CHESTER BANCORP INC - 10-K Annual Report

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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

[ ] Annual Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934

For the Fiscal Year Ended December 31, 2002

OR

Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934

For the transition period from to
----------- ------------

Commission File Number: 000-21167

CHESTER BANCORP, INC.
(Exact name of registrant as specified in its charter)

Delaware 37-1359570
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)

1112 State Street, Chester, Illinois 62233
(Address of Principal Executive Offices)

(618) 826-5038
(Registrant's telephone number, including area code)

Securities Registered Pursuant to Section 12(b) of the Act:
None

Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
(Title of Class)

Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding twelve months (or for such shorter period that the
Registrant was required to file such reports) and (2) has been subject to such
requirements for the past 90 days. YES X NO
---

Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]

Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). YES NO X
---

The aggregate market value of the voting stock held by non-affiliates
of the Registrant, computed by reference to the last sale price June 30, 2002,
as reported by the Nasdaq SmallCap Market, was approximately $6,870,675.

As of February 1, 2003 there were 2,182,125 shares issued, of which
896,568 shares were outstanding, of the Registrant's Common Stock.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant's Annual Report to Stockholders for the year
ended December 31, 2002, are incorporated by reference in Part I and Part II.

Portions of the registrant's proxy statement for its April 11, 2003,
annual meeting of stockholders (the "2003 Proxy Statement") are incorporated by
reference in Part III.

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Table of Contents

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This annual report on Form 10-K contains forward-looking statements
regarding the Company, its business, prospects and results of operations that
involve risks and uncertainties. The Company's actual results could differ
materially from the results that may be anticipated by such forward-looking
statements and discussed elsewhere herein. Factors that could cause or
contribute to such differences include, but are not limited to, those discussed
herein as well as those discussed under the caption "Management's Discussion and
Analysis of Financial Condition and Results of Operations" as well as those
discussed elsewhere throughout this Annual Report on Form 10-K. Readers are
cautioned not to place undue reliance on these forward-looking statements, which
speak only as of the date of this report. The Company undertakes no obligation
to revise any forward-looking statements in order to reflect events or
circumstances that may subsequently arise. Readers are urged to carefully review
and consider the various disclosures made by the Company in this report and in
the Company's other reports filed with the Securities and Exchange Commission
that attempt to advise interested parties of the risks and factors that my
affect the Company's business, prospects and results of operations.

PART I

ITEM 1. Business

Chester Bancorp, Inc.

Chester Bancorp, Inc. (the "Company") is a Delaware corporation that
was organized in October 1996. The only significant assets of the Company are
the outstanding capital stock of Chester National Bank ("Chester National Bank")
and Chester National Bank of Missouri ("Chester National Bank of Missouri")
(collectively the "Banks"). The Company is regulated as a bank holding company
by the Federal Reserve System ("Federal Reserve").

The Company employs executive officers and a support staff if and as
the need arises. Such personnel are provided by the Banks and are not paid
separate remuneration for such services. The Company reimburses the Banks for
the use of their personnel. At December 31, 2002, the Company had total
consolidated assets of $113.8 million, total consolidated deposits of $94.8
million, and consolidated stockholders' equity of $13.7 million. The Company's
principal office is located at 1112 State Street, Chester, Illinois 62233 and
its telephone number is (618) 826-5038.

Chester National Bank and Chester National Bank of Missouri

Chester National Bank and Chester National Bank of Missouri are
national banks headquartered in Chester, Illinois and Perryville, Missouri,
respectively. The predecessor entity to the Banks was originally chartered in
1919 as an Illinois-chartered mutual savings and loan association under the name
"Chester Building and Loan Association." In 1989, Chester Building and Loan
Association acquired Heritage Federal Savings and Loan Association ("Heritage
Federal") which at the time of acquisition had assets of approximately $50
million and offices in Sparta, Red Bud, and Pinckneyville, Illinois. In 1990,
Chester Building and Loan Association converted to a federal charter and adopted
the name "Chester Savings Bank, FSB." In 1996, Chester Savings Bank, FSB
converted from mutual to stock ownership and converted from a federal savings
bank into two national banks, Chester National Bank and Chester National Bank of
Missouri.

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Chester National Bank conducts its business from its main office and
two full-service branches located in Sparta and Red Bud, Illinois. Chester
National Bank's principal executive office is located at 1112 State Street,
Chester, Illinois, and its telephone number at that address is (618) 826-5038.
Chester National Bank of Missouri conducts its business from its main office in
Perryville, Missouri. Chester National Bank of Missouri's principal executive
office is located at 1010 N. Main, Perryville, Missouri 63775, and its telephone
number at that address is (573) 547-7611. The Banks' deposits are insured by the
Federal Deposit Insurance Corporation ("FDIC") and the Banks are regulated by
the Office of the Comptroller of the Currency ("OCC").

The Banks primarily engage in the business of attracting retail
deposits from the general public in the Banks' respective market areas and using
such funds together with borrowings and funds from other sources to primarily
originate mortgage loans secured by one-to-four family residential real estate.
The Banks also originate consumer loans, commercial real estate loans, land
loans, multi-family loans, and commercial loans. At December 31, 2002, the
Banks' gross loan portfolio totaled $36.2 million, of which 79.4% were
one-to-four family residential mortgage loans, 7.0% were consumer loans, 8.8%
were commercial real estate, multi-family loans, agriculture and land loans, and
4.8% were commercial loans. In addition, the Banks have maintained a significant
portion of their assets in marketable securities. The Banks' investment
portfolios have been weighted toward United States government and agency
securities. The portfolios also have included a significant amount of tax exempt
state and municipal securities. In addition, the Banks have invested in
mortgage-backed securities to supplement their lending operations. Investment
and mortgage-backed securities totaled $42.3 million and $3.2 million,
respectively, at December 31, 2002.

Market Area/Local Economy

The Banks offer a range of retail banking services to residents of
their market areas. The Banks' market areas include Randolph, Jackson,
Williamson and Perry counties in Illinois as well as Perry and Cape Girardeau
counties in Missouri.

The local market area is primarily rural and covers a fairly large
geographic area in southwestern Illinois and southeastern Missouri. The closest
major metropolitan area is the St. Louis area, approximately 60 miles to the
north. The largest town served is Carbondale, which has a population of
approximately 27,000, while the smallest town served, Red Bud, has a population
of approximately 3,000. Perryville, Missouri has a population of approximately
7,000.

The economy in southwestern Illinois is historically based in coal
mining and agriculture, although both industries have declined in recent
decades. The decline of mining employment has had a significant adverse impact
on the economy of the market area, particularly in Randolph and Perry counties,
Illinois. Loan demand in these counties has been limited as unemployment is high
and the population has been declining. The Perryville market is rural and small,
and economic stability is supported by its largest employer, Gilster-Mary Lee.
The economic environment in Perryville has generally been more favorable than
Randolph and Perry Counties, Illinois.

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Lending Activities

GENERAL. The principal lending activity of the Banks is the
origination of conventional mortgage loans for the purpose of purchasing,
constructing or refinancing owner-occupied, one-to-four family residential
property. To a significantly lesser extent, the Banks also originate
multi-family, commercial real estate, commercial loans, land and consumer loans.
The Banks' net loans receivable totaled $35.6 million at December 31, 2002,
representing 31.3% of total assets.

LOAN PORTFOLIO ANALYSIS. The following table sets forth the
composition of the Banks' consolidated loan portfolio by type of loan and type
of security as of the dates indicated. The Banks had no concentration of loans
exceeding 10% of total loans other than as set forth below.

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RESIDENTIAL REAL ESTATE LENDING. The primary lending activity of the
Banks is the origination of mortgage loans to enable borrowers to purchase or
refinance existing one-to-four family homes. Management believes that this
policy of focusing on one-to-four family residential mortgage loans located in
its market area has been successful in contributing to interest income while
keeping credit losses low. At December 31, 2002, $28.8 million, or 79.4% of the
Banks' gross consolidated loan portfolio, consisted of loans secured by
one-to-four family residential real estate. The average principal balance of the
loans in the Banks' one-to-four family portfolio was approximately $38,911 at
December 31, 2002. The Banks presently originate for retention in their
portfolio both adjustable rate mortgage ("ARM") loans with terms of up to 25
years and fixed-rate mortgage loans with terms of up to 20 years. Borrower
demand for ARM loans versus fixed-rate mortgage loans is a function of the level
of interest rates, the expectations of changes in the level of interest rates
and the difference between the initial interest rates and fees charged for each
type of loan. The relative amount of fixed-rate mortgage loans and ARM loans
that can be originated at any time is largely determined by the demand for each
in a competitive environment. At December 31, 2002, $8.1 million, or 22.3% of
the Banks' gross loans, were subject to periodic interest rate adjustments.

The loan fees charged, interest rates and other provisions of the
Banks' ARM loans are determined by the Banks based on their own pricing criteria
and competitive market conditions. The Banks originate one-year ARM loans
secured by owner-occupied residences whose interest rates and payments generally
are adjusted annually to a rate typically equal to 2.75% above the one-year or,
occasionally the three-year, constant maturity United States Treasury ("CMT")
index. The Banks occasionally offer ARM loans with initial rates below those
which would prevail under the foregoing terms, determined by the Banks based on
market factors and competitive rates for loans having similar features offered
by other lenders for such initial periods. At December 31, 2002, the initial
interest rate on ARM loans offered by the Banks ranged from 5.50% to 6.50% per
annum. The periodic interest rate cap (the maximum amount by which the interest
rate may be increased or decreased in a given period) on the Banks' ARM loans is
generally 2% per year and the lifetime interest rate cap is generally 6% over
the initial interest rate of the loan.

The Banks do not originate negative amortization loans. The terms and
conditions of the ARM loans offered by the Banks, including the index for
interest rates, may vary from time to time. The Banks believe that the
adjustment features of their ARM loans provide flexibility to meet competitive
conditions as to initial rate concessions while preserving the Banks' objectives
by limiting the duration of the initial rate concession.

The retention of ARM loans in the Banks' consolidated loan portfolio
helps reduce the Banks' exposure to changes in interest rates There are,
however, unquantifiable credit risks resulting from the potential of increased
costs due to changed rates to be paid by the customer. It is possible that
during periods of rising interest rates the risk of default on ARM loans may
increase as a result of repricing and the increased costs to the borrower.
Furthermore, because the ARM loans originated by the Banks generally provide, as
a marketing incentive, for initial rates of interest below the rate which would
apply were the adjustment index used for pricing initially (discounting), these
loans are subject to increased risks of default or delinquency. Another
consideration is that although ARM loans allow the Banks to increase the
sensitivity of their asset base to changes in the interest rates, the extent of
this interest sensitivity is limited by the periodic and lifetime interest rate
adjustment limits. Because of these considerations, the Banks have no assurance
that yields on ARM loans will be sufficient to offset increases in the Banks'
cost of funds.

While fixed-rate single-family residential real estate loans are
normally originated with five to seven year balloon payments or terms up to
20 years, such loans typically remain outstanding for substantially shorter
periods. This is because borrowers often prepay their loans in full upon sale of
the

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property pledged as security or upon refinancing the original loan. In addition,
substantially all mortgage loans in the Banks' consolidated loan portfolio
contain due-on-sale clauses providing that the Banks may declare the unpaid
amount due and payable upon the sale of the property securing the loan.
Typically, the Banks enforce these due-on-sale clauses to the extent permitted
by law and as business judgment dictates. Thus, average loan maturity is a
function of, among other factors, the level of purchase and sale activity in the
real estate market, prevailing interest rates and the interest rates payable on
outstanding loans.

The Banks generally require title insurance insuring the status of
their liens on all of the real estate secured loans. The Banks also require
earthquake, fire and extended coverage casualty insurance and, if appropriate,
flood insurance in an amount at least equal to the outstanding loan balance.

Appraisals are obtained on all properties and are conducted by
independent fee appraisers approved by the Board of Directors. The Banks'
lending policies generally limit the maximum loan-to-value ratio on mortgage
loans secured by owner-occupied properties to 80% of the lesser of the appraised
value or the purchase price, with the condition that the loan-to-value ratio may
be increased to 95% provided that private mortgage insurance coverage is
obtained for the amount in excess of 80%.

COMMERCIAL REAL ESTATE AND MULTI-FAMILY LENDING: Historically, the
Banks have engaged in limited amounts of commercial real estate and multi-family
lending. At December 31, 2002, commercial real estate loans aggregated $2.6
million, or 7.2% of the total consolidated loan portfolio and multi-family loans
aggregated $253,000 or .7% of the total consolidated loan portfolio. The
principal balance of such loans in the Banks' consolidated loan portfolio ranged
from approximately $1,000 to $946,000 at December 31, 2002. Substantially all of
these loans are secured by properties located in the Banks' market area. Such
properties include churches, a library, golf courses and professional offices.
Commercial real estate and multi-family loans are generally made for balloon
terms of 5 to 10 years with a maximum amortization of 20 years.

Commercial real estate and multi-family loans generally involve
greater risks than one-to-four family residential mortgage loans. Payments on
loans secured by such properties often depend on successful operation and
management of the properties. Repayment of such loans may be subject to a
greater extent to adverse conditions in the real estate market or the economy.
The Banks seek to minimize these risks in a variety of ways, including limiting
the size of such loans, limiting the maximum loan-to-value ratio to 75% and
strictly scrutinizing the financial condition of the borrower, the quality of
the collateral and the management of the property securing the loan. All of the
properties securing the Banks' income property loans are inspected by the Banks'
lending personnel before the loan is made. The Banks also obtain appraisals on
each property in accordance with applicable regulations.

CONSTRUCTION LENDING. The Banks originate residential construction
loans to individuals to construct one-to-four family homes. The Banks generally
do not originate speculative construction loans (i.e., loans to builders to
construct homes for which there are no contracts for sale in place). At December
31, 2002, construction loans totaled $84,000, or .2% of the gross consolidated
loan portfolio.

Substantially all construction loans made to individuals provide
for the Banks to originate a permanent loan upon the completion of construction,
which is generally an ARM loan as described under "Residential Real Estate
Lending," above. The origination fee for construction loans is generally 1.0% of
the principal amount. Construction loans are generally made for terms of up to
six months.

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Construction lending is generally considered to involve a
higher level of risk as compared to one-to-four family residential permanent
lending because of the inherent difficulty in estimating both a property's value
at completion of the project and the estimated cost of the project. The nature
of these loans is such that they are generally more difficult to evaluate and
monitor. If the estimate of value proves to be inaccurate, the Banks may be
confronted at, or prior to, the maturity of the loan, with a project whose value
is insufficient to assure full repayment.

AGRICULTURE AND LAND LENDING. The Banks originate loans secured
by farm residences and combinations of farm residences and farm real estate. The
Banks also originate loans for the acquisition of land upon which the purchaser
can then build. At December 31, 2002, the agriculture and land consolidated loan
portfolio totaled $317,000 or .9% of total loans, substantially all of which
were secured by properties located in the Banks' market area. Agriculture and
land loans are generally made for the same terms and at the same interest rates
as those offered on commercial real estate and multi-family loans, with a
loan-to-value ratio which is generally limited to 75%.

Loans secured by farm real estate generally involve greater
risks than one-to-four family residential mortgage loans. Payments on loans
secured by such properties may, in some instances be dependent on farm income
from the properties. To address this risk, the Banks historically have not
considered farm income when qualifying borrowers. In addition, such loans are
more difficult to evaluate. If the estimate of value proves to be inaccurate,
the Banks may be confronted with a property the value of which is insufficient
to assure full repayment in the event of default and foreclosure.

COMMERCIAL BUSINESS LENDING. The Banks became active in the
origination of small commercial business loans in order to diversify their
credit risk and increase the average yield and repricing speed of their
interest-earning assets. At December 31, 2002, the commercial business loans
aggregated $1.7 million, or 4.8%, of the loan portfolio. The principal balance
of such loans in the Banks' loan portfolio ranged from approximately $4,000 to
$1.0 million at December 31, 2002. Substantially all of these loans were made
with borrowers located within the Banks' market area. Such loans are generally
secured by equipment inventory, stock, and commercial real estate. Commercial
business loans are generally made for one year or less, with the rate tied to
prime, repricing accordingly.

CONSUMER AND OTHER LOANS. The Banks offer a variety of secured
or guaranteed consumer loans, including automobile loans, home improvement
loans, unsecured loans and loans secured by savings deposits. Consumer loans are
made at fixed interest rates and for varying terms. At December 31, 2002 the
Banks' consumer loans totaled $2.5 million, or 7.0% of total loans. The Banks
view consumer lending as an important component of their business operations
because consumer loans generally have shorter terms and higher yields than
one-to-four family real estate loans, thus reducing exposure to changes in
interest rates. In addition, the Banks believe that offering consumer loans
helps to expand and create stronger ties to their customer base.

The largest category of consumer loans in the Banks' portfolio
consists principally of direct loans secured by automobiles. The Banks generally
do not originate loans secured by recreational vehicles. At December 31, 2002,
consumer loans secured by automobiles totaled $555,000, or 1.5% of the Banks'
total consolidated loan portfolio. Automobile loans are offered with maturities
of up to 60 months for new automobiles and up to 48 months for used automobiles.
Loans secured by used automobiles will have maximum terms which vary depending
upon the age of the automobile and will be made based on amounts as set forth in
the NADA "bluebook."

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The Banks began offering proprietary VISA credit cards during 1993
and, at December 31, 2002, there were 948 credit card accounts with a total
balance of $549,000. This program has been offered to residents of the Banks'
primary market area but card recipients need not otherwise be customers of the
Banks. The VISA card program currently provides an individual borrowing limit of
$3,500 or less, a fixed rate of interest of 12.9% and a "rebate" feature. The
Banks may alter the general terms of this program as they seek to expand their
credit card program.

The third largest category of consumer loans in the Banks'
portfolio consists of home improvement loans. At December 31, 2002, home
improvement loans totaled $504,000, or 1.4% of the Banks' total consolidated
loan portfolio. The Banks' home improvement loans are secured by the borrower's
principal residence. The maximum amount of a home improvement loan is generally
80% of the appraised value of a borrower's real estate collateral less the
amount of any prior mortgages or related liabilities. With respect to
substantially all home improvement loans, the Banks hold the first mortgage on
the borrower's residence. Home improvement loans are approved with fixed
interest rates which are determined by the Banks based upon market conditions.
Such loans may be fully amortized over the life of the loan or have a balloon
feature. The maximum term for a home improvement loan is five years.

The Banks had $125,000, or .4% of total loans in unsecured consumer
loans at December 31, 2002. These loans are made for a maximum of 30 months or
less with fixed rates of interest and are offered primarily to existing
customers of the Banks.

The Banks employ strict underwriting standards for consumer loans.
These procedures include an assessment of the applicant's payment history on
other debts and ability to meet existing obligations and payments on the
proposed loans. Although the applicant's creditworthiness is a primary
consideration, the underwriting process also includes a comparison of the value
of the security, if any, to the proposed loan amount. The Banks underwrite and
originate substantially all of their consumer loans internally which management
believes limits exposure to audit risks relating to loans underwritten or
purchased from brokers or other outside sources.

Consumer loans may entail greater risk than do residential mortgage
loans, particularly in the case of consumer loans which are unsecured or secured
by assets that depreciate rapidly, such as automobiles. In the latter case,
repossessed collateral for a defaulted consumer loan may not provide an adequate
source of repayment for the outstanding loan and the remaining deficiency often
does not warrant further substantial collection efforts against the borrower. In
addition, consumer loan collections are dependent on the borrower's continuing
financial stability, and thus are more likely to be adversely affected by job
loss, divorce, illness or personal bankruptcy. Furthermore, the application of
various federal and state laws, including federal and state bankruptcy and
insolvency laws, may limit the amount which can be recovered on such loans. Such
loans may also give rise to claims and defenses by the borrower against the
Banks as the holder of the loan, and a borrower may be able to assert claims and
defenses which it has against the seller of the underlying collateral.

MATURITY OF CONSOLIDATED LOAN PORTFOLIO. The following table sets
forth at December 31, 2002 certain information regarding the dollar amount of
loans maturing in the Banks' portfolio based on their contractual terms to
maturity. Demand loans (loans having no stated repayment schedule and no stated
maturity) and overdrafts are reported as due in one year or less. Loan balances
do not include undisbursed loan proceeds, unearned discounts, and allowance for
loan losses.

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The following table sets forth the dollar amount of all loans due after
December 31, 2003 which have fixed interest rates and have floating or
adjustable interest rates.

Scheduled contractual principal repayments of loans generally do not
reflect the actual life of such assets. The average life of loans ordinarily is
substantially less than their contractual terms because of prepayments. In
addition, due-on-sale clauses on loans generally give the Banks the right to
declare loans immediately due and payable in the event, among other things, that
the borrower sells the real property subject to the mortgage and the loan is not
repaid. The average life of mortgage loans tends to increase, however, when
current mortgage loan market rates are higher than rates on existing mortgage
loans and, conversely, decrease when rates on existing mortgage loans are higher
than current mortgage loan market rates.

LOAN SOLICITATION AND PROCESSING. Loan applicants come primarily
from walk-in customers including previous and present customers of the Banks and
to a lesser extent referrals by real estate agents. Upon receipt of a loan
application from a prospective borrower, a credit report and other data are
obtained to verify specific information relating to the loan applicant's
employment, income and credit standing. An appraisal of the real estate offered
as collateral generally is undertaken by a Board-approved independent fee
appraiser who is certified by the State of Illinois and/or the State of
Missouri.

All mortgage loans must be approved by the Banks' Executive
Committee. Unsecured consumer loans up to $3,500 and secured consumer loans up
to $20,000 may be approved by an individual

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loan officer. Amounts in excess of these limits must be approved by the
Executive Committee. Management of the Banks believes its local decision-making
capabilities and the accessibility of their senior officers is an attractive
quality to customers within their market area. The Banks' loan approval process
allows consumer loans to be approved in one to two days and mortgage loans to be
approved and closed in approximately two weeks.

LOAN ORIGINATIONS, SALES AND PURCHASES. During the years ended
December 31, 2002, 2001 and 2000, the Banks' total loan originations were $6.9
million, $7.4 million and $8.8 million, respectively. While the Banks originate
both adjustable-rate and fixed-rate loans, their ability to generate each type
of loan depends upon relative customer demand for loans in their market.

Consistent with their asset/liability management strategy, the policy
of the Banks has been to retain in their portfolio nearly all of the loans that
they originate. Any loan sales are generally made without recourse to the Banks.

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The following table shows total loans originated and repaid during
the periods indicated. No loans were purchased or sold during the periods
indicated.

LOAN COMMITMENTS. The Banks issue, without fee, commitments for
one-to-four family residential mortgage loans conditioned upon the occurrence of
certain events. Such commitments are made in writing on specified terms and
conditions and at a specified interest rate and are honored for up to three
months from the date of loan approval. At December 31, 2002, the Banks had
outstanding commitments to originate residential loans and fund outstanding
credit lines of approximately $5.1 million, of which $3.8 million were fixed
rate commitments ranging from a rate of 5.25% to 12.9%. Variable rate
commitments totaled $1.3 million. Commitments to extend credit may involve
elements of interest rate risk in excess of the amount recognized in the
consolidated balance sheets. Interest rate risk on commitments to extend credit
results from the possibility that interest rates may have moved unfavorably from
the position of the Banks since the time the commitment was made.

LOAN ORIGINATION AND OTHER FEES. The Banks, in some instances,
receive loan origination fees. Loan fees are a percentage of the principal
amount of the mortgage loan which are charged to the borrower for funding the
loan. The amount of fees charged by the Banks is generally up to 1.0% for
mortgage loans and construction loans. Origination fees received (net of certain
loan origination costs) for originating loans should be deferred and amortized
into interest income over the contractual life of the loan. Net deferred fees or
costs associated with loans that are prepaid are recognized as income at the
time of prepayment. The Banks had $3,000 of net deferred loan fees at December
31, 2002.

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NON-PERFORMING ASSETS AND DELINQUENCIES. When a mortgage loan
borrower fails to make a required loan payment when due, the Banks institute
collection procedures. The first written notice is mailed to a delinquent
borrower 10-15 days after the due date, followed by a second written notice
mailed and a telephone call approximately 15 days thereafter. On or about 60
days after the due date, a certified letter is sent to the delinquent borrower.
Foreclosure procedures are instituted on or about 90 days after the due date if
the delinquency continues to that date.

Consumer loan collection procedures are substantially the same as
those for mortgage loans. In most cases, delinquencies are cured promptly;
however, if, by the 90th day of delinquency the delinquency has not been cured,
the Banks begin legal action to repossess the collateral. At the 120th day of
delinquency, the Bank charges off the full principal amount of the consumer
loan.

The Board of Directors is informed monthly as to the status of all
mortgage and consumer loans that are delinquent more than 30 days, the status on
all loans currently in foreclosure, and the status of all foreclosed and
repossessed property owned by the Banks.

The following table sets forth information regarding the Banks'
delinquent loans, excluding loans 90 days or more delinquent and accounted for
on a non-accrual basis.

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The following table sets forth information with respect to the Banks'
non-performing assets at the dates indicated. The Banks have no restructured
loans at any of the dates indicated.

At December 31, 2002 management of the Banks was unaware of any
material loans not disclosed in the above table but where known information
about possible credit problems of the borrowers caused management to have
serious doubts as to the ability of such borrowers to comply with their loan
repayment terms at that date and which may result in future inclusion in the
non-performing assets category.

REAL ESTATE ACQUIRED BY FORECLOSURE. The Banks had $20,000 in real
estate acquired by foreclosure at December 31, 2002, which consisted of one
piece of property.

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ASSET CLASSIFICATION. The Banks are subject to various regulations
regarding problem assets of banks. The regulations require that each insured
institution review and classify their assets on a regular basis. In addition, in
connection with examinations of insured institutions, examiners have the
authority to identify problem assets and, if appropriate, require them to be
classified. There are three classifications for problem assets: substandard,
doubtful and loss. Substandard assets have one or more defined weaknesses and
are characterized by the distinct possibility that the insured institution will
sustain some loss if the deficiencies are not corrected. Doubtful assets have
the weaknesses of substandard assets with the additional characteristic that the
weaknesses make collection or liquidation in full on the basis of currently
existing facts, conditions and values questionable, and there is a high
possibility of loss. An asset classified as loss is considered uncollectible and
of such little value that continuance as an asset of the institution is not
warranted. If an asset or portion thereof is classified as loss, the insured
institution establishes specific allowances for loan losses for the full amount
of the portion of the asset classified as loss. All or a portion of general loan
loss allowances established to cover probable losses related to specific
valuation allowances for loan losses generally do not qualify as regulatory
capital. Assets that do not currently expose the insured institution to
sufficient risk to warrant classification in one of the aforementioned
categories but possess weaknesses are designated "special mention" and monitored
by the Banks.

The aggregate amounts of the Banks' classified assets including
assets designated special mention and general and specific loss allowances at
the dates indicated, were as follows:

ALLOWANCE FOR LOAN LOSSES. The Banks have established a systematic
methodology for determining provisions for loan losses. The methodology is set
forth in a formal policy and considers the need for an overall general valuation
allowance as well as specific allowances for individual loans.

In originating loans, the Banks recognize that losses will be
experienced and that the risk of loss will vary with, among other things, the
type of loan being made, the creditworthiness of the borrower over the term of
the loan, general economic conditions and, in the case of a secured loan, the
quality of the security for the loan. The Banks increase their allowance for
loan losses by charging provisions for loan losses against the Banks' income.

14

The allowance for loan losses is maintained to cover known and
probable losses in the loan portfolio. Management reviews the adequacy of the
allowance at least quarterly based on management's assessment of numerous
factors, including, but not necessarily limited to, general economic conditions,
consolidated loan portfolio composition, prior loss experience, and independent
appraisals. In addition to the allowance for estimated losses on identified
problem loans, an overall unallocated allowance is established to provide for
unidentified credit losses. In estimating such losses, management considers
various risk factors including geographic location, loan collateral, and payment
history. Specific valuation allowances are established to absorb losses on loans
for which full collectibility may not be reasonably assured. The amount of the
allowance is based on the estimated value of the collateral securing the loan
and other analyses pertinent to each situation.

At December 31, 2002, the Banks had an allowance for general loan
losses of $575,000. Management believes that the amount maintained in the
allowance will be adequate to absorb known and probable losses in the
consolidated portfolio. Although management believes that it uses information
available to make such determinations, future adjustments to the allowance for
loan losses may be necessary and results of operations could be significantly
and adversely affected if circumstances differ substantially from the
assumptions used in making the determinations.

While the Banks believe the existing allowance for loan losses is
adequate, there can be no assurance that regulators, in reviewing the Banks'
loan portfolio, will not request the Banks to increase significantly their
allowance for loan losses. In addition, because future events affecting
borrowers and collateral cannot be predicted with certainty, there can be no
assurance that substantial increase will not be necessary should the quality of
any loans deteriorate as a result of the factors discussed above. Any material
increase in the allowance for loan losses may adversely affect the Banks'
financial condition and results of operations.

15

The following table sets forth an analysis of the Banks' allowances
for loan losses for the periods indicated.

The following table sets forth the breakdown of the allowance for
loan losses by loan category for the periods indicated. The portion of the
allowance to each loan category does not necessarily represent the total
available for losses within that category since the total allowance applies to
the entire loan portfolio. The allocation of the allowance to each category is
not necessarily indicative of future losses and does not restrict the use of the
allowance to absorb losses in any other category.

16

INVESTMENT ACTIVITIES

GENERAL. The Banks' policies generally limit investments to U.S.
Government and agency securities, certificates of deposit in other financial
institutions and municipal bonds, and mortgage-backed securities. All of the
Banks' investment securities are subject to market risk insofar as increases in
market rates of interest may cause a decrease in their market value. Investment
decisions are made by the Company's Chairman, President and Chief Financial
Officer Michael W. Welge and reported at the monthly Board of Directors'
meetings.

At December 31, 2002, the Banks' investment portfolio,
mortgage-backed security portfolio, federal funds sold and interest-bearing
deposits totaled $74.2 million and consisted principally of U.S. Government and
agency obligations, mortgage-backed securities, municipal obligations, equity
securities, federal funds sold, interest-bearing deposits, Federal Home Loan
Bank Stock ("FHLB"), and Federal Reserve Bank Stock ("FRB"). At December 31,
2002, the Banks' investment portfolio did not contain any securities of a single
issuer (other than the United States Government and agencies thereof) which had
an aggregate book value in excess of 10% of the Banks' equity at that date.

As of December 31, 2002, the held to maturity investment portfolio
of the Banks contained securities with an amortized cost of $37.6 million and a
fair value of $38.5 million and consisted of U.S. Government and agency
obligations, municipal and state obligations, corporate bonds and
mortgage-backed bonds. At December 31, 2002, the Banks' investment securities
available for sale portfolio consisted of securities of states and
municipalities with an amortized cost and fair value of $900,000. At December
31, 2002, the Banks held $353,000 in securities that were classified as trading
securities.

INVESTMENT STRATEGY. Historically, the Banks have maintained a
substantial proportion of their assets in investments and mortgage-related
securities. The objectives of these investments are to: (i) provide sufficient
liquidity to fund the operational needs of the Banks, (ii) provide a stable base
of income with minimal credit risk, (iii) invest those deposit funds in excess
of the mortgage and consumer lending

17

volumes available to the Banks in their market area, (iv) invest the deposit
funds attributable to Gilster-Mary Lee, and (v) generally assist in managing the
interest rate risk of the Banks. The Banks invest in U.S. Government and U.S.
Government agency securities, securities of U.S. Government-sponsored
enterprises (e.g., Government National Mortgage Association ("GNMA"), Federal
National Mortgage Association ("FNMA"), and Federal Home Loan Mortgage
Corporation ("FHLMC")), tax-exempt securities of states and municipalities,
corporate bonds, mutual fund shares, short-term interest-bearing deposits and
federally insured certificates of deposits in other financial institutions,
FHLB-Chicago stock, and mortgage-related securities (including mortgage-backed
securities and collateralized mortgage obligations). The foregoing securities
serve different functions within the context of the Banks' investment practices.

U.S. Government agency, Government-sponsored enterprise, and
tax-exempt state and municipal securities and short-term interest-bearing
deposits and federally insured certificates of deposits in other financial
institutions function as an income base and non-lending investment vehicle for
the Banks. Management views the foregoing investments generally as substitutes
of each other, and the relative proportion of them in the portfolio depends on
the relative yields of each as compared to their perceived credit risks and
interest rate sensitivities. As these investments mature, the Banks seek to
reinvest the proceeds in those investments that, at that time, provide an
attractive trade-off among the foregoing factors. With respect to the tax-exempt
state and municipal securities portfolio, the Banks also seek to invest so as to
meet specific community needs in their primary market area and to take advantage
of the federal and, on some securities, state tax exemption for the interest
thereon. As a general rule, the Banks limit their tax-exempt investments to
those having a rating by a nationally recognized statistical rating organization
of "AA" or better or those unrated securities issued by entities within their
market area. Generally, the Banks also limit the maturities of all of the
foregoing securities to five years or less.

MORTGAGE-BACKED SECURITIES. The Banks purchase mortgage-backed
securities primarily to supplement their lending activities and, to a lesser
extent, to: (i) generate positive interest rate spreads on large principal
balances with minimal administrative expense; (ii) lower the credit risk of the
Banks as a result of the guarantees provided by FHLMC, FMNA, and GNMA; (iii)
enable the Banks to use mortgage-backed securities as collateral for financing;
and (iv) increase the Banks' liquidity.

The Banks have invested primarily in federal agency securities,
principally FNMA, FHLMC and GNMA. The Banks also invest in collateralized
mortgage obligations ("CMOs") that have fixed interest rates. At December 31,
2002, net mortgage-backed and related securities totaled $3.2 million, or 2.9%
of total assets. At December 31, 2002, all of the mortgage-backed and mortgage
related securities were fixed rate. The mortgage-backed securities portfolio had
coupon rates ranging from 5.00% to 7.50% and had a weighted average yield of
5.70% at December 31, 2002. The estimated fair value of the Banks'
mortgage-backed securities at December 31, 2002 was $3.4 million.

Mortgage-backed securities (which also are known as mortgage
participate certificates or pass-through certificates) typically represent a
participation interest in a pool of single-family or multi-family mortgages. The
principal and interest payments on these mortgages are passed from the mortgage
originators, through intermediaries (generally U.S. Government agencies and
government sponsored enterprises) that pool and resell the participation
interests in the form of securities, to investors such as the Banks. Such U.S.
Government agencies and government sponsored enterprises, which guarantee the
payment of principal and interest to investors, primarily include the FHLMC,
FNMA and the GNMA. Mortgage-backed securities typically are issued with stated
principal amounts, and the securities are backed by pools of mortgages that have
loans with interest rates that fall within a specific range and have varying
maturities. Mortgage-backed securities generally yield less than the loans that
underlie such securities

18

because of the cost of payment guarantees and credit enhancements. In addition,
mortgage-backed securities are usually more liquid than individual mortgage
loans and may be used to collateralize certain liabilities and obligations of
the Banks. These types of securities also permit the Banks to optimize their
regulatory capital because they have a low risk weighting.

CMOs generally have similar characteristics as derivative
financial instruments because they are created by redirecting the cash flows
from the pool of mortgages or mortgage-backed securities underlying these
securities to create two or more classes (or tranches) with different maturity
or risk characteristics designed to meet a variety of investor needs and
preferences. Management believes these securities may represent attractive
alternatives relative to other investments due to the wide variety of maturity,
repayment and interest rate options available. The Banks held investment grade
CMOs with a net carrying value of $888,000 at December 31, 2002. CMOs may be
sponsored by private issuers, such as mortgage bankers or money center banks, or
by U.S. Government agencies and government sponsored entities. At December 31,
2002, the Banks did not own any privately issued CMOs.

Derivatives also include "off balance sheet" financial products
whose value is dependent on the value of an underlying financial asset, such as
a stock, bond, foreign currency, or a reference rate or index. Such derivatives
include "forwards," "futures," "options" or "swaps." The Banks have not invested
in, and currently do not intend to invest in, these "off balance sheet"
derivative instruments, although the Banks' investment policies do not prohibit
such investments. The Banks evaluate their mortgage-related securities portfolio
quarterly for compliance with applicable regulatory requirements, including
testing for identification of high risk investments. At December 31, 2002, the
Banks did not have any derivatives or high risk securities.

Of the Banks' $3.2 million mortgage-backed securities portfolio at
December 31, 2002, $2.1 million with an average coupon rate of 6.05% had
contractual maturities within ten years and $1.1 million with an average coupon
rate of 6.70% had contractual maturities over ten years. However, the actual
maturity of a mortgage-backed security may be less than its stated maturity due
to prepayments of the underlying mortgages. Prepayments that are faster than
anticipated may shorten the life of the security and may result in a loss of any
premiums paid and thereby reduce the net yield on such securities. Although
prepayments of underlying mortgages depend on many factors, including the type
of mortgages, the coupon rate, the age of mortgages, the geographical location
of the underlying real estate collateralizing the mortgages and general levels
of market interest rates, the difference between the interest rates on the
underlying mortgages and the prevailing mortgage interest rates generally is the
most significant determinant of the rate of prepayments. During periods of
declining mortgage interest rates, if the coupon rate of the underlying
mortgages exceeds the prevailing market interest rates offered for mortgage
loans, refinancing generally increases and accelerates the prepayment of the
underlying mortgages and the related security. Under such circumstances, the
Banks may be subject to reinvestment risk because, to the extent that the Banks'
mortgage-backed securities amortize or prepay faster than anticipated, the Banks
may not be able to reinvest the proceeds of such repayments and prepayments at a
comparable rate. In contrast to mortgage-backed securities in which cash flow is
received (and hence, prepayment risk is shared) pro rata by all securities
holders, the cash flow from the mortgages or mortgage-backed securities
underlying CMOs are segmented and paid in accordance with a predetermined
priority to investors holding various tranches of such securities or
obligations. A particular tranche of CMOs may therefore carry prepayment risk
that differs from that of both the underlying collateral and other tranches.

19

The following table sets forth the composition of the Banks'
mortgage-backed securities portfolio at the dates indicated.

The following table shows purchases, sales and repayments of
mortgage-backed securities during the periods indicated.

20

The following tables set forth the composition of the Banks'
investment portfolio at the dates indicated.

(1) Tax exempt state and municipal securities are presented on a tax equivalent
basis assuming a tax rate of 34%.

(2) Nonmarketable equity securities have no stated maturity, therefore stated
maturities are not disclosed.

U.S. AGENCY OBLIGATIONS. The Banks' portfolio of U.S. agency
obligations, and nonmarketable equity securities had a fair value of $31.7
million ($31.4 million at amortized cost) at December 31, 2002. The portfolio
consisted of short to medium-term (up to ten years) securities.

SECURITIES OF STATES AND MUNICIPALITIES. The Banks' municipal bond
portfolio, which at December 31, 2002, totaled $7.5 million at estimated fair
value ($7.1 million at amortized cost), was comprised primarily of general
obligation bonds (i.e., backed by the general credit of the issuer) and revenue
bonds (i.e., backed only by revenues from the specific project being financed)
issued by various housing authorities and public hospital, water and sanitation
districts in various states. At December 31, 2002, general obligation bonds and
revenue bonds totaled $4.5 million and $2.5 million, respectively. The bonds are
purchased with laddered maturities of up to four years with an average principal
amount of approximately $250,000, of which $900,000 (at amortized cost) were
held in the Banks' available for sale portfolio. Most of the municipal bonds are
rated by a nationally recognized statistical rating organization (e.g., Moody's
or Standard and Poor's) and the unrated bonds have been purchased principally
from local authorities. At December 31, 2002, the Banks' municipal bond
portfolio was comprised of 32 bonds, the average principal amount of which was
$221,000. At such date the weighted average life of the portfolio was
approximately 8.3 years and had a weighted average coupon rate of 4.51%. At that
date, the largest security in the portfolio was a revenue bond issued by a local
government, with an amortized cost of $1.6 million and a fair value of $1.8
million. Because interest earned on municipal bonds is exempt from federal, and,
in certain cases, state and local income taxes, the municipal bond portfolio has
contributed to an effective income tax rate for the Banks below the federal tax
rate and one that the Banks believe is below their peers.

CORPORATE BONDS. The Banks' portfolio of corporate bonds had a fair
value of $2.7 million ($2.5 million at amortized cost) at December 31, 2002. The
portfolio consisted of medium-term (up to ten years) securities with an average
yield of 6.32%.

MORTGAGE BACKED BONDS. At December 31, 2002, the Banks' investment
portfolio included securities issued by the FHLMC. At December 31, 2002, such
bonds had an aggregate amortized cost and fair value of $1.0 million, an average
life of approximately 9.3 years, and an average coupon rate of 4.50%.

22

TRADING SECURITIES. At December 31, 2002, the Bank's investment
portfolio included three stocks, which were held in the trading portfolio.
Trading securities, which are held for the short term, in anticipation of market
gains, are carried at fair value. At December 31, 2002, such stocks had a fair
value of $353,000. Realized and unrealized gains and losses on trading
securities are included in current income as a component of other income.

DEPOSIT ACTIVITIES AND OTHER SOURCES OF FUNDS

GENERAL. Deposits, federal funds purchased, FHLB advances and loan
repayments are the major sources of the Banks' funds for lending and other
investment purposes. Scheduled loan repayments are a relatively stable source of
funds, while deposit inflows and outflows and loan prepayments are influenced
significantly by general interest rates and money market conditions. Borrowings
through the FHLB-Chicago or federal funds purchased may be used on a short-term
basis to compensate for reductions in the availability of funds from other
sources. At December 31, 2002 the Banks had $5.0 million in FHLB advances.

DEPOSIT ACCOUNTS. Substantially all of the Banks' depositors are
residents of the State of Illinois or Missouri. Deposits are attracted from
within the Banks' market area through the offering of a broad selection of
deposit instruments, including NOW accounts, money market deposit accounts,
regular savings accounts, certificates of deposit and retirement savings plans.
Deposit account terms vary, according to the minimum balance required, the time
periods the funds must remain on deposit and the interest rate, among other
factors. In determining the terms of their deposit accounts, the Banks consider
current market interest rates, profitability to the Banks, matching deposit and
loan products and their customer preferences and concerns. The Banks review
their deposit mix and pricing weekly.

The following table sets forth certain information concerning the
Banks' time deposits and other interest-bearing deposits at December 31, 2002.

23

The following table indicates the amount of the Banks' certificates
of deposit of $100,000 or more by time remaining until maturity as of December
31, 2002.

DEPOSIT FLOW

The following table sets forth the balances of savings deposits in
the various types of savings accounts offered by the Banks at the dates
indicated.

(1) At December 31, 2002 and at December 31, 2001, certificates of deposits of
$100,000 or more amounted to $12.4 million and $10.3 million, respectively.

(2) IRA accounts included in certificate balances are $8.5 million and $7.7
million at December 31, 2002 and December 31, 2001, respectively.

24

TIME DEPOSITS BY RATES

The following table sets forth the time deposits in the Banks
classified by rates at the dates indicated.

The following table sets forth the amount and maturities of time
deposits at December 31, 2002.

The following table sets forth the average balances and interest
rates based on monthly balances for transaction accounts and certificates of
deposit for the periods indicated.

25

The following table sets forth the savings activities of the Banks
for the periods indicated.

BORROWINGS

The Banks have the ability to use advances from the FHLB-Chicago to
supplement their supply of lendable funds and to meet deposit withdrawal
requirements. The FHLB-Chicago functions as a central reserve bank providing
credit for savings and loan associations and certain other member financial
institutions. As a member of the FHLB-Chicago, the Banks are required to own
capital stock in the FHLB-Chicago and are authorized to apply for advances on
the security of such stock and certain of their mortgage loans and other assets
(principally securities which are obligations of, or guaranteed by, the U.S.
Government) provided certain creditworthiness standards have been met. Advances
are made pursuant to several different credit programs. Each credit program has
its own interest rate and range of maturities. Depending on the program,
limitations on the amount of advances are based on the financial condition of
the member institution and the adequacy of collateral pledged to secure the
credit. At December 31, 2002 and 2001 the Banks had $5.0 million of fixed-term,
callable advances from the FHLB, with a weighted average interest rate of 4.86%,
maturing January 17, 2011. At December 31, 2000, the Banks had no borrowings
from the FHLB-Chicago.

COMPETITION

In the face of significant competition by financial and non-bank
entities over the last few years, the Banks have had limited success in
increasing their retail deposit base, excluding the historical benefit of the
large corporate relationship with Gilster-Mary Lee. The Banks compete for
deposits and loans with a number of financial institutions in a four contiguous
county market area that has approximately 135,000 people. In three of the
counties served, the Banks' market share is low and average branch size is below
average. A number of the competing financial institutions are larger than the
Banks and are subsidiaries of larger regional bank holding companies. The Banks
also face competition, to an unquantifiable extent, from money market mutual
funds and local and regional securities firms.

Under the Gramm-Leach-Bliley Act of 2000, effective March 11, 2000,
securities firms and insurance companies that elect to become financial holding
companies may acquire banks and other financial

26

institutions. The Gramm-Leach-Bliley Act may significantly change the
competition environment in which the Company and the Banks conducts business.
The financial services industry is also likely to become more competitive as
further technological advances enable more companies to provide financial
services. These technological advances may diminish the importance of depository
institutions and other financial intermediaries in the transfer of funds between
points.

PERSONNEL

As of December 31, 2002, the Banks had 23 full-time employees and 9
part time employees, none of whom were represented by a collective bargaining
unit. The Banks believe their relationships with their employees is good.

REGULATION OF THE BANKS

The Banks are national banks subject to regulation, supervision and
examination by the OCC. In addition, the Banks' deposits are insured by the FDIC
up to the maximum amount permitted by law, and are therefore subject to
regulation, supervision and examination by the FDIC. See "2002 Annual Report -
Note 8 Regulatory Matters."

The Company and the Banks are legal entities separate and distinct.
Various legal limitations restrict the Banks from lending or otherwise supplying
funds to the Company (an "affiliate"), generally limiting such transactions with
the affiliate to 10% of each bank's capital and surplus, and limiting all such
transactions to 20% of each bank's capital and surplus. Such transactions,
including extensions of credit, sales of securities or assets and provision of
services, also must be on terms and conditions consistent with safe and sound
banking practices, including credit standards, that are substantially the same
or at least as favorable to each bank as those prevailing at the time for
transactions with unaffiliated companies.

Federal banking laws and regulations govern all areas of the operation
of the Banks, including reserves, loans, mortgages, capital, issuance of
securities, payment of dividends and establishment of branches. Federal bank
regulatory agencies also have the general authority to limit the dividends paid
by insured banks and bank holding companies if such payments should be deemed to
constitute an unsafe and unsound practice. The respective primary federal
regulators of the Company and the Banks have authority to impose penalties,
initiate civil and administrative actions and take other steps intended to
prevent the Banks from engaging in unsafe or unsound practices.

Federally insured banks are subject, with certain exceptions, to
certain restrictions or extensions of credit to their parent holding companies
or other affiliates, on investments in the stock or other securities of
affiliates and on the taking of such stock or securities as collateral from any
borrower. In addition, such banks are prohibited from engaging in certain tie-in
arrangements in connection with any extension of credit or the providing of any
property or service.

Banks are also subject to the provisions of the Community Reinvestment
Act of 1977, which requires the appropriate federal bank regulatory agency, in
connection with its regular examination of a bank, to assess the bank's record
in meeting the credit needs of the community serviced by the bank, including low
and moderate income neighborhoods. The regulatory agency's assessment of the
bank's record is made available to the public. Further, such assessment is
required of any bank which has applied,

27

among other things, to establish a new branch office that will accept deposits,
relocate an existing office or merge or consolidate with, or acquire the assets
or assume the liabilities of, a federally regulated financial institution.

Dividends from the Banks will constitute the major source of funds for
dividends to be paid by the Company. The amount of dividends payable by the
Banks to the Company will depend upon the Banks' earnings and capital position,
and is limited by federal and state laws, regulations and policies.

As national banks, the Banks may not pay dividends from their paid-in
surplus. All dividends must be paid out of undivided profits then on hand, after
deducting expenses, including reserves for losses and bad debts. In addition, a
national bank is prohibited from declaring a dividend on its shares of common
stock until its surplus equals its stated capital, unless there has been
transferred to surplus no less than one-tenth of the bank's net profits of the
preceding two consecutive half-year periods (in the case of an annual dividend).
The approval of the OCC is required if the total of all dividends declared by a
national bank in any calendar year exceeds the total of its net profits for that
year combined with its retained net profits for the proceeding two years, less
any required transfers to surplus.

The OCC has the authority to prohibit any bank from engaging in an
unsafe or unsound practice in conducting its business. The payment of dividends,
depending upon the financial condition of the bank, could be deemed to
constitute such an unsafe or unsound practice. The Federal Reserve and the OCC
have indicated their view that it generally would be an unsafe and unsound
practice to pay dividends except out of current operating earnings. Moreover,
the Federal Reserve has indicated that bank holding companies should serve as a
source of managerial and financial strength to their subsidiary banks.
Accordingly, the Federal Reserve has stated that a bank holding company should
not maintain a level of cash dividends to its shareholders that places undue
pressure on the capital of its bank subsidiaries, or that can be funded only
through additional borrowings or other arrangements that may undermine the bank
holding company's ability to serve as a source of strength.

The amount of dividends actually paid during any one period are
strongly affected by the Banks' management policy of maintaining a strong
capital position. Federal law further provides that no insured depository
institution may make any capital distribution (which would include a cash
dividend) if, after making the distribution, the institution would not satisfy
one or more of its minimum capital requirements. Moreover, the federal bank
regulatory agencies also have the general authority to limit the dividends paid
by insured banks if such payments should be deemed to constitute an unsafe and
unsound practice.

BANK HOLDING COMPANY REGULATION

GENERAL. Bank holding companies are subject to comprehensive regulation
by the Federal Reserve under the Bank Holding Company Act ("BHCA") and the
regulations of the Federal Reserve. As a bank holding company, the Company is
required to file with the Federal Reserve annual reports and such additional
information as the Federal Reserve may require and is subject to regular
examinations by the Federal Reserve. The Federal Reserve also has extensive
enforcement authority over bank holding companies, including, among other
things, the ability to assess civil money penalties, to issue cease and desist
or removal orders, and to require that a Company divest subsidiaries (including
its bank subsidiaries). In general, enforcement actions may be initiated for
violations of law and regulations and unsafe or unsound practices.

28

Under the BHCA, a bank holding company must obtain Federal Reserve
approval before: (1) acquiring, directly or indirectly, ownership or control of
any voting shares of another bank or bank holding company if, after such
acquisition, it would own or control more than 5% of such shares (unless it
already owns or controls the majority of such shares); (2) acquiring all or
substantially all of the assets of another bank or bank holding company; or (3)
merging or consolidating with another bank holding company.

Any direct or indirect acquisition by a bank holding company or its
subsidiaries of more than 5% of the voting shares of, or substantially all of
the assets of, any bank located outside of the state in which the operations of
the bank holding company's banking subsidiaries are "principally conducted", may
not be approved by the Federal Reserve unless the laws of the state in which the
bank to be acquired is located specifically authorize such an acquisition. The
term "principally conducted" generally means the state in which the total
deposits of all banking subsidiaries is the largest. The Company's business is
"principally conducted" in the State of Illinois. Most states have authorized
interstate bank acquisitions by out-of-state bank holding companies on either a
regional or a national basis, and most such statues require the home state of
the acquiring bank holding company to have enacted a reciprocal statue. Illinois
law permits bank holding companies located outside Illinois to acquire bank or
bank holding companies located in Illinois subject to the requirements that the
laws of the state in which the acquiring bank holding company is located permit
bank holding companies located in Illinois to acquire banks or bank holding
companies in the acquirer's state and that the laws of the state in which the
acquirer is located are not unduly restrictive when compared to those imposed by
the laws of Illinois.

The BHCA also prohibits a bank holding company, with certain
exceptions, from acquiring direct or indirect ownership or control of more than
5% of the voting shares of any company which is not a bank or bank holding
company, or from engaging directly or indirectly in activities other than those
of banking, managing or controlling banks, or providing services for its
subsidiaries. The principal exceptions to these prohibitions involve certain
non-bank activities which, by statue or by Federal Reserve regulation or order,
have been identified as activities closely related to the business of banking or
managing or controlling banks. The list of activities permitted by the Federal
Reserve includes, among other things, operating a savings institution, mortgage
company, finance company, credit card company or factoring company, performing
certain data processing operations; providing certain investment and financial
advice; underwriting and acting as an insurance agent for certain types of
credit-related insurance; leasing property on a full-payout, non-operating
basis; selling money orders, travelers' checks and United States Savings Bonds;
real estate and personal property appraising; providing tax planning and
preparation services; and, subject to certain limitations, providing securities
brokerage services for customers. The Company has no present plans to engage in
any of these activities.

DIVIDENDS. The Federal Reserve has issued a policy statement on the
payment of cash dividends by bank holding companies, which expresses the Federal
Reserve's view that a bank holding company should pay cash dividends only to the
extent that the company's net income for the past year is sufficient to cover
both the cash dividends and a rate of earning retention that is consistent with
the company's capital needs, asset quality and overall financial condition. The
Federal Reserve also indicated that it would be inappropriate for a company
experiencing serious financial problems to borrow funds to pay dividends.
Furthermore, under the prompt corrective action regulations adopted by the
Federal Reserve pursuant to FDICIA, the Federal Reserve may prohibit a bank
holding company from paying any dividends if the Company's bank subsidiary is
classified as "undercapitalized."

29

Bank holding companies are required to give the Federal Reserve prior
written notice of any purchase or redemption of its outstanding equity
securities if the gross consideration for the purchase or redemption, when
combined with the net consideration paid for all such purchases or redemptions
during the preceding 12 months, is equal to 10% or more of their consolidated
net worth. The Federal Reserve may disapprove such a purchase or redemption if
it determines that the proposal would constitute an unsafe or unsound practice
or would violate any law, regulation, Federal Reserve order, or any condition
imposed by, or written agreement with, the Federal Reserve.

CAPITAL REQUIREMENTS. The Federal Reserve has established capital
requirements for bank holding companies that generally parallel the capital
requirements for national banks under the OCC's regulations. The Federal Reserve
regulations provide that capital standards will generally be applied on a bank
only (rather than a consolidated) basis in the case of a bank holding company
with less than $150 million in total consolidated assets.

FEDERAL SECURITIES LAWS

The common stock of the Company is registered with the Securities
Exchange Commission (the "SEC") and is subject to the disclosure, proxy
solicitation, insider trading restrictions and other requirements of the federal
securities laws. Shares of the Common Stock purchased by persons who are not
affiliates of the Company may be resold without registration. Shares purchased
by an affiliate of the Company may comply with the resale restrictions of Rule
144 under the Securities Act. If the Company meets the current public
information requirements of Rule 144 under the Securities Act, each affiliate of
the Company who complies with the other conditions of Rule 144 (including those
that require the affiliate's sale to be aggregated with those of certain other
persons) would be able to sell in the public market, without registration, a
number of shares not to exceed, in any three-month period, the greater of (i) 1%
of the outstanding shares of the Company or (ii) the average weekly volume of
trading in such shares during the preceding four calendar weeks. Provision may
be made in the future by the Company to permit affiliates to have their shares
registered for sale under the Securities Act under certain circumstances. There
are currently no demand registration rights outstanding. However, in the event
the Company, at some future time, determines to issue additional shares from its
authorized but unissued shares, the Company might offer registration rights to
certain of its affiliates who want to sell their shares.

30

ITEM 2. Properties

The following table sets forth the Banks' offices, as well as certain
additional information relating to the offices, as of December 31, 2002.

ITEM 3. Legal Proceedings

Periodically, there have been various claims and lawsuits involving the Banks,
such as claims to enforce liens, condemnation proceedings on properties in which
the Banks hold security interests, claims involving the making and servicing of
real property loans and other issues incident to the Banks' business. The Banks
are not parties to any pending legal proceedings that management believes would
have a material adverse effect on the financial condition or operations of the
Banks.

ITEM 4. Submission of Matters to a Vote of the Security Holders

During the fourth quarter of the fiscal year covered by this report, the Company
did not submit any matters to the vote of security holders through the
solicitation of proxies or otherwise.

31

PART II

ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters.

The section of Annual Report to the Stockholders for the fiscal year ended
December 31, 2002, entitled "Common Stock and Related Matters" is hereby
incorporated by reference. No other sections of such Annual Report are
incorporated herein by this reference.

ITEM 6. Selected Financial Data.

The section of the Annual Report to the Stockholders for the fiscal year ended
December 31, 2002, entitled "Selected Consolidated Financial Information" is
hereby incorporated by reference. No other sections of such Annual Report are
incorporated herein by this reference.

ITEM 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.

The section of the Annual Report to the Stockholders for the fiscal year ended
December 31, 2002, entitled "Management's Discussion and Analysis of Financial
Condition and Results of Operations" is hereby incorporated by reference. No
other sections of such Annual Report are incorporated herein by this reference.

ITEM 7A. Quantitative and Qualitative Disclosures About Market Risks.

The Company's principal financial objective is to achieve long-term
profitability while reducing its exposure to fluctuating market interest rates.
The Company has sought to reduce the exposure of its earnings to changes in
market interest rates by attempting to manage the mismatch between asset and
liability maturities and interest rates. The principal element in achieving this
objective is to increase the interest-rate sensitivity of the Company's
interest-earning assets by originating adjustable rate residential mortgage
loans and shorter term consumer loans and maintaining a consistent level of
short- and intermediate-term investment securities and interest-bearing
deposits.

The Company does not engage in hedging activities or purchase high-risk
derivative instruments. Furthermore, the Company is not subject to foreign
currency exchange rate risk or commodity price risk.

Interest rate risk is the risk of loss in value due to changes in interest
rates. Management monitors and considers methods of managing interest rate risk
by monitoring changes in net portfolio value ("NPV") and its interest rate GAP
position (See "Interest Rate Risk Management" for the interest rate gap
analysis). The Company attempts to manage the various components of its balance
sheet to minimize the impact of sudden and sustained changes in interest rates
on net interest income.

In order to reduce the exposure to interest rate risk, the Company has developed
strategies to manage its liquidity, shorten the effective maturities of certain
interest-earning assets, and increase the effective maturities of certain
interest-bearing liabilities. The Company has focused on: (i) residential
lending of ARMs, which generally reprice within one to three years; (ii)
non-residential lending of adjustable or floating rate and/or short-term loans;
(iii) investment activities of short- and medium-term securities; (iv)
maintaining and increasing its passbook and transaction deposit accounts, which
are considered to be relatively resistant to changes in interest rates; and (v)
utilizing long-term borrowings to adjust the term to repricing of its
liabilities.

32

The Company uses an independent consulting firm to perform interest rate
sensitivity analysis for all product categories. The Company's primary focus of
its analysis is on the effect of interest rate increases and decreases on net
interest income. Management believes that this analysis reflects the potential
effects on current earnings on interest rate changes. Call criteria and
prepayment assumptions are taken into consideration for fixed term assets. The
following table shows projected results at December 31, 2002 and December 31,
2001 of the impact on net interest income from an immediate change in interest
rates. The results are shown as a percentage change in net interest income over
the next twelve months.

As with any method of measuring interest rate risk, certain shortcomings are
inherent in the method of analysis presented in the foregoing table. For
example, although certain assets and liabilities may have similar maturities or
periods to repricing, they may react in different degrees to changes in market
interest rates. Also, the interest rates on certain types of assets and
liabilities may fluctuate in advance of changes in market interest rates, while
other types may lag behind changes in market rates. Additionally, certain
assets, such as substantially all of the Company's ARM loans, have features that
restrict changes in interest rates on a short-term basis and over the life of
the asset. Further, in the event of a change in interest rates, expected rates
of prepayments on loans and early withdrawals from certificates could likely
deviate significantly from those assumed in calculating the table. Therefore,
the data presented in the foregoing table should not be relied upon as
indicative of actual results.

ITEM 8. Financial Statements and Supplementary Data.

The sections of the Annual Report to the Stockholders for the fiscal year ended
December 31, 2002, entitled "Chester Bancorp, Inc. and Subsidiaries Consolidated
Balance Sheets," "Chester Bancorp, Inc. and Subsidiaries Consolidated Statements
of Income," "Chester Bancorp, Inc. and Subsidiaries Consolidated Statements of
Stockholders' Equity," "Chester Bancorp, Inc. and Subsidiaries Consolidated
Statements of Cash Flows," "Chester Bancorp, Inc. and Subsidiaries Notes to
Consolidated Financial Statements" are hereby incorporated by reference. No
other sections of such Annual Report are incorporated herein by this reference.

ITEM 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.

The section of the 2003 Proxy Statement, entitled "Auditors", is hereby
incorporated by reference. No other sections of such Proxy Statement are
incorporated herein by this reference.

33

PART III

ITEM 10. Directors and Executive Officers of the Registrant.

The sections of the 2003 Proxy Statement, entitled "Proposal I - Election of
Directors," and "Compliance with Section 16(a) of the Exchange Act," as well as
the "Employment Agreements" portion of the section entitled "Executive
Compensation," are hereby incorporated by reference. No other sections of such
Proxy Statement are incorporated herein by this reference.

ITEM 11. Executive Compensation.

The section of the 2003 Proxy Statement, entitled "Executive Compensation," is
hereby incorporated by reference. No other sections of such Proxy Statement are
incorporated herein by this reference.

ITEM 12. Security Ownership of Certain Beneficial Owners and Management

The section of the 2003 Proxy Statement, entitled "Security Ownership of Certain
Beneficial Owners and Management," is hereby incorporated by reference. No other
sections of such Proxy Statement are incorporated herein by this reference.

ITEM 13. Certain Relationships and Related Transactions.

The section of the 2003 Proxy Statement, entitled "Transactions with
Management," is hereby incorporated by reference. No other sections of such
Proxy Statement are incorporated herein by this reference.

ITEM 14. Controls and Procedures

An evaluation was performed under the supervision and with the participation of
the Company's management, including the Chief Executive Officer (CEO) and Chief
Financial Officer (CFO), of the effectiveness of the design and operation of the
Company's disclosure controls and procedures within 90 days before the filing
date of this quarterly report. Based on that evaluation, the Company's
management, including the CEO and CFO, concluded that the Company's disclosure
controls and procedures were effective. There have been no significant changes
in the Company's internal controls or in other factors that could significantly
affect internal controls subsequent to their evaluation.

ITEM 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.

(a)(1) Financial Statements

The following information appearing in the Company's Annual Report to
Stockholders for the Fiscal Year Ended December 31, 2002 is incorporated by
reference as Exhibit 13 to this Annual Report on Form 10-K. No other sections of
such Annual Report are incorporated herein by this reference.

Annual Report Sections:

Independent Auditors' Report:

34

Chester Bancorp, Inc. and Subsidiaries Consolidated Balance Sheets as of the
Years Ended December 31, 2002 and 2001.

Chester Bancorp, Inc. and Subsidiaries Consolidated Statements of Income for the
Years Ended December 31, 2002, 2001, and 2000.

Chester Bancorp, Inc. and Subsidiaries Consolidated Statements of Comprehensive
Income for the Years Ended December 31, 2002, 2001, 2000.

Chester Bancorp, Inc. and Subsidiaries Consolidated Statements of Stockholders'
Equity for the Years Ended December 31, 2002, 2001, and 2000.

Chester Bancorp, Inc. and Subsidiaries Consolidated Statements of Cash Flows for
the Years Ended December 31, 2002, 2001, and 2000.

Chester Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial
Statements December 31, 2002 and 2001.

(a)(2) Financial Statement Schedules. Not applicable.

(a)(3) Exhibits

35

(1) Documents incorporated by reference to the Company's Registration Statement
on Form S-1 filed with the SEC on August 12, 1996, (No. 333-2470) at the
corresponding exhibit. All such previously filed documents are hereby
incorporated by reference in accordance with Item 601 of Regulation S-K.

(2) Documents incorporated by reference to the Company's Registration Statement
on Form S-8 filed with the SEC on September 1, 2000 (No. 333-445134).

* These agreements are management contracts or compensation plans or
arrangements required to be filed as exhibits to this Form 10-K.

(b) Reports on Form 8-K.

No reports on Form 8-K have been filed during the last quarter of the
period covered by this report.

36

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

Chester Bancorp, Inc.

March 26, 2003 By /s/ Michael W. Welge
---------------------------------
Michael W. Welge,
Chairman of the Board, President,
Chief Financial Officer, and Director

Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.

March 26, 2003 By /s/ Edward K. Collins
------------------------------
Edward K. Collins,
Treasurer, Secretary, and Director

March 26, 2003 By /s/ Carl H. Welge
------------------------------
Carl H. Welge,
Director

March 26, 2003 By /s/ Thomas E. Welch
------------------------------
Thomas E. Welch, Jr.
Director

March 26, 2003 By /s/ John R. Beck
------------------------------
John R. Beck, M.D.
Director

March 26, 2003 By /s/ James C. McDonald
------------------------------
James C. McDonald,
Director

37

CERTIFICATIONS

Certification of Principal Executive Officer

I, Edward K. Collins, certify that:

1. I have reviewed this annual report on Form 10-K of Chester Bancorp, Inc.;

2. Based on my knowledge, this annual report does not contain any untrue
statement of material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) Designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this annual report is being prepared;

b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures of a date within 90 days prior to the filing date of this annual
report (the "Evaluation Date"); and

c) Presented in this annual report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):

a) All significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and

b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and

6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.

March 26, 2003 /s/ Edward K. Collins
-----------------------------
Edward K. Collins
Chief Executive Officer
(Principal Executive Officer)

1

CERTIFICATIONS

Certification of Principal Financial Officer

I, Michael W. Welge, certify that:

1. I have reviewed this annual report on Form 10-K of Chester, Inc.;

2. Based on my knowledge, this annual report does not contain any untrue
statement of material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) Designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this annual report is being prepared;

b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures of a date within 90 days prior to the filing date of this annual
report (the "Evaluation Date"); and

c) Presented in this annual report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):

a) All significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and

b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and

6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.

March 26, 2003 /s/ Michael W. Welge
------------------------------------
Michael W. Welge
Chairman of the Board, President and
Financial Officer
(Principal Financial Officer)

2