability to bank anywhere, anytime, from their phone.

Our free Mobile Banking app, introduced in November, enables customers to turn their smart phone into a virtual bank and conduct transactions 24/7. Using our refreshed and free online banking platform, customers have the ability to pay bills, check balances and transfer funds within their accounts, for example, without having to step into a Banking Center.

At year-end, we realized 23% new growth in Online Banking enrollments and, after two months, over half of our 2012 goal of the number of mobile banking customers enrolled. Both results are proof that we are successfully delivering products and services through delivery channels appropriate for today’s customers.

In today’s world, a community bank cannot ignore the fact that millions of people are active users of a social networking service. Because it is important to be connected and maintain an open forum for communication with our customers and communities, we launched the Bank’s Facebook page in the spring. An ever-growing fan base tells us that the messages we send are engaging and have value, affording us the opportunity to further develop current and future customer relationships in the spirit of You First Banking.

Working with business customers to satisfy their unique business needs is what You First Banking is all about. Our partnership with small business customers is built on relationships, not just transactions, and it means that we work to provide financial solutions that best meet our customer’s needs and help grow their business. We are very proud of the outcomes. This year’s awards by the Northwest Indiana Small Business Development Center for “Small Business Person of the Year” and “Minority-Owned Business of the Year” went to our customers.

Shareholder Value

Income for the year totaled $5.4 million as banking fundamentals continue to produce strong results for our shareholders. Core income remained robust, our capital position continued to grow, asset quality improved, and operating costs held steady. At the end of 2011, the Bancorp reported a net interest margin of 4.17%, tangible equity capital of 9.66%, a 40.7% decrease in non-performing loans, and a 3.0% increase in operating costs. Our return on assets (ROA) was 0.84% and our return on equity (ROE) was 8.90%, as both of these key indicators of bank performance exceeded the results for our industry.

During the year, our priorities focused on core income, the reduction of non-performing loans, increasing our capital, and controlling the cost of our operations. Our results confirm that our goals were achieved in each of these key performance measurements.

The Bank’s core earnings are driven by our net interest margin, the difference between interest income from loans and investments and interest expense paid primarily to our funds providers. Our lowest cost funds are our core deposits: savings, checking, and money markets. During the year, core deposits increased by $28.2 million and, at year-end, core accounts exceeded 66.4% of deposits, demonstrating customer confidence in the strength of the Bank as well as our delivery channels for those products.

The economic stress of the recession has taken its toll on asset quality in the banking industry. Reducing past due loans and non-performing credits, and removing them from our balance sheet, continues to be our highest priority with favorable results from our effort. During the year, past due loans were reduced by $15.1 million or 45.5% and non-performing loans were reduced by $9.8 million or 40.7%. As a result, the Bancorp’s ratio of non-performing assets to total assets was 2.68%, a reduction of 39.9%. The market values for distressed credits have been measured by current appraisals with appropriate reserves in our allowance for loan losses which stood at 1.99% as a percentage of total loans at the end of the year.

Management closely monitored our operating costs during the year with an eye on our bottom line. We were pleased that our cost control measures held operating costs steady as our expenses increased by 3.0% during the year.

Maintaining a strong capital base is essential sound banking practice that has been given additional scrutiny by banking regulators as they demand increasing capital levels. Using balance sheet strategies as well as income generated from operations, the Bancorp increased our tangible equity capital to 9.7% of total assets during the year. Significantly, under all regulatory capital requirements, the Bancorp and our operating subsidiary Peoples Bank, are considered well capitalized, the highest rating for bank capital. The Bancorp’s regulatory capital ratios at year-end were 14.3% for total capital to risk weighted assets and 9.2% for Tier 1 capital to adjusted average assets.

Community Value

The well-being of the communities we serve continued to take center stage in 2011 as we looked to assist our youth, schools, neighborhoods, and community organizations with our time, talent, and treasure. Consistent with our You First Banking principles, the Peoples team provided thousands of hours of volunteer time to lend a hand in the collective effort to improve the quality of our community.

As a community bank with a century-old tradition, we know that the privilege of our banking charter extends not only to our customers but also to volunteering to serve side by side with our friends and neighbors in a collective effort to sustain our communities. We serve on the boards of numerous community groups, assist faith based endeavors, teach our youth, and work to improve our neighborhoods.

You First Banking puts our customers and our communities first. We maintained our active involvement in the Bank On initiative in conjunction with the Lake Area United Way to provide affordable financial support to the unbanked and under-banked residents of Northwest Indiana. Our talent was matched with the Boys and Girls Clubs as we taught financial literacy to the youth of our community. Internally we formed a Community Reinvestment team to seek opportunities and create innovative ways to reinvest in our neighborhoods.

The Bank’s Community First Committee, run entirely by employees, raised the most money from employee contributions ever in its 17-year history despite the challenges of the economy. Those funds were distributed to such diverse agencies as the Boys and Girls Clubs of Lake and Porter counties, the Food Bank of Northwest Indiana, the Legacy Foundation, Opportunity Enterprises, and Neighborhoods, Inc. among others. All in all, the Bank and the Peoples team assisted 186 organizations with financial assistance during 2011.

Banking on Our Future

Moving forward, your company will continue to look for ways to grow as the economy, regardless of the uncertainty of the pace, begins to recover. In 2012, the Bancorp will continue to focus on improving asset quality, grow our core accounts, monitor costs consistent with long term growth opportunities, and maintain a strong capital base. We will also look to opportunities to increase our loan volume to households and small businesses as the economy improves.

We will maintain open lines of communication with our consumer, small business, commercial, and wealth management customers, ensuring that we continue to provide viable financial solutions based on their needs, and deliver the products and services they desire through relevant channels.

Your Directors are all investors in your company and each of them understands the importance of dividends to community bank investors. The Board will continue to review our dividend policy on a quarterly basis to ensure that dividend payments are appropriate in relationship to capital ratios, current earnings, and shareholder returns.

On behalf of our Board of Directors and the entire Peoples team, thank you for your support and confidence in your company. With your assistance, the Bancorp has weathered the storm of the economy despite many unforeseen challenges. We are confident that with your continued assistance our customers, communities, and shareholders will benefit from your investment in the Bancorp.

	Sincerely,
	David A. Bochnowski
	Chairman and Chief Executive Officer
	“Peoples Bank is committed to providing you exceptional value and an unparalleled banking experience that enable you to achieve your financial goals.”
	MISSION STATEMENT

Selected Consolidated Financial Data

in thousands of dollars, except per share data

Business

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

The Bancorp conducts business from its Corporate Center in Munster and its twelve full-service offices located in Crown Point, Dyer, East Chicago, Gary, Hammond, Hobart, Merrillville, Munster, St. John, Schererville, and Valparaiso, 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, and loans to local municipalities. 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, and 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 January 31, 2012, the Bancorp had 2,837,562 shares of common stock outstanding and 408 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 the Bancorp’s 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 foreclosed real estate, 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, 2011, the Bancorp had total assets of $651.8 million and total deposits of $526.9 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, 2011, stockholders' equity totaled $63.0 million, with book value per share at $22.20. Net income for 2011 was $5.4 million, or $1.90 basic and diluted earnings per common share. The return on average assets was 0.84%, while the return on average stockholders’ equity was 8.90%.

Recent Developments

The Current Economic Environment. We continue to operate in a challenging and uncertain economic environment, including generally uncertain national conditions and local conditions in our markets. Overall economic growth continues to be slow and national and regional unemployment rates remain at elevated levels. The risks associated with our business remain acute in periods of slow economic growth and high unemployment. Moreover, financial institutions continue to be affected by a sluggish real estate market and constrained financial markets. While we are continuing to take steps to decrease and limit our exposure to problem loans, we nonetheless retain direct exposure to the residential and commercial real estate markets, and we are affected by these events.

Our loan portfolio includes residential mortgage loans, construction loans, and commercial real estate loans. Continued declines in real estate values, home sales volumes and financial stress on borrowers as a result of the uncertain economic environment, including job losses, could have an adverse effect on our borrowers or their customers, which could adversely affect our financial condition and results of operations. In addition, the current level of low economic growth on a national scale, the occurrence of another national recession, or further deterioration in local economic conditions in our markets could drive loan losses beyond that which are provided for in our allowance for loan losses and result in the following other consequences: increases in loan delinquencies; problem assets and foreclosures may increase; demand for our products and services may decline; deposits may decrease, which would adversely impact our liquidity position; and collateral for our loans, especially real estate, may decline in value, in turn reducing customers’ borrowing power, and reducing the value of assets and collateral associated with our existing loans.

Impact of Legislation. Over the last three-and-a-half years, Congress and the U.S. Department of the Treasury have enacted legislation and taken actions to address the disruptions in the financial system, declines in the housing market, and the overall regulation of financial institutions and the financial system. In this regard, on July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which significantly changed the regulation of financial institutions and the financial services industry. The Dodd-Frank Act includes provisions affecting large and small financial institutions alike, including several provisions that profoundly affect the regulation of community banks, thrifts, and small bank and thrift holding companies, such as the Bancorp. Among other things, the Dodd-Frank Act abolished the Office of Thrift Supervision effective July 21, 2011 and transferred its functions to the Office of the Comptroller of the Currency, FDIC, and Federal Reserve. The Dodd-Frank Act also relaxes rules regarding interstate branching, allows financial institutions to pay interest on business checking accounts, changes the scope of federal deposit insurance coverage, imposes new capital requirements on bank and thrift holding companies, and imposes limits on debit card interchange fees charged by issuer banks (commonly known as the Durbin Amendment). The Dodd-Frank Act also established the Bureau of Consumer Financial Protection (the “BCFP”) within the Federal Reserve, which has broad authority to regulate consumer financial products and services and entities offering such products and services, including banks. In July 2011, many of the consumer financial protection functions formerly assigned to the federal banking and other designated agencies transferred to the BCFP. The BCFP has a large budget and staff, and has broad rulemaking authority over providers of credit, savings, and payment services and products. In this regard, the BCFP has the authority to implement regulations under federal consumer protection laws and enforce those laws against, and examine, financial institutions. State officials also will be authorized to enforce consumer protection rules issued by the BCFP. This bureau also is authorized to collect fines and provide consumer restitution in the event of violations, engage in consumer financial education, track consumer complaints, request data, and promote the availability of financial services to underserved consumers and communities. The BCFP also is directed to prevent “unfair, deceptive or abusive practices” and ensure that all consumers have access to markets for consumer financial products and services, and that such markets are fair, transparent, and competitive. Because the BCFP was only recently established and its director has been only recently appointed, there is significant uncertainty as to how the BCFP actually will exercise its regulatory, supervisory, examination, and enforcement authority. However, the BCFP’s authority to change regulations adopted in the past by other regulators (i.e., regulations issued under the Truth in Lending Act, for example), or to rescind or ignore past regulatory guidance, could increase the Bancorp’s compliance costs and litigation exposure.

Additionally, the Dodd-Frank Act includes a series of provisions covering mortgage loan origination standards affecting, among other things, originator compensation, minimum repayment standards, and pre-payments. Moreover, the Dodd-Frank Act requires public companies like the Bancorp to hold shareholder advisory “say-on-pay” votes on executive compensation at least once every three years and submit related proposals to a vote of shareholders. However, the SEC has provided a temporary exemption for smaller reporting companies, such as the Bancorp, from the requirement to hold “say-on-pay” votes until the first annual or other shareholder meeting occurring on or after January 21, 2013. The Dodd-Frank Act contains numerous other provisions affecting financial institutions of all types, many of which may have an impact on the operating environment of the Bancorp in substantial and unpredictable ways. Consequently, the Dodd-Frank Act is expected to increase our cost of doing business, it may limit or expand our permissible activities, and it may affect the competitive balance within our industry and market areas. The Bancorp’s management continues to actively monitor the implementation of the Dodd-Frank Act and the regulations promulgated thereunder and assess its probable impact on the business, financial condition, and results of operations of the Bancorp. However, the ultimate effect of the Dodd-Frank Act on the financial services industry in general, and the Bancorp in particular, continues to be uncertain.

Difficult Market Conditions Have Adversely Affected Our Industry. We are particularly exposed to downturns in the U.S. housing market. Dramatic declines in the housing market over the past four years, with falling home prices and increasing foreclosures, unemployment and under-employment, have negatively impacted the credit performance of mortgage and construction loans and securities and resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities, major commercial and investment banks, and regional financial institutions. Reflecting concern about the stability of the financial markets generally and the strength of counterparties, especially in light of the recent European sovereign debit crisis, many lenders and institutional investors have continued to observe tight lending standards, including with respect to other financial institutions. These market conditionshave led to an increased level of commercial and consumer delinquencies, lack of consumer confidence, and increased market volatility. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on the Bancorp and others in the financial institutions industry. In particular, the Bancorp may face the following risks in connection with these events:

In addition, the Federal Reserve Bank has been injecting vast amounts of liquidity into the banking system to compensate for weaknesses in short-term borrowing markets and other capital markets. A reduction in the Federal Reserve’s activities or capacity could reduce liquidity in the markets, thereby increasing funding costs to the Bancorp or reducing the availability of funds to the Bancorp to finance its existing operations.

Concentrations of Real Estate Loans Subjects the Bancorp to Increased Risks as a result of a Protracted Real Estate Recession. A significant portion of the Bancorp’s loan portfolio is secured by real estate. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. While real estate values in almost all regions of the country, including the Midwest, have shown signs of stabilizing, the overall real estate market on a national level continues to show weakness indicative of a protracted real estate recession. A further weakening of the real estate market could result in an increase in the number of borrowers who default on their loans and a reduction in the value of the collateral securing their loans, which in turn could have an adverse effect on our profitability and asset quality. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our earnings and capital could be adversely affected.

Financial Condition

During the year ended December 31, 2011, total assets increased by $20.7 million (3.3%), to $651.8 million, with interest-earning assets increasing by $21.9 million (3.7%). At December 31, 2011, interest-earning assets totaled $607.9 million and represented 93.3% of total assets. Loans totaled $401.4 million and represented 66.0% of interest-earning assets, 61.6% of total assets and 76.2% 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 emphasizes quality growth, product diversification, and competitive and profitable pricing. The loan portfolio includes $154.2 million (38.3%) in residential real estate loans, $146.4 million (36.5%) in commercial real estate loans, $21.1 million (5.3%) in construction and land development loans, $63.3 million (15.8%) in commercial business loans, $8.6 million (2.2%) in government and other loans, $7.3 million (1.8%) in multifamily loans, and $472 thousand (0.1%) in consumer loans. Adjustable rate loans comprised 60.8% of total loans at year-end. During 2011, loan balances decreased by $16.8 million (4.1%), with commercial real estate, commercial business, and residential real estate loan balances increasing, while construction and development, government, multifamily, and consumer balances decreased. The decrease in loans during the year is partially the result of management’s interest rate risk reduction strategy of selling fixed rate mortgage loans to the secondary market. Additionally, the current economic environment has led to an increase in loan payoffs and decreased loan demand, which have also contributed to a decrease in loan balances.

The Bancorp is primarily a portfolio lender. Mortgage banking activities are generally limited to the sale of fixed rate mortgage loans with contractual maturities greater than 15 years. During 2011, the Bancorp also began selling loans with contractual maturities of 15 years, as long-term interest rates revisited historic lows. These loans are identified as held-for-sale when originated and sold, on a loan-by-loan basis, in the secondary market. During 2011, the Bancorp sold $10.6 million in newly originated fixed rate mortgage loans, compared to $36.3 million during 2010. The decline in loan sales during 2011 is primarily the result of reduced refinance activity, as well as reduced demand for residential mortgages. Net gains realized from mortgage loan sales totaled $256 thousand for 2011, compared to $1.3 million for 2010. At December 31, 2011, the Bancorp had no loans that were classified as held-for-sale.

The allowance for loan losses (ALL) is a valuation allowance for probable incurred credit losses, increased by the provision for loan losses, and decreased by charge-offs less recoveries. A loan is charged-off against the allowance by management as a loss when deemed uncollectible, although collection efforts continue and future recoveries may occur. The determination of the amounts 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 collectability as of the reporting date. The appropriateness of the current period provision and the overall adequacy of the ALL are determined through a disciplined and consistently applied quarterly process that reviews the Bancorp’s current credit risk within the loan portfolio and identifies the required allowance for loan losses given the current risk estimates.

Historically, the Bancorp has successfully originated commercial real estate loans within its primary lending area. However, beginning in the fourth quarter of 2005, in response to a decrease in local loan demand and in an effort to reduce the potential credit risk associated with geographic concentrations, a strategy was implemented to purchase commercial real estate participation loans outside of the Bancorp’s primary lending area. The strategy to purchase these commercial real estate participation loans was limited to 10% of the Bancorp’s loan portfolio. The Bancorp’s management discontinued the strategy during the third quarter of 2007. As of December 31, 2011, the Bancorp’s commercial real estate participation loan portfolio carried an aggregate balance of $20.2 million. Of the $20.2 million in commercial real estate participation loans, $5.8 million has been purchased within the Bancorp’s primary lending area and $14.4 million outside of the primary lending area. At December 31, 2011, $7.2 million, or 35.6%, of the Bancorp’s commercial real estate participation loans have been internally classified as substandard and have been placed on non-accrual status. All $7.2 million in substandard commercial real estate participation loans placed on non-accrual status are located outside of the Bancorp’s primary lending area. The discussion in the paragraphs that follow regarding non-performing loans, internally classified loans and impaired loans includes loans from the Bancorp’s commercial real estate participation loan portfolio.

For all of its commercial real estate participation loans, consistent with current regulatory guidelines the Bancorp’s management requires that the lead lenders obtain external appraisals to determine the fair value of the underlying collateral for any collateral dependent loans. The Bancorp’s management requires current external appraisals when entering into a new lending relationship or when events have occurred that materially change the assumptions in the existing appraisal. The lead lenders receive external appraisals from qualified appraisal firms that have expertise in valuing commercial properties and are able to comply with the required scope of the engagement. After the lead lender receives the external appraisal and performs its compliance review, the appraisal is forwarded to the Bancorp for review. The Bancorp’s management validates the external appraisal by conducting an internal in-house review by personnel with expertise in commercial real estate developments. If additional expertise is needed, an independent review appraiser is hired to assist in the evaluation of the appraisal. The Bancorp is not aware of any significant time lapses during this process. Periodically, the Bancorp’s management may make adjustments to the external appraisal assumptions if additional known quantifiable data becomes available that materially impacts the value of a project. Examples of adjustments that may occur are changes in property tax assumptions or changes in capitalization rates. The Bancorp’s management relies on up-to-date external appraisals to determine the current value of its impaired commercial real estate participation loans. These values are appropriately adjusted to reflect changes in market value and, when necessary, are the basis for establishing the appropriate allowance for loan losses (ALL). If an updated external appraisal for a commercial real estate participation loan is received after the balance sheet date, but before the annual or quarterly financial statements are issued, material changes in appraised values are “pushed back” in the yet to be issued financial statements in order that appropriate loan loss provision is recorded for the current reporting period. The Bancorp’s management consistently records loan charge-offs based on the fair value or income approach of the collateral as presented in the current external appraisal.

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 $14.3 million at December 31, 2011, compared to $24.1 million at December 31, 2010, a decrease of $9.8 million or 40.7%. The decrease is related to loan pay downs, upgrades and charge-offs during 2011. The current level of non-performing loans is concentrated three substandard commercial real estate participation loans in the aggregate of approximately $7.2 million. As previously reported, one commercial real estate participation loan is a condominium construction project in Orlando, Florida, with a current balance of approximately $1.5 million, which has been charged down to its fair value that is based on the current fair value of the project’s collateral, less estimated selling costs. The second commercial real estate participation loan is an end loan for a hotel located in Dundee, Michigan, with a current balance of approximately $1.0 million, which has been charged down to its fair value that is based on the current fair value of the hotel, less estimated selling costs. The third commercial real estate participation loan is an end loan for a hotel located in Fort Worth, Texas, with a balance of approximately $4.7 million and has a specific allowance for loan losses allocation of $465 thousand. The carrying value of this loan is based on the current fair value of the hotel, less estimated selling costs. For these commercial real estate participation loans, to the extent that actual cash flows, collateral values and strength of personal guarantees differ from current estimates, additional provisions to the allowance for loan losses may be required.

The 2011 decrease in non-performing loans is related to the note sale of a previously reported commercial real estate participation construction loan for a hotel project located in Clearwater, Florida, with a balance at the time of sale of $2.8 million. During the fourth quarter of 2011, the Bancorp’s management sold the note for $2.2 million, while recording a loan charge-off of $549 thousand, of which $27 thousand was established as a specific reserve. Also impacting the 2011 non-performing loan balance, was the fourth quarter transfer of a $1.6 million commercial real estate participation land development project located in Crown Point, Indiana from loans to foreclosed real estate. Upon transfer to foreclosed real estate a $226 thousand loan charge-off was recorded to reflect a decline in market value. Lastly, during the fourth quarter of 2011, a $2.4 million commercial real estate loan was moved back into accrual status as a result of sustained performance by the borrower.

The ratio of non-performing loans to total loans was 3.56% at December 31, 2011, compared to 5.77% at December 31, 2010. The ratio of non-performing loans to total assets was 2.19% at December 31, 2011, compared to 3.82% at December 31, 2010. The December 31, 2011, non-performing loan balances include $14.0 million in loans accounted for on a non-accrual basis and $279 thousand in accruing loans, which were contractually past due 90 days or more. Loans, internally classified as substandard, totaled $24.6 million at December 31, 2011, compared to $32.7 million at December 31, 2010 a decrease of $8.1 million or 24.8%. The current level of substandard loans is concentrated in the previously mentioned three non-accruing commercial real estate participation loans and one accruing commercial real estate hotel loan in the amount of $5.0 million, which is the largest loan in this group. 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. No loans were internally classified as doubtful or loss at December 31, 2011 or December 31, 2010. 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 closely monitoring due to one or more factors that may cause the loan to become classified. Watch loans totaled $16.6 million at December 31, 2011, compared to $24.3 million at December 31, 2010 a decrease of $7.7 million or 31.7%.

A loan is considered impaired when, based on current information and events it is probable that a borrower will be unable to pay all amounts due according to the contractual terms of the loan agreement. At December 31, 2011, impaired loans totaled $21.7 million, compared to $26.0 million at December 31, 2010. The December 31, 2011, impaired loan balances consist of thirty-one commercial real estate and commercial business loans totaling $20.4 million that are secured by business assets and real estate, and are personally guaranteed by the owners of the businesses. In addition, fourteen mortgage loans totaling $1.3 million, which are troubled debt restructurings have also been classified as impaired. The December 31, 2011 ALL contained $1.6 million in specific allowances for collateral deficiencies, compared to $2.8 million at December 31, 2010. During the fourth quarter of 2011, one additional commercial development project totaling $1.8 million was newly classified as impaired. Management’s current estimates indicate a $205 thousand collateral deficiency for this loan. In addition, during the fourth quarter of 2011, five loans totaling $4.9 million were removed from impaired status due to payoffs, transfers to foreclosed real estate and charge-offs. As of December 31, 2011, all loans classified as impaired were also included in the previously discussed substandard loan balances, except for mortgage loans. There were no other loans considered to be impaired loans as of December 31, 2011. Typically, management does not individually classify smaller-balance homogeneous loans, such as residential mortgages or consumer loans, as impaired, unless they are troubled debt restructurings.

At December 31, 2011, the Bancorp classified nineteen loans totaling $14.8 million as troubled debt restructurings, which involves modifying the terms of a loan to forego a portion of interest or principal or reducing the interest rate on the loan to a rate materially less than market rates, or materially extending the maturity date of a loan. All of the loans classified as troubled debt restructurings are also considered impaired. The Bancorp’s troubled debt restructurings include two commercial real estate participation hotel loans in the amount of $5.6 million and one commercial real estate hotel loan in the amount of $5.0 million, for which significant deferrals of principal repayments were granted; one commercial real estate loan in the amount of $2.4 million for which a significant deferral of principal and interest repayment was granted; one commercial real estate loan in which the borrower is in bankruptcy in the amount of $463 thousand, for which a significant deferral of principal and interest repayment was granted by the Bank as required by the bankruptcy plan; and fourteen mortgage loans totaling $1.3 million, for which maturity dates were materially extended. All of the loans classified as troubled debt restructurings are currently on non-accrual status except for two loans totaling $7.4 million, which are performing and have been kept on accrual status. The valuation basis for the Bancorp’s troubled debt restructurings is based on the present value of cash flows, unless consistent cash flows are not present, then the fair value of the collateral securing the loan is the basis for valuation.

At December 31, 2011, 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 will imminently result in such loans being classified as past due, non-accrual or a troubled debt restructure. Management does not presently anticipate that any of the non-performing loans or classified loans would materially impact future operations, liquidity or capital resources.

For 2011, $3.5 million in provisions to the ALL were required, compared to $5.6 million for 2010. The ALL provision decrease for 2011 is primarily a result of improved asset quality. The current year ALL provisions were primarily related to the current credit risk in the commercial real estate participation and commercial real estate loan portfolios. For 2011, charge-offs, net of recoveries, totaled $4.6 million, compared to $2.6 million for 2010. The 2011 net loan charge-offs of $4.6 million were comprised of $3.4 million in commercial real estate participation loans, $698 thousand in commercial real estate loans, $358 thousand in residential real estate loans, $160 thousand in commercial business loans and $12 thousand in consumer loans. The ALL provisions take into consideration management’s current judgments about the credit quality of the loan portfolio, loan portfolio balances, changes in the portfolio mix and local economic conditions. In determining the provision for loan losses for the current period, management has given consideration to historically elevated risks associated with the local economy, changes in loan balances and mix, and asset quality.

The ALL to total loans was 1.99% at December 31, 2011, compared to 2.18% at December 31, 2010. The decrease in ALL to total loans was largely a result of charge-offs related to loans with previously identified valuation reserves. The ALL to non-performing loans (coverage ratio) was 56.03% at December 31, 2011, compared to 37.82% at December 31, 2010. The December 31, 2011 balance in the ALL account of $8.0 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 reserves to both performing and non-performing loans based on current information available.

At December 31, 2011, foreclosed real estate totaled $2.5 million, which was comprised of eleven properties, compared to $3.3 million and eighteen properties at December 31, 2010. The decrease is primarily a result of selling a $1.1 million commercial real estate condominium participation during the second quarter of 2011. At the end of December 2011 all of the Bancorp’s foreclosed real estate was located within its primary market area.

At December 31, 2011, the Bancorp's investment portfolio totaled $187.0 million and was invested as follows: 59.5% in U.S. government agency mortgage-backed securities and collateralized mortgage obligations, 31.4% in municipal securities, 8.4% in U.S. government agency debt securities, and 0.7% in trust preferred securities. During 2011, management transferred its entire held-to-maturity securities portfolio to available-for-sale in order to provide management with the ability to sell lower balance odd lot securities, divest of certain securities to reduce credit or interest rate risk within the portfolio, and be positioned to take advantage of other portfolio restructuring opportunities. Available-for-sale securities are those the Bancorp may decide to sell if needed for liquidity, asset-liability management or other reasons. The book value of the securities transferred totaled $16.4 million, with an unrealized gain of $1.0 million that was recorded as a component of other comprehensive income at the date of transfer. During 2011, securities increased by $26.5 million (16.5%). In addition, at December 31, 2011, the Bancorp had $3.1 million in FHLB stock.

As of December 31, 2011, three of the Bancorp’s four investments in trust preferred securities are in “payment in kind” status. Payment in kind status results in a temporary delay in the payment of interest. As a result of a delay in the collection of the interest payments, management placed these securities on non-accrual status. At December 31, 2011, the cost basis of the three trust preferred securities on non-accrual status totaled $3.9 million. Current estimates indicate that the interest payment delays may exceed ten years. One trust preferred security with a cost basis of $1.3 million remains on accrual status.

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, 2011, deposits totaled $526.9 million. During 2011, deposits increased by $6.6 million (1.3%). The 2011 change in deposits was comprised of the following: certificates of deposit decreased by $21.5 million (10.8%), while checking accounts increased by $16.2 million (11.4%), money market deposit accounts (MMDA’s) increased by $5.7 million (4.9%), and savings accounts increased by $6.2 million (9.6%). During 2011, management allowed higher cost certificates of deposit to mature while relying on funding from checking, MMDA, and savings deposits. The increase in checking, savings, and MMDA balances is a result of customer preferences for liquid investments in the current low interest rate environment.

The Bancorp’s borrowed funds are primarily comprised of repurchase agreements and FHLB advances that are used to fund asset growth not supported by deposit generation. At December 31, 2011, borrowed funds totaled $52.0 million compared to $48.6 million at December 31, 2010, an increase of $3.4 million (7.0%). During 2011, management added borrowed funds with an average rate of 0.95%, to take advantage of historically low interest rates. Retail repurchase agreements totaled $15.4 million at December 31, 2011, compared to $16.1 million at December 31, 2010, a decrease of $0.7 million (4.2%). FHLB advances totaled $36.0 million, increasing $7.0 million or 24.1%, as management extended the duration of its borrowings with low cost advances. The Bancorp’s FHLB line of credit carried a zero balance at December 31, 2011, compared to $3.2 million at December 31, 2010. Other short-term borrowings totaled $0.6 million at December 31, 2011, compared to $0.3 million at December 31, 2010.

Liquidity and Capital Resources

The Bancorp’s primary goals for funds and liquidity management are to generate sufficient cash to fund current loan demand, meet deposit withdrawals, and pay dividends and operating expenses. Because profit and liquidity are often conflicting objectives, management attempts to 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 as funding costs increase.

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, sale, 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, FHLB advances and federal funds purchased) as a source of funds.

During 2011, cash and cash equivalents increased $15.4 million compared to a decrease of $2.3 million for 2010. During 2011, the primary sources of cash and cash equivalents were from loan sales and repayments, maturities and sales of securities, FHLB advances, increase in deposits, and cash from operating activities. The primary uses of cash and cash equivalents were loan originations, purchase of securities, expenditures for premises and equipment, FHLB advance repayments, and the payment of common stock dividends. During 2011, cash from operating activities totaled $14.8 million, compared to $14.5 million for 2010. The 2011 increase in cash provided by operating activities was primarily a result of higher net income. Cash outflows from investing activities totaled $7.9 million during 2011, compared to inflows of $19.9 million during 2010. The changes for the current year were related to purchases of AFS securities, a smaller decrease in loans receivable, no sale of fixed rate mortgage loans from the loan portfolio, and less foreclosed real estate sales as compared to 2010. Security balances increased by $26.5 million during 2011 compared to $16.1 million during 2010, as management implemented it’s investment strategy. Loans receivable decreased $15.7 million during 2011 compared to a decrease of $43.0 million during 2010, as refinance activity slowed and fewer loans were transferred in foreclosure. Net cash inflows from financing activities totaled $8.4 million in 2011, compared to net cash outflows of $36.7 million in 2010. The change during 2011 was due to an increase in deposits, fewer repayments of FHLB advances, and lower dividend payouts. Deposits increased by $6.6 million during 2011, compared to a decrease of $20.3 million for 2010. FHLB advances increased by $7.0 million during 2011 compared to a $9.0 million decrease during 2010. The higher deposit growth was the result of the Bancorp’s banking center network and management’s ability to attract and retain core funds. The increase in FHLB advances was the result of managements portfolio allocation strategy during a historically low interest rate environment. The Bancorp paid dividends on common stock of $1.7 million and $2.2 million during 2011 and 2010, respectively. During 2011, the Bancorp’s Board of Directors reduced dividends to build capital and preserve long-term capital strength.

Management strongly believes that safety and soundness is enhanced by maintaining a high level of capital. Stockholders' equity totaled $63.0 million at December 31, 2011, compared to $56.1 million at December 31, 2010, an increase of $6.9 million (12.3%). The increase was a result of $5.4 million in net income for 2011. Additional items increasing stockholders' equity were $3.0 million from the change in valuation of available-for-sale securities, change in classification of held-to-maturity securities to available-for-sale, $124 thousand from the sale of treasury stock, and $33 thousand from stock-based compensation plans. Decreasing stockholders' equity were the Bancorp’s declaration of $1.7 million in cash dividends, and $9 thousand from the change in net unrealized items from the Bank’s postretirement plans. At December 31, 2011, book value per share was $22.20 compared to $19.84 for 2010.

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, 2011, the Bancorp’s capital exceeded all regulatory capital requirements. At December 31, 2011, the Bancorp’s and the Bank’s regulatory capital ratios were substantially the same. The dollar amounts are in millions.

The Bancorp’s ability to pay dividends to its shareholders is entirely dependent upon the Bank’s ability to pay dividends to the Bancorp. Under Indiana law, the Bank may pay dividends from its undivided profits (generally, earnings less losses, bad debts, taxes and other operating expenses) as is considered expedient by the Bank’s Board of Directors. However, the Bank must obtain the approval of the Indiana Department of Financial Institutions (DFI) for the payment of a dividend if the total of all dividends declared by the Bank during the current year, including the proposed dividend, would exceed the sum of retained net income for the year to date plus its retained net income for the previous two years. For this purpose, “retained net income,” means net income as calculated for call report purposes, less all dividends declared for the applicable period. The aggregate amount of dividends that may declared by the Bank in 2012, with prior DFI approval, is $7.7 million, plus current 2012 net profits. Moreover, the FDIC and the Federal Reserve Board may prohibit the payment of dividends if it determines that the payment of dividends would constitute an unsafe or unsound practice in light of the financial condition of the Bank.

On January 28, 2011, in accordance with prior direction from the Federal Reserve Bank of Chicago (the “Reserve Bank”), the Bancorp’s Board of Directors adopted a resolution providing that the prior written consent of the Reserve Bank is required for the declaration of dividends by the Bancorp. During December 2011, the Reserve Bank approved the fourth quarter 2011 dividend payments. On December 7, 2011, the Bancorp announced that the Board of Directors of the Bancorp declared a fourth quarter dividend of $0.15 per share. The Bancorp’s fourth quarter dividend was paid to shareholders on January 6, 2012. The current dividend policy is reflective of the Bancorp Board’s commitment that the shareholders’ long term interests are best served through the preservation of capital in the current stressed economic environment.

Results of Operations - Comparison of 2011 to 2010

Net income for 2011 was $5.4 million, compared to $5.2 million for 2010, an increase of $206 thousand (4.0%). The increase in net income for 2011 was the result of lower interest expense, lower required provisions for loan losses, and higher noninterest income. The earnings represent a return on average assets of 0.84% for 2011 compared to 0.77% for 2010. The return on average equity was 8.90% for 2011 compared to 9.03% for 2010.

Net interest income for 2011 was $23.8 million, a decrease of $1.3 million (5.2%) from $25.1 million for 2010. The decrease in net interest income has been impacted by the Federal Reserve’s actions to lower longer-term interest rates. The weighted-average yield on interest-earning assets was 4.49% for 2011 compared to 4.84% for 2010. The weighted-average cost of funds was 0.56% for 2011 compared to 0.82% for 2010. The impact of the 4.49% return on interest earning assets and the 0.56% cost of funds resulted in a net interest spread of 3.93% for 2011 compared to 4.02% for 2010. During 2011, total interest income decreased by $3.1 million (10.3%) while total interest expense decreased by $1.8 million (35.2%). The net interest margin was 3.96% for 2011 compared to 4.04% for 2010. The Bancorp’s tax equivalent net interest margin for 2011 was 4.17% compared to 4.25% for 2010.

During 2011, interest income from loans decreased by $3.2 million (13.1%) compared to 2010. The change was primarily due to a decrease in the weighted-average yield of the loan portfolio and lower average balances. The weighted-average yield on loans outstanding was 5.10% for 2011 compared to 5.39% for 2010. Loan balances averaged $409.8 million for 2011, a decrease of $36.8 million (8.2%) from $446.6 million for 2010. During 2011, interest income from securities and other interest earning assets increased by $58 thousand (1.0%) compared to 2010. The increase was due to an increase in average balances as excess liquidity was reinvested in the securities portfolio. The weighted-average yield on securities and other interest earning assets was 3.20% for 2011 compared to 3.45% for 2010. Securities and other interest earning assets averaged $190.7 million for 2011, up $15.6 million (8.9%) from $175.1 million for 2010.

Interest expense for deposits decreased by $1.4 million (36.8%) during 2011 compared to 2010. The change was due to a decrease in the weighted-average rate paid on deposits and lower average balances. The weighted-average rate paid on deposits for 2011 was 0.47% compared to 0.71% for 2010. Total deposit balances averaged $526.0 million for 2011, a decrease of $26.9 million (4.9%) from $552.9 million for 2010. Interest expense for borrowed funds decreased by $317 thousand (29.5%) during 2011 compared to 2010. The change was due to a decrease in the cost of borrowing and lower average balances. The weighted-average cost of borrowed funds was 1.50% for 2011 compared to 2.04% for 2010. Borrowed funds averaged $50.5 million during 2011, a decrease of $2.3 million (4.4%) from $52.8 million for 2010.

Noninterest income for 2011 was $6.2 million, an increase of $457 thousand (7.9%) from $5.8 million for 2010. During 2011, fees and service charges totaled $2.50 million, a decrease of $37 thousand (1.5%) from $2.54 million for 2010. Fees from Wealth Management operations totaled $1.18 million for 2011, an increase of $12 thousand (1.0%) from $1.17 million for 2010. Gains from the sale of securities totaled $966 thousand for the current year, an increase of $53 thousand (5.8%) from $913 thousand for 2010. Current market conditions provided opportunities to manage securities cash flows, while shortening the duration of cash flows. For 2011, foreclosed real estate sales gains totaled $887 thousand, an increase of $1.3 million (332.8%) from losses of $381 thousand for 2010. The increase is primarily related to the Bancorp’s favorable settlement in its lawsuit against the lead lender of a commercial real estate participation loan. Additionally, during 2010, a one-time sale of portfolio fixed rate mortgage loans, which the Bancorp sold to reduce interest rate risk on its balance sheet, attributed for $217 thousand of gains realized from loan sales. Income from the increase in the cash value of bank owned life insurance totaled $398 thousand for 2011, a decrease of $5 thousand (1.2%), compared to $403 thousand for 2010. During 2011, other-than-temporary impairment of $1 thousand was recognized compared to $128 thousand of impairment recognized during 2010. Gains from loan sales totaled $256 thousand for the year, a decrease of $1.0 million (79.7%), compared to $1.3 million for 2010. The decrease in gains from the sale of loans is a result of decreased consumer mortgage refinancing activity. During 2011, other noninterest income totaled $63 thousand, an increase of $46 thousand (270.6%) from $17 thousand for 2010.

Noninterest expense for 2011 was $19.9 million, up $587 thousand (3.0%) from $19.3 million for 2010. During 2011, compensation and benefits totaled $10.0 million, an increase of $354 thousand (3.7%) from $9.6 million for 2010. The change in compensation and benefits is related to the increase in personnel for retail banking activities related to the newly opened St. John, Indiana banking centers, and annual compensation increases for bank personnel. Occupancy and equipment expense totaled $3.3 million for 2011, an increase of $323 thousand (10.7%) compared to $3.0 million for 2010. The increase is related to the operations of the new banking center in St. John. Federal deposit insurance premiums totaled $946 thousand for 2011, a decrease of $4 thousand (0.4%) from $950 thousand for 2010. Data processing expense totaled $1.0 million for 2011, an increase of $64 thousand (6.8%) from $941 thousand for 2010. The change is a result of increased utilization of internal systems. Marketing expense related to banking products totaled $403 thousand for the year, a decrease of $82 thousand (16.9%) from $485 thousand for 2010. The decrease the result of a reduction in third party costs and running fewer marketing campaigns during the year. Statement and check processing expense totaled $329 thousand for the year, an increase of $22 thousand (7.2%) from $307 thousand for 2010. Professional service expense totaled $303 thousand for the year, a decrease of $33 thousand (9.8%) from $336 thousand for 2010. Other expenses related to banking operations totaled $3.66 million for 2011, a decrease of $57 thousand (1.5%) from $3.71 million for 2010. The Bancorp’s efficiency ratio for 2011 was 66.42% compared to 62.62% for 2010. The decrease is the result of lower net interest income and higher total noninterest expense. The ratio is determined by dividing total noninterest expense by the sum of net interest income and total noninterest income for the period.

The Bancorp had an income tax expense for 2011 of $1.2 million compared to income tax expense of $797 thousand for 2010, an increase to expense of $382 thousand (47.9%). The combined effective federal and state tax rates for the Bancorp were 18.0% for 2011 and 13.3% for 2010. The current year’s higher effective tax rate is the result of higher taxable income as a percentage of total income. The Bancorp’s current lower effective tax rate relative to federal and state statutory rates is a result of continued tax strategies associated with the Bancorp’s tax-exempt investments and loans, bank owned life insurance, and real estate investment trust, all of which reduce the effective tax rate. Details of deferred and current tax items can be found in Note 7 – Income Taxes.

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 policies are summarized below. Other accounting policies, including those related to the fair values of financial instruments and the status of contingencies, are summarized in Note 1 to the Bancorp’s consolidated financial statements.

Valuation of Investment Securities - The fair values of securities available for sale are determined on a recurring basis by obtaining quoted prices on nationally recognized securities exchanges or pricing models utilizing significant observable inputs such as matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities. Different judgments and assumptions used in pricing could result in different estimates of value. In certain cases where market data is not readily available because of lack of market activity or little public disclosure, values may be based on unobservable inputs and classified in Level 3 of the fair value hierarchy.

At the end of each reporting period securities held in the investment portfolio are evaluated on an individual security level for other-than-temporary impairment in accordance with the Investments – Debt and Equity Securities Topic of the Accounting Standards Codification. Significant judgments are required in determining impairment, which include making assumptions regarding the estimated prepayments, loss assumptions and the change in interest rates.

We consider the following factors when determining an other-than-temporary impairment for a security: The length of time and the extent to which the market value has been less than amortized cost; the financial condition and near-term prospects of the issuer; the underlying fundamentals of the relevant market and the outlook for such market for the near future; and an assessment of whether the Bancorp has (1) the intent to sell the debt securities or (2) more likely than not will be required to sell the debt securities before its anticipated market recovery. If either of these conditions is met, management will recognize other-than-temporary impairment. If, in management’s judgment, an other-than-temporary impairment exists, the cost basis of the security will be written down for the credit loss, and the unrealized loss will be transferred from accumulated other comprehensive loss as an immediate reduction of current earnings. Management will utilize an independent valuation specialist to value securities for other-than-temporary impairment.

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 collectability. 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 either the projected discounted cash flows or 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 a weighted average of net charge-offs for the most recent three 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 three year weighted average historical factors are then adjusted for current subjective risks attributable to: regional 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. 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.

Report of Independent Registered Public Accounting Firm

Board of Directors

NorthWest Indiana Bancorp and Subsidiary

Munster, Indiana

We have audited the accompanying consolidated balance sheets of NorthWest Indiana Bancorp and Subsidiary (the “Company”) as of December 31, 2011 and 2010, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for the years then ended. The consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the 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 audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly we express no such opinion. 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 consolidated financial position of NorthWest Indiana Bancorp and Subsidiary as of December 31, 2011 and 2010, and the consolidated results of their operations and cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.

	Plante & Moran, PLLC

Chicago, Illinois

February 17, 2012

Consolidated Balance Sheets

See accompanying notes to consolidated financial statements.

Consolidated Statements of Income

See accompanying notes to consolidated financial statements.

Consolidated Statements of Changes in Stockholders' Equity

See accompanying notes to consolidated financial statements.

Consolidated Statements of Cash Flows