CFS BANCORP INC - 10-K Annual Report

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED: DECEMBER 31, 2003

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

COMMISSION FILE NO.: 0-24611
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CFS BANCORP, INC.
(Exact name of registrant as specified in its charter)

DELAWARE 35-2042093
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)

707 RIDGE ROAD 46321
MUNSTER, INDIANA (Zip Code)
(Address of Principal Executive Offices)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(219) 836-9990

SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NOT APPLICABLE

SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK (PAR VALUE $0.01 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 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing 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 Exchange Act Rule 12b-2). Yes [X] No [ ]

As of June 30, 2003, the aggregate value of the 11,396,105 shares of Common
Stock of the Registrant outstanding on such date, which excludes 749,843 shares
held by all directors and executive officers of the Registrant as a group, was
approximately $170.9 million. This figure is based on the last known trade price
of $15.00 per share of the Registrant's Common Stock on June 30, 2003.

Number of shares of Common Stock outstanding as of March 5, 2004:
12,254,223

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive proxy statement for the Annual Meeting of
Stockholders to be held on April 27, 2004 are incorporated by reference into
Part III.
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CFS BANCORP, INC. AND SUBSIDIARIES

FORM 10-K

INDEX

1

When used in this Annual Report on Form 10-K or future filings by the
Company with the Securities and Exchange Commission (SEC), in the Company's
press releases or other public or stockholder communications, 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, or the negative thereof, are intended to identify
"forward-looking statements" within the meaning of the Private Litigation Reform
Act of 1995.

The Company wishes to caution readers not to place undue reliance on any
such forward-looking statements, which speak only as of the date made, and to
advise readers that various factors, including regional and national economic
conditions, changes in levels of market interest rates, credit and other risks
which are inherent in the Company's lending and investment activities,
legislative changes, changes in the cost of funds, demand for loan products and
financial services, changes in accounting principles and competitive and
regulatory factors, could affect the Company's financial performance and could
cause the Company's actual results for future periods to differ materially from
those anticipated or projected. Such forward-looking statements are not
guarantees of future performance. The Company does not undertake, and
specifically disclaims any obligation, to update any forward-looking statements
to reflect occurrences or unanticipated events or circumstances after the date
of such statements.

PART I.

ITEM 1. BUSINESS

GENERAL

CFS Bancorp, Inc. (including its consolidated subsidiaries, the Company)
was organized in March 1998 at the direction of the Board of Directors of
Citizens Financial Services, FSB (the Bank or Citizens Financial) for the
purpose of holding all of the capital stock of the Bank and in order to
facilitate the conversion of the Bank from a federally-chartered mutual savings
bank to a federally-chartered stock savings bank (Conversion). In connection
with the Conversion, the Office of Thrift Supervision (OTS) approved the
Company's application to become a savings and loan holding company. The Company
now conducts business as a registered unitary savings and loan holding company
and is subject to oversight and examination by the OTS. See
"Regulation -- Regulation of Savings and Loan Holding Companies."

The Company's assets consist of the outstanding shares of common stock of
the Bank, investments made with the portion of the net proceeds from the sale of
Company shares in the Company's July 1998 initial public offering (Offering),
which was undertaken in conjunction with the Conversion, retained by the
Company, and the Company's loan to the Bank for the employee stock ownership
plan (ESOP). The Company has no significant liabilities. The management of the
Company and the Bank are substantially identical, and the Company neither owns
nor leases any property but instead uses the premises, equipment and furniture
of the Bank. The Company does not employ any persons other than officers who are
also officers of the Bank. In addition, the Company utilizes the support staff
of the Bank from time to time. Additional employees may be hired as appropriate
to the extent the Company expands or changes its business in the future.

The Bank is subject to examination and comprehensive regulation by the OTS,
which is the Bank's chartering authority and primary federal regulator. The Bank
is also regulated by the Federal Deposit Insurance Corporation (FDIC),
administrator of the Savings Association Insurance Fund (SAIF). The Bank is also
subject to certain reserve requirements established by the Board of Governors of
the Federal Reserve System (FRB) and is a member of the Federal Home Loan Bank
(FHLB) of Indianapolis, which is one of the 12 regional banks comprising the
FHLB System.

Citizens Financial is a federally-chartered stock savings bank that was
originally organized in 1934. The Bank conducts its business from its executive
offices in Munster, Indiana, as well as 22 banking centers located in Lake and
Porter Counties in northwest Indiana and Cook, DuPage and Will Counties in
Illinois. The Company also has an Operations Center located in Highland, Indiana
which is dedicated to its Customer Call Center and other back office operations.

2

At December 31, 2003, the Company had $1.57 billion in total assets, $975.8
million in deposits, $418.5 million in borrowed funds and $156.0 million of
stockholders' equity. The Bank is primarily engaged in attracting deposits from
the general public and using those funds to originate loans and invest in
securities.

During 1998, the Bank began leveraging its capital base, using borrowings
to provide additional funds to support its lending and investing activities.
Historically, the Bank's primary lending emphasis was on loans secured by the
first liens on single-family (one-to four-units) residential properties located
in its market area. However, the Bank decided not to participate aggressively in
the substantial refinancing of home loans that occurred nationally due to record
low interest rates during the three years ended December 31, 2003. Instead the
Bank's strategy in recent periods has been to accumulate liquidity in order to
take advantage of loans and other investments that are expected to become
available as the economy improves and interest rates rise to higher levels.

The Bank also originates commercial real estate and multi-family
residential loans, construction and land development loans, home equity lines of
credit (HELOC) and other commercial and consumer loans. Since 1998, the Bank
shifted its lending emphasis, increasing its involvement in commercial real
estate loans, multi-family residential mortgage loans, and construction and land
development loans, while concurrently reducing its originations of single-family
residential loans.

The Bank's revenue is derived from interest on loans, mortgage-backed and
related securities and investments, loan and deposit fees, and investment
commissions. The Bank's operations are significantly impacted by general and
economic conditions, the monetary policy of the federal government, including
the Federal Reserve Board, legislative tax policies and governmental budgetary
matters. In the past, the Bank's revenue has been largely dependent on net
interest income, which is the difference between interest earned on
interest-bearing assets and the interest expense paid on interest-bearing
liabilities. However, the Bank has focused on generating other sources of income
through loan and deposit fees, investment commissions and other non-interest
income to be a significant source of revenue.

AVAILABLE INFORMATION

CFS Bancorp, Inc. is a public company and files annual, quarterly and
special reports, proxy statements and other information with the Securities and
Exchange Commission. The Company's filings are available to the public at the
SEC's web site at http://www.sec.gov. Members of the public may also read and
copy any document the Company files at the SEC's Public Reference Room at 450
Fifth Street, N.W., Washington, D.C. 20549. You can request copies of these
documents by writing to the SEC and paying a fee for the copying cost. Please
call the SEC at 1-800-SEC-0330 for more information about the operation of the
public reference room. In addition, the Company's stock is listed for trading on
the Nasdaq National Market and trades under the symbol "CITZ." You may find
additional information regarding the Company at www.nasdaq.com.

In addition to the foregoing, the Company maintains a web site at
www.cfsbancorp.com. The Company makes available on its Internet web site copies
of its Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current
Reports on Form 8-K and any amendments to such documents as soon as reasonably
practicable after it files such material with or furnishes such documents to the
SEC.

CORPORATE GOVERNANCE

The Company has established certain committees of its Board of Directors,
specifically audit, compensation, and nominating committees. The charters of
these committees as well as the Company's Code of Conduct and Ethics can be
found on the above mentioned Company website. The information is also available
in printed form to any shareholder who requests it by writing to the Company in
care of the Vice President -- Corporate Secretary, 707 Ridge Road, Munster,
Indiana 46321.

3

MARKET AREA AND COMPETITION

Citizens Financial operates out of its headquarters in Munster, Indiana,
which is located in Lake County in northwest Indiana. Citizens Financial
maintains 22 banking centers in Lake and Porter Counties in northwest Indiana
and in Cook, DuPage and Will Counties in Illinois. The areas served by Citizens
Financial are part of the Chicago Metropolitan Statistical Area.

Citizens Financial has historically concentrated its efforts in the market
surrounding its offices and has in recent years broadened that market into the
geographic Midwest mainly through the development of commercial lending
relationships. The Bank's market area reflects diverse socioeconomic factors.
Traditionally, the market area in northwest Indiana and the suburban areas south
of Chicago were dependent on heavy manufacturing. While manufacturing is still
an important component of the local economies, service-related industries have
become increasingly significant to the region in the last decade. Growth in the
local economies can be expected to occur largely as a result of the continued
interrelation with Chicago as well as suburban business centers in the area.

The Bank faces significant competition both in making loans and in
attracting deposits. The Chicago metropolitan area is one of the largest money
centers in the United States, and the market for deposit funds is highly
competitive. The Bank's competition for loans comes principally from commercial
banks, other savings banks, savings associations and mortgage-banking companies.
The Bank's most direct competition for deposits has historically come from
savings banks, commercial banks and credit unions. The Bank faces additional
competition for deposits from short-term money market funds, other corporate and
government securities funds and from other non-depository financial institutions
such as brokerage firms and insurance companies.

LENDING ACTIVITIES

General. The Bank offers various loan products including single-family and
multi-family residential mortgage loans, commercial real estate loans,
construction and land development loans, home equity lines of credit, commercial
business loans, and consumer loans. The Bank's lending strategy is to diversify
its portfolio to limit risks associated with a particular loan type or industry
while building a quality portfolio. The Bank has established specific industry
concentration limits in a manner that will not hamper its lenders in the pursuit
of new business in a variety of sectors.

Loan underwriting focuses on the financial strength of the borrower and
guarantors, the cash flow of a business, and the underlying collateral. While
the Bank offers both fixed and adjustable rate products, the emphasis remains on
adjustable rate products to better control interest rate risk.

The types of loans that the Bank may originate are subject to federal and
state laws and regulations. Interest rates charged by the Bank on loans are
affected principally by the demand for such loans, the supply of money available
for lending purposes, the rates offered by its competitors and the risks
involved on such loans. These factors are, in turn, affected by general and
economic conditions, the monetary policy of the federal government, including
the Federal Reserve Board, legislative tax policies and governmental budgetary
matters.

4

Loan Portfolio Composition. The following table sets forth the composition
of the Bank's loans at the dates indicated.

Contractual Principal Repayments and Interest Rates. The following table
sets forth scheduled contractual amortization of the Bank's loans at December
31, 2003, as well as the dollar amount of such loans which are scheduled to
mature after one year which have fixed or adjustable interest rates. Demand
loans, loans having no schedule of repayments with no stated maturity and
overdraft loans are reported as due in one year or less.

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(1) Of the $876.9 million of loan principal repayments contractually due after
December 31, 2004, $331.0 million have fixed interest rates and $545.9
million have variable interest rates which reprice from one month up to five
years.

5

Scheduled contractual loan amortization does not reflect the expected term
of the Bank's loan portfolio. The average life of loans is substantially less
than their contractual terms because of prepayments and due-on-sale clauses,
which give the Bank the right to declare a conventional loan 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 when current market rates of interest for
mortgage loans are higher than rates on existing mortgage loans and, conversely,
decrease when rates on existing mortgage loans are higher than current market
rates as borrowers refinance adjustable-rate and fixed-rate loans at lower
rates. Under the latter circumstance, the weighted average yield on loans
decreases as higher yielding loans are repaid or refinanced at lower rates.

Loan Activity. The following table shows the Bank's loan activity during
the years indicated.

The lending activities of Citizens Financial are subject to the credit
policy approved by the Bank's Board of Directors. Applications for residential
mortgages are taken at all of the Bank's offices by mortgage originators and are
forwarded to the Bank's retail operations center for underwriting and analysis.
Commercial

6

loan requests are taken through business development efforts and commercial loan
officer relationships. The business bankers and commercial loan officers collect
necessary information regarding the potential borrower and request. The request
and information are then forwarded to the Bank's commercial loan credit analysts
who complete the underwriting and analysis on the loan. The Bank requires that a
property appraisal be obtained in connection with all new real estate mortgage
loans. Citizens Financial requires that title insurance and hazard insurance be
maintained on all properties secured by a first mortgage and that adequate flood
insurance be maintained if the property is within a designated flood plain. For
HELOCs, the Bank requires an appraisal or evaluation and title search to confirm
any liens on the property.

Certain officers of the Bank have been authorized by the Board of Directors
to approve loans up to certain designated amounts. The Loan Committee of
Citizens Financial meets weekly and reviews all loans that exceed individual
loan authority. The full Board of Directors of Citizens Financial is provided
monthly with a listing of all loans approved during the period.

A federal savings bank generally may not make loans to one borrower and
related entities in an amount which exceeds 15% of its unimpaired capital and
surplus (or approximately $20.1 million in the case of the Bank at December 31,
2003), although loans in an amount equal to an additional 10% of unimpaired
capital and surplus may be made to a borrower if the loans are fully secured by
readily marketable securities.

Generally, Citizens Financial's aggregate loans to one borrower and related
entities have been well below the regulatory limits. As of December 31, 2003,
Citizens Financial's two largest relationships with one borrower and related
entities that comprise a common enterprise amounted to $19.4 million and $19.2
million, and all of the Bank's loans included in such relationships were
performing in accordance with their terms. Since January 2003, the Bank has had
a general guideline of limiting any one loan or multiple loans to the same
borrower to 75% of the regulatory limit.

The Bank also monitors the aggregate loans to corporate groups. These are
loans that are given to individual entities that have a similar ownership group
but are not considered to be a common enterprise. While the individual loans are
secured by separate property and underwritten based on separate cash flows, the
entities may all be owned or controlled by one individual or a group of
individuals. The Bank's limit to any corporate group is 50% of Tier 1 capital.
At December 31, 2003, Tier 1 capital was $131.5 million. Citizens Financial's
two largest corporate group relationships at December 31, 2003 equaled $37.9
million and $25.0 million, respectively. Both of these relationships are well
below the group limit of $65.8 million and are performing in accordance with
their terms.

Single-Family Residential and Home Equity Lines of Credit. Substantially
all of the Bank's single-family residential mortgage loans consist of
conventional loans. Conventional loans are neither insured by the Federal
Housing Administration (FHA) nor partially guaranteed by the Department of
Veterans Affairs (VA). The vast majority of the Bank's single-family residential
mortgage loans are secured by properties located in Lake and Porter Counties in
northwest Indiana and Cook, DuPage and Will Counties in Illinois.

Historically, the Bank retained virtually all mortgage loans which it
originated and did not engage in sales of residential mortgage loans. Beginning
July 1, 1999, the Bank instituted a new policy and began selling its newly
originated fixed-rate loans; such sales amounted to $12.7 million in 2003 and
included the release of servicing.

As of December 31, 2003, $317.6 million, or 30.6%, of the Bank's total
loans consisted of single-family residential mortgage loans. Citizens Financial
originated $57.4 million, $41.0 million and $23.5 million of single-family
residential mortgage loans in 2003, 2002 and 2001, respectively. Although the
Bank will continue to originate single-family residential mortgage loans, it
anticipates that the commercial lending portfolio and construction and land
development loans will continue to increase as a percentage of total new loan
originations as the Bank continues to focus on changing its asset mix based on
its strategic plan.

Citizens Financial's residential mortgage loans have either fixed interest
rates or variable interest rates which adjust periodically during the term of
the loan. Fixed-rate loans generally have maturities of 15 or 30 years and are
fully amortizing with monthly loan payments sufficient to repay the total amount
of the loan with interest by the maturity date. The Bank's fixed-rate loans are
generally originated under terms, conditions

7

and documentation which permit them to be pre-sold in the secondary market for
mortgages. By pre-selling these loans, the Bank limits the interest rate risk
associated with fixed rate loans. At December 31, 2003, $72.9 million, or 23.0%
of the Bank's single-family residential mortgage loans, were fixed-rate loans.
Substantially all of the Bank's single-family residential mortgage loans contain
due-on-sale clauses, which permit the Bank to declare the unpaid balance to be
due and payable upon the sale or transfer of any interest in the property
securing the loan. The Bank enforces such due-on-sale clauses.

The adjustable-rate single-family residential mortgage (ARM) loans
currently offered by the Bank have interest rates which are fixed for the
initial three or five years and are thereafter adjusted on an annual basis in
accordance with a designated index such as one-year U.S. Treasury obligations
adjusted to a constant maturity (CMT), plus a stipulated margin. The Bank's
adjustable-rate single-family residential real estate loans generally have a cap
of 2% on any increase or decrease in the interest rate at any adjustment date
and include a specified cap on the maximum interest rate over the life of the
loan. This cap is generally 6% above the initial rate. The Bank's
adjustable-rate loans require that any payment adjustment resulting from a
change in the interest rate of an adjustable-rate loan be sufficient to result
in full amortization of the loan by the end of the loan term and, thus, do not
permit any of the increased payment to be added to the principal amount of the
loan, or so-called negative amortization. At December 31, 2003, $244.7 million,
or 77.0% of the Bank's single-family residential mortgage loans, were
adjustable-rate loans.

While the Bank has focused on providing adjustable-rate loans to decrease
the risk related to changes in the interest rate environment, these types of
loans also involve other risks. As interest rates rise, the customers' payments
on an adjustable-rate loan also increase to the extent permitted by the loan
terms thereby increasing the potential for default. Also, when interest rates
decline substantially, borrowers tend to refinance into fixed rate loans. The
Bank believes that these risks, which have not had a material adverse effect on
the Bank to date, generally are less than the risks associated with holding
fixed-rate loans in an increasing interest rate environment.

The volume and types of ARMs originated by Citizens Financial are affected
by such market factors as the level of interest rates, competition, consumer
preferences and availability of funds. Accordingly, although the Bank
anticipates that it will continue to offer single-family ARMs, the increased
emphasis over the past few years on growing the Bank's commercial real estate
and multi-family residential loans and its construction and land development
portfolio has reduced the proportion of single-family residential loans to total
loans.

The Bank's single-family residential mortgage loans generally do not exceed
amounts limited to the maximum amounts contained in U.S. Government sponsored
agency guidelines. In addition, the maximum loan-to-value (LTV) ratio for the
Bank's single-family residential mortgage loans is generally 95% of the secured
property's appraised value, provided that private mortgage insurance is
generally obtained on the portion of the principal amount that exceeds 80% of
the appraised value.

At December 31, 2003, Citizens Financial's home equity products amounted to
$71.4 million, or 6.9% of the Bank's total loans. The majority of the Bank's
home equity products are HELOCs which are structured as an adjustable rate line
of credit with terms up to 20 years including a 10 year repayment period. The
Bank also offers home equity loans with a 10 year term which have a fixed-rate
for the first five years and a one-time rate adjustment after the fifth year.
Both types of home equity products are secured by the underlying equity in the
borrower's residence. The Bank's HELOCs generally require LTV ratios of 90% or
less after taking into consideration any first mortgage loan. However, certain
customers may qualify to receive up to 100% LTV. The Bank originated $66.6
million, $42.3 million and $30.7 million of home equity loans in 2003, 2002 and
2001, respectively.

Commercial Real Estate and Multi-Family Residential Loans. In recent
years, the Company's strategy has changed to shift the loan portfolio to more
commercial real estate and multi-family residential loans. In order to focus on
this shift, the Company significantly increased the number of experienced
commercial loan officers and employees to build a regionally structured
Commercial Loan Department. The regional structure allows the loan officers to
build better relationships with the businesses in their communities. The
Commercial Loan Department will be located in the Bank's new Dyer facility which
is expected to open by May 2004. The new commercial loan officers bring with
them other business relationships which have allowed the Company

8

to not only build more relationships within its market area but also expand and
generate new business outside of its historical lending area, mainly the
geographic Midwest.

At December 31, 2003, Citizens Financial's commercial real estate loans and
multi-family residential loans amounted to $340.8 million and $87.9 million, or
32.8% and 8.5%, respectively, of the Bank's total loan portfolio, as compared to
$93.3 million and $33.8 million, or 9.7% and 3.5%, respectively, of the Bank's
total loan portfolio at December 31, 1999. The Bank originated $91.4 million of
commercial real estate loans during the year ended December 31, 2003 compared to
$137.0 million and $23.2 million, respectively, in 2002 and 2001.

The Bank's multi-family residential loans are concentrated in the
geographic Midwest. The Bank originated $10.2 million of multi-family
residential loans in 2003 compared to $22.6 million and $2.5 million in 2002 and
2001, respectively. As of December 31, 2003, the Bank's five largest commercial
real estate and multi-family residential loan relationships were $19.4 million,
$19.2 million, $18.3 million, $17.2 million and $16.9 million, all of which were
performing in accordance with their terms.

Commercial real estate and multi-family residential loans generally have 3
to 15 year terms with an amortization period of 25 years. These loans often have
interest rates that are fixed for an initial three or five year period and then
adjust annually to a CMT plus a stipulated margin for the remainder of the term.
The Bank has also historically offered commercial real estate and multi-family
residential loans with a fixed interest rate for a five year term followed by a
one time adjustment which is then fixed for the remaining term. Commercial real
estate and multi-family residential loans generally have shorter terms to
maturity and higher yields than the Bank's single-family residential mortgage
loans. Also, fees of between 0.5% and 1.0% of the principal loan balance are
charged to the borrower upon closing. These loans are subject to prepayment
penalties. The Bank generally obtains personal guarantees of the borrower's
principals as additional security for any commercial real estate and
multi-family residential loans.

The Bank's commercial real estate loans are secured by hotels, medical
office facilities, churches, small office buildings, strip shopping centers and
other commercial uses primarily located throughout the Bank's market area and
into the geographic Midwest. These loans are usually less than $15.0 million,
and as of December 31, 2003, the average size of the Bank's commercial real
estate loans was approximately $1.3 million.

Citizens Financial evaluates various aspects of commercial real estate and
multi-family residential loan transactions in an effort to mitigate credit risk
to the greatest extent possible. In underwriting these loans, consideration is
given to the stability of the property's cash flow history, future operating
projections, management experience, current and projected occupancy, position in
the market, location and physical condition. In addition, the Bank also performs
sensitivity analysis on cash flow, vacancy and interest rate projections when
underwriting the loans to determine how different scenarios may impact the
borrowers' ability to repay the loans. The Bank has also generally imposed a
debt coverage ratio (the ratio of net income before payment of debt service to
debt service) of not less than 120% for commercial real estate and multi-family
residential loans. The underwriting analysis also includes credit checks and a
review of the financial condition of the borrower and guarantor. An appraisal
report is prepared by an independent appraiser commissioned by the Bank to
substantiate property values for every commercial real estate and multi-family
residential loan transaction. All appraisal reports and any necessary
environmental site assessments are reviewed by the Bank before the loan closes.

Commercial real estate and multi-family residential lending entails
substantially different risks when compared to single-family residential lending
because such loans often involve large loan balances to single borrowers and
because the payment experience on such loans is typically dependent on the
successful operation of the project or the borrower's business. These risks can
also be significantly affected by supply and demand conditions in the local
market for apartments, offices, warehouses, or other commercial space. The Bank
attempts to minimize its risk exposure by limiting such lending to proven
businesses, only considering properties with existing operating performance
which can be analyzed, requiring conservative debt coverage ratios and
periodically monitoring the operation and physical condition of the collateral
as well as the business occupying the property.

9

As of December 31, 2003, the Bank had $7.8 million, or 2.3% of its
commercial real estate loans identified as non-performing loans while $3.7
million, or 4.2%, of its multi-family residential loans were considered
non-performing. Refer to "Asset Quality" for more information on non-performing
loans.

The Bank also invests, on a participating basis, in commercial real estate
and multi-family residential loans originated by other lenders. In these
transactions, the Bank reviews such loans utilizing the same credit policies
applicable to loans it originates. At December 31, 2003, participation loans
purchased totaled approximately $65.4 million and $37.7 million for commercial
real estate and multi-family residential loans, respectively.

Construction and Land Development Loans. As previously indicated, the Bank
increased its emphasis on construction and land development loans beginning in
the second half of 1998. Historically, in the years prior to the Bank's
Conversion, the Bank had concentrated its construction lending efforts primarily
on residential construction loans to local real estate builders, generally with
whom it had an established relationship. The Bank also originated such loans to
individuals for the construction of their residences. Commencing in the second
half of 1998, the Bank expanded its efforts to originate construction loans for
commercial real estate and multi-family residential properties.

At December 31, 2003, the average size of construction loans for commercial
real estate and multi-family residential properties was approximately $4.1
million. At December 31, 2003, construction and land development loans amounted
to $182.5 million, or 17.6% of the Bank's loan portfolio (including $54.1
million of loans in process). Of the Bank's construction and land development
loans at December 31, 2003, $16.5 million were construction/permanent,
single-family residential loans which, by their terms, convert to permanent
mortgage loans upon the completion of construction. The Bank originated $69.4
million of construction and land development loans during 2003, compared to
$98.1 million and $63.0 million in 2002 and 2001, respectively. The amount of
construction and land development loans originated in 2003 included an aggregate
of $49.8 million for commercial real estate and multi-family residential
construction loans. Of the Bank's commercial real estate and multi-family
residential mortgage loans at December 31, 2003, $40.2 million were
construction/permanent loans.

The Bank originates land loans to local developers for the purpose of
developing the land (i.e., roads, sewer and water) for sale. These loans are
secured by a mortgage on the property which is generally limited to 75% of the
appraised value of the property and are typically made for a period of up to two
years. The Bank requires monthly interest payments during the term of the loan.
The principal of the loan is reduced as lots are sold and released. All of the
Bank's land loans are secured by property located in its primary market area. In
addition, the Bank generally obtains personal guarantees from the borrower's
principals for construction and land development loans.

The Bank's loan underwriting and processing procedures require a property
appraisal by an approved independent appraiser and that each construction and
development loan be reviewed by independent architects, engineers or other
qualified third parties for verification of costs. Disbursements during the
construction phase are based on regular on-site inspections and approved
certifications. In the case of construction loans on commercial projects where
the Bank provides the permanent financing, the Bank usually requires firm lease
commitments on some portion of the property under construction from qualified
tenants. In addition, the Bank limits both its residential and commercial
construction lending to northwest Indiana and the Chicagoland area. At December
31, 2003, the Bank's five largest construction and land development
relationships were $17.5 million, $17.0 million, $15.0 million, $13.9 million
and $12.5 million, all of which were performing in accordance with their terms.

Construction and development financing is generally considered to involve a
higher degree of risk of loss than long-term financing on improved,
owner-occupied real estate. The Bank's risk of loss on a construction loan is
dependent largely upon the accuracy of the initial estimate of the property's
value at completion of construction or development and the estimated cost
(including interest) of construction. If the estimate of construction cost
proves to be inaccurate, the Bank first requires the borrower to inject cash
equity to cover any shortfall. The Bank may then need to advance funds beyond
the amount originally committed to permit completion of the development.
Construction and development loans generally are considered to be more

10

difficult to evaluate and monitor than single-family residential mortgage loans.
In addition, the Bank's commercial real estate and construction and development
loans generally have larger principal balances than its single-family
residential mortgage loans.

In evaluating any new originations of construction and development loans,
the Bank generally considers evidence of the availability of permanent financing
or a takeout commitment to the borrower, the reputation of the borrower and the
contractor, the amount of the borrower's equity in the project, independent
valuations and reviews of cost estimates, pre-construction sale and leasing
information, and cash flow projections of the borrower. To reduce the inherent
lending risk, the Bank may require performance bonds in the amount of the
construction contract and often obtains personal guarantees from the principals
of the borrower.

As of December 31, 2003, $4.2 million, or 2.3%, of Citizens Financial's
construction and land development loans were considered non-performing. Refer to
"Asset Quality" for additional discussions on non-performing loans.

Other Loans. Citizens Financial's other loans consist primarily of
commercial loans, consumer loans and loans secured by deposit accounts. Included
in the category of commercial loans are loans secured by business assets other
than real estate, unsecured loans, and secured and unsecured operating lines of
credit. As of December 31, 2003, Citizens Financial's other loans amounted to
$38.6 million compared to $42.6 million and $26.1 million at December 31, 2002
and 2001, respectively. The Bank is not actively marketing its consumer loans
and offers them primarily as a service to its existing customers.

ASSET QUALITY

General. All of the Bank's assets are subject to review under its
classification system. See discussion on "Classified and Criticized Assets."
Loans are periodically reviewed by the Bank's Loan Committee. The Board of
Directors also reviews the classified assets on a quarterly basis. When a
borrower fails to make a required payment on a loan, the Bank attempts to cure
the deficiency by contacting the borrower and seeking payment. Contacts are
generally made prior to 30 days after a payment is due. If a delinquency
continues, late charges are assessed and additional efforts are made to collect
the past due payments. While the Bank generally prefers to work with borrowers
to resolve such problems, when the account becomes 90 days delinquent, the Bank
may institute foreclosure or other proceedings, as deemed necessary, to minimize
any potential loss.

Loans are placed on non-accrual status when, in the judgment of management,
the probability of collection of interest is deemed to be insufficient to
warrant further accrual. When a loan is placed on non-accrual status, previously
accrued but unpaid interest is deducted from interest income. The Bank does not
accrue interest on loans past due 90 days or more.

Real estate acquired by the Bank as a result of foreclosure or by
deed-in-lieu of foreclosure is classified as real estate owned until sold.
Foreclosed assets are held for sale and such assets are carried at the lower of
fair value minus estimated costs to sell the property or cost (generally the
balance of the loan on the property at the date of acquisition with any
resulting losses being charged to the allowance for losses on loans). After the
date of acquisition, all costs incurred in maintaining the property are
expensed, and costs incurred for the improvement or development of such property
are capitalized up to the extent of the property's net realizable value.

Delinquent Loans. The following table sets forth information concerning
certain delinquent loans, at the dates indicated, in dollar amounts and as a
percentage of each category of the Bank's loan portfolio. The amounts presented
represent the total outstanding principal balances of the related loans. The
following table

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contains information on loans that are 60 to 89 days delinquent. Loans that are
delinquent 90 days or more are included in the next table below in the
non-accrual loans category.

Non-Performing and Under-Performing Assets. The following table sets forth
information with respect to non-performing and certain under-performing assets
identified by Citizens Financial, including non-accrual loans and other real
estate owned. Citizens Financial had no accruing loans 90 days or more past due
as to principal or interest at any of the below-referenced dates.

During the fourth quarter 2003, three large loans were transferred to
non-accrual. These loans included a $2.2 million multi-family residential loan
secured by an apartment complex, a $3.9 million commercial real

12

estate loan secured by a strip mall and a $2.8 million construction and land
development loan secured by an apartment complex. The Company believes that
these three loans are fully collateralized and its risk of loss, if any, is
minimal. Also included in non-accrual loans as of December 31, 2003 is a loan
secured by a motel with a carrying value of approximately $3.9 million. The
property is currently operated by a court appointed receiver. This property is
expected to become real estate owned during the second quarter of 2004.

The interest income that would have been recorded during the year ended
December 31, 2003, if all of the Bank's non-performing loans at the end of such
period had been current in accordance with their terms during such periods, was
$1.3 million. The actual amount of interest recorded as income (on a cash basis)
on such loans during the period amounted to $658,000.

Classified and Criticized Assets. Federal regulations require that each
insured institution classify its assets on a regular basis. Furthermore, in
connection with examinations of insured institutions, federal examiners have
authority to identify problem assets and, if appropriate, classify them. There
are three classifications for problem assets:

- 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 probability of loss.

- Loss assets are considered uncollectible and of such little value that
continuance as an asset of the institution is not warranted.

Federal examiners have designated another category as "special mention" for
assets which have some identified weaknesses but do not currently expose an
insured institution to a sufficient degree of risk to warrant classification as
substandard, doubtful or loss.

As of December 31, 2003, the Bank had an aggregate of $43.0 million of
classified assets, 99.0% of which were classified substandard and 1.0% of which
were classified as doubtful, compared to $48.3 million of classified assets as
of December 31, 2002.

Additionally, the Bank utilizes an independent third party to review its
commercial real estate and multi-family residential loans approximately three
times per year. The recommendations provided by the third party are reviewed
during the Loan Committee meetings and management makes the final determination
on the loan classifications.

Allowance for Losses on Loans. The Bank's policy is to establish
allowances for estimated losses on loans when it determines that losses are
expected to be incurred on such loans. The allowance for losses on loans is
maintained at a level believed adequate by management to absorb losses inherent
in the portfolio. Management's determination of the adequacy of the allowance is
based on an evaluation of the portfolio, past loss experience, current economic
conditions, volume, growth and composition of the portfolio, and other relevant
factors. The allowance is increased by provisions for loan losses which are
charged against income. As shown in the table on the following page, at December
31, 2003, the Bank's allowance for losses on loans amounted to $10.5 million or
46.0% and 1.06% of the Bank's non-performing loans and total loans receivable,
respectively. The Bank's provision for losses on loans amounted to $2.3 million
for the year ended December 31, 2003 and $2.0 million for 2002. Management of
the Company believes that, as of December 31, 2003, the allowance for losses on
loans was adequate.

A savings institution's determination as to the classification of its
assets and the amount of its valuation allowances is subject to review by the
OTS which can order the establishment of additional general or specific loss
allowances. The OTS, in conjunction with the other federal banking agencies, has
adopted an interagency policy statement on the allowance for loan and lease
losses. The policy statement provides guidance for financial institutions on
both the responsibilities of management for the assessment and establishment of

13

adequate allowances and guidance for banking agency examiners to use in
determining the adequacy of general valuation guidelines. Generally, the policy
statement recommends that:

- institutions have effective systems and controls to identify, monitor and
address asset quality problems;

- management has analyzed all significant factors that affect the
collectibility of the portfolio in a reasonable manner; and

- management has established acceptable allowance evaluation processes that
meet the objectives set forth in the policy statement.

The Bank's policy for establishing loan losses is consistent with the OTS'
policy statement.

The following table sets forth the activity in the Bank's allowance for
losses on loans during the periods indicated.

Allocation of the Allowance for Losses on Loans. Management of the Bank
determines the sufficiency of the allowance for losses on loans based upon its
periodic assessment of the risk elements in its loan portfolio. Management of
Citizens Financial utilizes analytical data as well as anticipated borrower
performance in light of general economic conditions existing in the Bank's
market area.

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The determination of the adequacy of the allowance at December 31, 2003
specifically considered various factors, including the balance of outstanding
loans and the increases in the ratio of commercial real estate, multi-family
residential and construction and land development loans to total loans. These
loans were in excess of 58% of total loans receivable at December 31, 2003.
Because of the increase in balances of these types of loans and the fact that
such loans have historically resulted in more losses than single-family
residential mortgage loans, during 2002, management adjusted the manner by which
the allowance for losses on loans is allocated. Previously, various percentages
were assigned to loan categories based on management's analysis of their
relative risks. Beginning in 2002, classified commercial type loans were
evaluated and allocated separately from the general allocation of the entire
portfolio.

Management of the Bank will continue to monitor and modify its approach to
estimate the allowances for losses on loans as conditions dictate. While
management believes that, based on information currently available, the Bank's
allowance for losses on loans is sufficient to cover losses inherent in its loan
portfolio at this time, no assurance will be given that the Bank's level of
allowance for losses on loans will be sufficient to absorb inherent losses in
the portfolio or that future adjustments to the allowance for losses on loans
will not be necessary if economic and other conditions differ substantially from
those used by management to determine the current level of the allowance for
losses on loans. In addition, the OTS, as an integral part of its examination
process, periodically reviews the Bank's allowance for losses on loans and may
require the Bank to make additional provisions for estimated loan losses based
upon judgments different from those of management.

The Bank allocates its allowance for losses on loans by loan category.
Various percentages are assigned to the loan categories based on management's
analysis of their relative risks. The allowance for losses on loans was
allocated as follows for the years shown:

SECURITIES ACTIVITIES

General. The Company's investment policy, which has been established by
the Board of Directors, is designed to prescribe authorized investments and
outline the Company's practices for managing risks involved with investment
securities. The policy emphasizes:

- principal preservation,

- favorable returns on investment,

- liquidity within designated guidelines,

15

- minimal credit risk, and

- flexibility.

The Company's investment policy permits investments in various types of
securities including obligations of the U.S. Treasury and federal agencies,
investment grade corporate obligations (A rated or better), trust preferred
stocks, other equity securities, commercial paper, certificates of deposit, and
federal funds sold to financial institutions approved by the Board of Directors.
In August 2003, the Company hired an independent third party to provide
investment advice to the Company.

The Company currently does not participate in hedging programs, interest
rate swaps, or other activities involving the use of off-balance sheet
derivative instruments.

As of December 31, 2003, the Company held $327.8 million of
available-for-sale securities which represented 20.9% of its total assets. The
net unrealized gain on the Company's available-for-sale securities totaled $1.4
million at such date.

At December 31, 2003, all of the Company's investment securities were
classified as available-for-sale, and none were classified as held-to-maturity.
Securities classified as available-for-sale are carried at fair value.
Unrealized gains and losses on available-for-sale securities are recognized as
direct increases or decreases in equity, net of applicable deferred income
taxes. Securities which are classified as held-to-maturity are carried at cost,
adjusted for the amortization of premiums and the accretion of discounts using a
method which approximates a level yield.

During the fourth quarter of 2003, the Company sold $15.3 million of its
held-to-maturity securities resulting in gross gains of $1.4 million. Market
conditions were deemed optimal for selling these securities and allowed the
Company to reinvest the proceeds into securities with anticipated higher total
returns.

In conjunction with the sale of the above held-to-maturity securities, the
Company reclassified the remaining held-to-maturity portfolio totaling $3.2
million to available-for-sale as a reflection of its intent to hold all
investments as available-for-sale. The transfers of these securities to
available-for-sale resulted in $61,000 of additional unrealized gains as of
December 31, 2003.

16

The following table set forth information regarding the carrying and fair
value of the Company's securities at the dates indicated.

- ---------------

(1) The majority of the agency securities at December 31, 2002 and December 31,
2001 were callable agency securities. The Company held no callable agency
securities at December 31, 2003.

Debt Securities. The Company's debt securities consist primarily of agency
securities, which amounted to $127.0 million, and commercial paper, which
amounted to $5.8 million, at December 31, 2003. The Company attempts to maintain
a high degree of liquidity in its other securities and generally does not invest
in debt securities with estimated average lives in excess of 10 years.

As of December 31, 2003, the Company does not have any callable agency
securities. Prior to 2003, the Company purchased substantial amounts of callable
agency securities, which are U.S. Government agency debt obligations, generally
having a contractual term to maturity of 10 years. These securities may be
called for redemption at predetermined dates (generally every three months)
throughout their terms. During 1998 and the first half of 1999, virtually all of
the Company's callable agency securities were called within one year of
purchase. As interest rates rose during the second half of 1999, these agency
securities were not called. This trend continued into 2000, with no securities
being called until late in the year, when rates again began to decline. The
trend toward lower interest rates continued for the next three years with 2003
seeing record low interest rates. As of December 31, 2003, the contractual
weighted average life of the Company's investment securities was 2.3 years.

17

The following table sets forth certain information regarding the maturities
and weighted average yield of the Company's debt securities.

Mortgage-Backed Securities. At December 31, 2003, the Company's
mortgage-backed securities included $184.9 million of mortgage participation
certificates, collateralized mortgage obligations (CMOs) and securities which
qualified as real estate mortgage investment conduits (REMICs). At December 31,
2003, the unrealized gain on the Company's mortgage-backed securities
available-for-sale amounted to $791,000 net of deferred income taxes. At
December 31, 2003, all of the Company's mortgage-backed securities were
classified as available-for-sale.

At December 31, 2003, $30.2 million, or 16.3%, of the Company's
mortgage-backed securities portfolio consisted of adjustable-rate securities, as
compared to $39.9 million, or 12.6%, and $28.7 million, or 9.2%, at December 31,
2002 and 2001, respectively.

Participation certificates represent a participation interest in a pool of
single-family or multi-family mortgages. The principal and interest payments on
mortgage-backed securities are passed from the mortgage originators, as
servicers, through intermediaries (generally U.S. Government agencies and
government-sponsored enterprises) that pool and repackage the participation
interests in the form of securities, to investors such as the Company. Such U.S.
Government agencies and government sponsored enterprises, which guarantee the
payment of principal and, in some cases, interest to investors, primarily
include the Federal Home Loan Mortgage Corporation, the Federal National
Mortgage Association and the Government National Mortgage Association.

In contrast to pass-through mortgage-backed securities where cash flow is
received pro-rata by all security holders, the cash flow from the mortgages
underlying a CMO is segmented and paid in accordance with a predetermined
priority to investors holding various CMO classes. By allocating the principal
and interest cash flows from the underlying collateral among the separate CMO
classes, different classes of bonds are created, each with its own stated
maturity. CMOs are typically issued by governmental agencies, government
sponsored enterprises and special purpose entities, such as trusts, corporations
or partnerships, established by financial institutions or other similar
institutions. REMICs are a form of CMO with particular attributes under the
Internal Revenue Code. At December 31, 2003, $73.2 million of the Company's
REMICs were issued by government-related entities while $2.6 million were issued
by other issuers.

SOURCE OF FUNDS

General. Deposits are the primary source of the Bank's funds for lending
and other investment purposes. In addition to deposits, the Bank derives funds
from loan principal repayments, prepayments, and borrowings. Loan repayments are
historically a relatively stable source of funds, while deposit inflows and
outflows are significantly influenced by general interest rates and money market
conditions. The Bank has used borrowings in the past, primarily Federal Home
Loan Bank advances, to supplement its deposits as a source of funds.

Deposits. The Bank's deposit products include a broad selection of deposit
instruments, including checking accounts, money market accounts, statement and
passbook savings accounts, and term certificate accounts. Deposit account terms
may vary with principal differences including: (i) the minimum balance required;
(ii) the time periods the funds must remain on deposit; and (iii) the interest
rate paid on the account.

18

The Bank utilizes traditional marketing methods to attract new customers
and deposits, and it does not advertise for deposits outside of its market area.
The Bank does not utilize the services of deposit brokers. The Bank
traditionally has relied on customer service and convenience in marketing its
deposit products. In the past, the Bank has offered certificate of deposit
promotions in an effort to increase market share and build customer
relationships. These promotions provided above-market-rate short-term
certificates of deposit on new money deposits to attract new customers. The Bank
has implemented an initiative to attract core deposits in all markets by
offering various limited-time promotions for new deposit accounts. The Bank may
continue to use certificate of deposit promotions in new markets to build its
customer base. The Bank experienced a net increase in deposits before interest
credited of $6.2 million in 2003 and a net decrease in deposits of $14.5 million
in 2002.

The following table sets forth the activity in the Bank's deposits during
the periods indicated.

The following table sets forth the amount and remaining maturities of the
Bank's certificates of deposit at December 31, 2003.

19

As of December 31, 2003, the aggregate amount of outstanding time
certificates of deposit in amounts greater than or equal to $100,000 was $133.2
million. The following table presents the maturity of these time certificates of
deposit.

The following table sets forth the dollar amount of deposits and the
percentage of total deposits in various types of deposits offered by the Bank at
the dates indicated.

BORROWINGS

Although deposits are the Bank's primary source of funds, the Bank's policy
has been to utilize borrowings, such as advances from the Federal Home Loan Bank
(FHLB). The advances from the FHLB of Indianapolis are secured by capital stock
of the FHLB of Indianapolis, a blanket pledge of certain of the Bank's mortgage
loans, investment securities, and mortgage-backed securities and the FHLB of
Indianapolis time deposits. The advances from the FHLB of Chicago are secured by
stock in the FHLB of Chicago, FHLB corporate notes and certain mortgage-backed
securities. These advances are made in accordance with several different credit
programs, each of which has its own interest rate and range of maturities.

Of the total advances, $400 million are fixed-rate advances with an
original scheduled maturity in 2010, putable quarterly at the discretion of the
FHLB of Indianapolis. At inception, the Bank received a lower cost of borrowing
on this type of advance than on similar termed non-putable advances in return
for granting the FHLB of Indianapolis the option to put the advances prior to
their final maturity. If put, the FHLB of Indianapolis will provide replacement
funding at the then prevailing market rate of interest subject to standard terms
and conditions.

The $6.5 million advances from the FHLB of Chicago are fixed-rate advances
that have a contractual maturity in 2008. These advances are currently callable
at the discretion of the FHLB of Chicago. If the advances are called, the
advances can either be paid off or converted to a new advance at the then
prevailing market rate of interest.

20

The Bank also has $12.0 million of fixed-rate advances from the FHLB of
Indianapolis which are amortizing advances over the scheduled maturity dates
ranging from 2014 to 2019.

All of the advances from FHLB of Indianapolis have prepayment penalties
which are calculated based on the present value of the future cash flows of the
advances. Given the low interest rate environment at December 31, 2003 and the
relatively high interest rates on the advances, the penalty to prepay these
advances was estimated to be $54.7 million. The Bank's Asset/Liability Committee
regularly monitors the prepayment penalty associated with these advances.

A summary of the Company's borrowed funds at December 31, 2003 and 2002 is
as follows:

TRUST ACTIVITIES

The Company also provides fiduciary services as a secondary line of
business through the Bank's Trust Department for convenience to its existing
customers. Services offered include fiduciary services for trusts and estates
and land trusts. As of December 31, 2003, the Trust Department maintained 20
trust/fiduciary accounts with an aggregate principal balance of $2.7 million at
such date. The Trust Department also administered 73 beneficiary-managed land
trusts during 2003. Gross revenue from the Trust Department for the year ended
December 31, 2003 was $16,000.

The accounts maintained by the Trust Department consist of "managed" and
"non-managed" accounts. Managed accounts are those accounts under custody for
which the Bank has responsibility for administration and investment management
and/or investment advice. Non-managed accounts are those accounts for which the
Bank merely acts as a custodian. The Company receives fees dependent upon the
level and type of service provided. The Trust Department administers various
trust accounts (revocable and irrevocable trusts, and trusts under wills),
estates and guardianships. Executive management of the department is provided by
the Bank's Vice President -- Corporate Counsel, subject to direction by the
Trust Committee.

SUBSIDIARIES

Prior to 2003, the Bank had three active, wholly-owned subsidiaries, CFS
Holdings, Ltd., CFS Insurance Agency, Inc. and CFS Investment Services, Inc. In
2002, the Bank sold the assets of the insurance agency and began outsourcing the
investment services operation. At the end of 2003, Citizens Financial had one
active wholly-owned subsidiary.

CFS Holdings, Ltd. (CFS Holdings) was approved by the OTS in January 2001
and was funded and began operations in June 2001. CFS Holdings is located in
Hamilton, Bermuda. It was funded with approximately $140.0 million of the Bank's
investments and performs a significant amount of the Bank's

21

investment securities and mortgage-backed securities investing activities.
Certain of these activities are performed by a resident agent in Hamilton in
accordance with the operating procedures and investment policy established for
CFS Holdings by the Bank. Revenues of CFS Holdings were $3.7 million for the
year ended December 31, 2003 compared to $5.2 million for the year ended
December 31, 2002. Operating expenses of this operation were $58,000 for the
year ended December 31, 2003 compared to $61,000 for the prior year period.

CFS Insurance Agency, Inc. (CFS Insurance) was an independent insurance
brokerage subsidiary which offered a full line of insurance products to the
general public. CFS Insurance operated out of the Bank's Insurance/Investment
Center in Munster, Indiana. The Bank has owned CFS Insurance since 1972.
Effective November 30, 2002 the Bank sold the assets of this agency and entered
into a five year lease, with the purchaser, for the building from which the
agency conducted its operations. Pre-tax profit on the sale of these assets was
approximately $1.1 million in 2002. CFS Insurance was marginally profitable in
2002 and less than profitable in 2001 with revenues totaling $1.3 million and
$1.1 million, respectively, and operating expenses equal to $1.2 million and
$1.2 million, respectively. This subsidiary is no longer active.

CFS Investment Services, Inc. (CFS Investments) was primarily involved in
the sale of mutual funds and other securities to members of the general public
in the Bank's primary market area. CFS Investments commenced full service
securities brokerage activities in 1994. During August 2002, the Bank entered
into an agreement to outsource this activity with the Independent Financial
Marketing Group (IFMG) and discontinued providing these services directly
through CFS Investment Services. As a result of this outsourcing, the Company
was able to significantly reduce the operating expenses associated with
maintaining CFS Investments while still being able to generate commission
revenue through IFMG. The type of investment products also switched from mutual
funds to predominantly tax deferred annuities through this outsourcing
arrangement. CFS Investments had total commission revenue of $651,000, $770,000
and $873,000 for the years ended December 31, 2003, 2002 and 2001, respectively.
CFS Investments had total operating expenses of $56,000, $948,000 and $1.1
million in each of the years ended December 31, 2003, 2002 and 2001,
respectively. Effective January 1, 2004, this subsidiary is no longer active and
the commissions earned from the outsourced relationship will be recognized by
the Bank going forward.

EMPLOYEES

Citizens Financial had 324 full-time equivalent employees at December 31,
2003. None of these employees is represented by a collective bargaining agent,
and the Bank believes that it enjoys good relations with its personnel.

REGULATION

REGULATION OF SAVINGS AND LOAN HOLDING COMPANIES

The Company is a registered savings and loan holding company. The Home
Owners' Loan Act (HOLA), as amended, and OTS regulations generally prohibit a
savings and loan holding company, without prior OTS approval, from acquiring,
directly or indirectly, the ownership or control of any other savings
association or savings and loan holding company, or all, or substantially all,
of the assets or more than 5% of the voting shares thereof. These provisions
also prohibit, among other things, any director or officer of a savings and loan
holding company, or any individual who owns or controls more than 25% of the
voting shares of such holding company, from acquiring control of any savings
association not a subsidiary of such savings and loan holding company, unless
the acquisition is approved by the OTS.

Holding Company Activities. The Company currently operates as a unitary
savings and loan holding company. Generally, there are limited restrictions on
the activities of a unitary savings and loan holding company and its non-savings
association subsidiaries. If the Company ceases to be a unitary savings and loan
holding company, the activities of the Company and its non-savings association
subsidiaries would thereafter be subject to substantial restrictions.

22

The HOLA requires every savings association subsidiary of a savings and
loan holding company to give the OTS at least 30 days advance notice of any
proposed dividends to be made on its guarantee, permanent or other
non-withdrawable stock, or else such dividend will be invalid.

Affiliate Restrictions. Transactions between a savings association and its
"affiliates" are subject to quantitative and qualitative restrictions under
Sections 23A and 23B of the Federal Reserve Act. Affiliates of a savings
association include, among other entities, the savings association's holding
company and companies that are under common control with the savings
association.

In general, Sections 23A and 23B and OTS regulations issued in connection
therewith limit the extent to which a savings association or its subsidiaries
may engage in certain "covered transactions" with affiliates to an amount equal
to 10% of the association's capital and surplus, in the case of covered
transactions with any one affiliate, and to an amount equal to 20% of such
capital and surplus, in the case of covered transactions with all affiliates. In
addition, a savings association and its subsidiaries may engage in covered
transactions and certain other transactions only on terms and under
circumstances that are substantially the same, or at least as favorable to the
savings association or its subsidiary, as those prevailing at the time for
comparable transactions with nonaffiliated companies. A "covered transaction" is
defined to include a loan or extension of credit to an affiliate; a purchase of
investment securities issued by an affiliate; a purchase of assets from an
affiliate, with certain exceptions; the acceptance of securities issued by an
affiliate as collateral for a loan or extension of credit to any party; or the
issuance of a guarantee, acceptance or letter of credit on behalf of an
affiliate.

In addition, under OTS regulations, a savings association may not make a
loan or extension of credit to an affiliate unless the affiliate is engaged only
in activities permissible for bank holding companies; a savings association may
not purchase or invest in securities of an affiliate other than shares of a
subsidiary; a savings association and its subsidiaries may not purchase a
low-quality asset from an affiliate; and covered transactions and certain other
transactions between a savings association or its subsidiaries and an affiliate
must be on terms and conditions that are consistent with safe and sound banking
practices. With certain exceptions, each loan or extension of credit by a
savings association to an affiliate must be secured by collateral with a market
value ranging from 100% to 130% (depending on the type of collateral) of the
amount of the loan or extension of credit.

The OTS regulation generally excludes all non-bank and non-savings
association subsidiaries of savings associations from treatment as affiliates,
except to the extent that the OTS or the Federal Reserve Board decides to treat
such subsidiaries as affiliates. The regulation also requires savings
associations to make and retain records that reflect affiliate transactions in
reasonable detail and provides that certain classes of savings associations may
be required to give the OTS prior notice of transactions with affiliates.

Financial Modernization. Under the Gramm-Leach-Bliley Act enacted into law
on November 12, 1999, no company may acquire control of a savings and loan
holding company after May 4, 1999, unless the company is engaged only in
activities traditionally permitted for a multiple savings and loan holding
company or newly permitted for a financial holding company under Section 4(k) of
the Bank Holding Company Act. Existing savings and loan holding companies, such
as the Company, and those formed pursuant to an application filed with the OTS
before May 4, 1999, may engage in any activity including non-financial or
commercial activities provided such companies control only one savings and loan
association that meets the Qualified Thrift Lender test. Corporate
reorganizations are permitted, but the transfer of grandfathered unitary holding
company status through acquisition is not permitted.

Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 (Act)
implemented legislative reforms intended to address corporate and accounting
fraud. In addition to the establishment of a new accounting oversight board
which will enforce auditing, quality control and independence standards and will
be funded by fees from all publicly traded companies, the bill restricts
provision of both auditing and consulting services by accounting firms. To
ensure auditor independence, any non-audit services being provided to an audit
client require pre-approval by the company's audit committee members. In
addition, the audit partners must be rotated. The bill requires the principal
chief executive officer and the principal chief financial officer to certify to
the accuracy of periodic reports filed with the SEC, subject to civil and
criminal penalties if they knowingly

23

or willfully violate this certification requirement. In addition, under the Act,
counsel are required to report evidence of a material violation of the
securities laws or a breach of fiduciary duty by a company to its chief
executive officer or its chief legal officer, and, if such officer does not
appropriately respond, to report such evidence to the audit committee or other
similar committee of the Board of Directors or the Board itself.

The Act extended the period during which certain types of suits can be
brought against a company or its officers and provides for disgorgement of
bonuses issued to top executives prior to restatement of a company's financial
statements if such restatement was due to corporate misconduct and a range of
enhanced penalties for corporate executives who are guilty of fraud or other
violations. Executives are also prohibited from insider trading during
retirement plan "blackout" periods, and loans to company executives are
restricted. In addition, a provision directs that civil penalties levied by the
SEC as a result of any judicial or administrative action under the Act be
deposited to a fund for the benefit of harmed investors. The Federal Accounts
for Investor Restitution (FAIR) provision also requires the SEC to develop
methods of improving collection rates. The legislation accelerates the time
frame for disclosures by public companies, as they must immediately disclose any
material changes in their financial condition or operations. Directors and
executive officers must also provide information for most changes in ownership
in a company's securities within two business days of the change.

The Act also increases the oversight of, and codifies certain requirements
relating to audit committees of public companies and how they interact with the
company's registered public accounting firm (RPAF). Audit committee members must
be independent and are barred from accepting consulting, advisory or other
compensatory fees from the issuer. In addition, companies must disclose whether
at least one member of the committee is a "financial expert" as defined by the
SEC and if not, why not. Under the Act, a RPAF is prohibited from performing
statutorily mandated audit services for a company if such company's chief
executive officer, chief financial officer, comptroller, chief accounting
officer or any person serving in equivalent positions has been employed by such
firm and participated in the audit of such company during the one-year period
preceding the audit initiation date. The Act also prohibits any officer or
director of a company or any other person acting under their direction from
taking any action to fraudulently influence, coerce, manipulate or mislead any
independent public or certified accountant engaged in the audit of the company's
financial statements for the purpose of rendering the financial statement's
materially misleading. The Act also requires the SEC to prescribe rules
requiring inclusion of an internal control report and assessment by management
in the annual report to shareholders. The Act requires the RPAF that issues the
audit report to attest to and report on management's assessment of the company's
internal controls. In addition, the Act requires that each financial report
required to be prepared in accordance with (or reconciled to) generally accepted
accounting principles and filed with the SEC reflect all material correcting
adjustments that are identified by a RPAF in accordance with generally accepted
accounting principles and the rules and regulations of the SEC.

REGULATION OF FEDERAL SAVINGS BANKS

As a federally insured savings bank, lending activities and other
investments of the Bank must comply with various statutory and regulatory
requirements. The Bank is regularly examined by the OTS and must file periodic
reports concerning its activities and financial condition.

Although the OTS is the Bank's primary regulator, the FDIC has "backup
enforcement authority" over the Bank. The Bank's eligible deposit accounts are
insured by the FDIC under the SAIF, up to applicable limits.

Federal Home Loan Banks. The Bank is a member of the FHLB System. Among
other benefits, FHLB membership provides the Bank with a central credit
facility. The Bank is required to own capital stock in a FHLB in an amount equal
to at least 1% of its aggregate unpaid single-family and multi-family
residential mortgage loans, home purchase contracts and similar obligations at
the beginning of each calendar year or 5% of its advances from the FHLB,
whichever is greater.

Regulatory Capital Requirements. OTS capital regulations require savings
banks to satisfy minimum capital standards: risk-based capital requirements, a
leverage requirement, and a tangible capital requirement.

24

Savings banks must meet each of these standards in order to be deemed in
compliance with OTS capital requirements. In addition, the OTS may require a
savings association to maintain capital above the minimum capital levels.

All savings banks are required to meet a minimum risk-based capital
requirement of total capital (core capital plus supplementary capital) equal to
8% of risk-weighted assets (which includes the credit risk equivalents of
certain off-balance sheet items). In calculating total capital for purposes of
the risk-based requirement, supplementary capital may not exceed 100% of core
capital. Under the leverage requirement, a savings bank is required to maintain
core capital equal to a minimum of 3% of adjusted total assets. In addition,
under the prompt corrective action provisions of the OTS regulations, all but
the most highly-rated institutions must maintain a minimum leverage ratio of 4%
in order to be adequately capitalized. A savings bank is also required to
maintain tangible capital in an amount at least equal to 1.5% of its adjusted
total assets.

These capital requirements are viewed as minimum standards by the OTS, and
most institutions are expected to maintain capital levels well above the
minimum. In addition, the OTS regulations provide that minimum capital levels
higher than those provided in the regulations may be established by the OTS for
individual savings associations, upon a determination that the savings
association's capital is or may become inadequate in view of its circumstances.
The OTS regulations provide that higher individual minimum regulatory capital
requirements may be appropriate in circumstances where, among others: (i) a
savings association has a high degree of exposure to interest rate risk,
prepayment risk, credit risk, concentration of credit risk, certain risks
arising from nontraditional activities, or similar risks of a high proportion of
off-balance sheet risk; (ii) a savings association is growing, either internally
or through acquisitions, at such a rate that supervisory problems are presented
and are not managed adequately under OTS regulations; and (iii) a savings
association may be adversely affected by activities or condition of its holding
company, affiliates, subsidiaries or other persons or savings associations with
which it has significant business relationships. The Bank is not subject to any
such individual minimum regulatory capital requirement.

The Bank's tangible and core capital ratios were 8.46%, and its total
risk-based capital ratio was 13.04% at December 31, 2003. At such date, the Bank
met the capital requirements of a "well-capitalized" institution under
applicable OTS regulations.

Certain Consequences of Failure to Comply with Regulatory Capital
Requirements. Any savings bank not in compliance with all of its capital
requirements is required to submit a capital plan that addresses the bank's need
for additional capital and meets certain additional requirements. While the
capital plan is being reviewed by the OTS, the savings bank must certify, among
other things, that it will not, without the approval of its appropriate OTS
Regional Director, grow beyond net interest credited or make capital
distributions. If a savings bank's capital plan is not approved, the bank will
become subject to additional growth and other restrictions. In addition, the
OTS, through a capital directive or otherwise, may restrict the ability of a
savings bank not in compliance with the capital requirements to pay dividends
and compensation, and may require such a bank to take one or more of certain
corrective actions, including, without limitation: (i) increasing its capital to
specified levels, (ii) reducing the rate of interest that may be paid on savings
accounts, (iii) limiting receipt of deposits to those made to existing accounts,
(iv) ceasing issuance of new accounts of any or all classes or categories except
in exchange for existing accounts, (v) ceasing or limiting the purchase of loans
or the making of other specified investments, and (vi) limiting operational
expenditures to specified levels. Noncompliance with the standards established
by the OTS or other regulators may also constitute grounds for other enforcement
action by the federal banking regulators, including cease and desist orders and
civil monetary penalty assessments.

The HOLA permits savings banks not in compliance with the OTS capital
standards to seek an exemption from certain penalties or sanctions for
noncompliance. Such an exemption will be granted only if certain strict
requirements are met and must be denied under certain circumstances. If an
exemption is granted by the OTS, the savings bank still may be subject to
enforcement actions for other violations of law or unsafe or unsound practices
or conditions.

25

Prompt Corrective Action. The prompt corrective action regulation of the
OTS, promulgated under the Federal Deposit Insurance Corporation Improvement Act
of 1991, requires certain mandatory actions and authorizes certain other
discretionary actions to be taken by the OTS against a savings bank that falls
within certain undercapitalized capital categories specified in the regulation.
The regulation establishes five categories of capital classification:
"well-capitalized," "adequately capitalized," "undercapitalized," "significantly
undercapitalized" and "critically undercapitalized." Under the regulation, the
ratio of total capital to risk-weighted assets, core capital to risk-weighted
assets and the leverage ratio are used to determine an institution's capital
classification. At December 31, 2003, the Bank met the capital requirements of a
"well-capitalized" institution under applicable OTS regulations.

Capital Distribution Regulation. In January 1999, the OTS amended its
capital distribution regulation to bring such regulations into greater
conformity with the other bank regulatory agencies. Specifically, savings
associations that would be well-capitalized following a capital distribution are
not subject to any requirement for notice or application unless the total amount
of all capital distributions, including any proposed capital distribution, for
the applicable calendar year would exceed an amount equal to the savings bank's
net income for that year to date plus the savings bank's retained net income for
the preceding two years. However, because the Bank is a subsidiary of a savings
and loan holding company, the Bank is required to give the OTS at least 30 days
notice prior to any capital distribution to the Company.

Qualified Thrift Lender Test. In general, savings associations are
required to maintain at least 65% of their portfolio assets in certain qualified
thrift investments (which consist primarily of loans and other investments
related to residential real estate and certain other assets). A savings
association that fails the qualified thrift lender test is subject to
substantial restrictions on activities and to other significant penalties. A
savings association may qualify as a qualified thrift lender not only by
maintaining 65% of portfolio assets in qualified thrift investments but also, in
the alternative, by qualifying under the Internal Revenue Code as a "domestic
building and loan association." The Bank is a domestic building and loan
association as defined in the Code.

FDIC Assessments. The deposits of the Bank are insured to the maximum
extent permitted by the SAIF, which is administered by the FDIC, and are backed
by the full faith and credit of the U.S. Government. As insurer, the FDIC is
authorized to conduct examinations of, and to require reporting by, FDIC-insured
institutions. It also may prohibit any FDIC-insured institution from engaging in
any activity the FDIC determines by regulation or order to pose a serious threat
to the FDIC. The FDIC also has the authority to initiate enforcement actions
against savings institutions, after giving the OTS an opportunity to take such
action.

Under FDIC regulations, institutions are assigned to one of three capital
groups for insurance premium purposes -- "well-capitalized," "adequately
capitalized" and "undercapitalized" -- which are defined in the same manner as
the regulations establishing the prompt corrective action system, as discussed
above. These three groups are then divided into subgroups which are based on
supervisory evaluations by the institution's primary federal regulator,
resulting in nine assessment classifications. Effective January 1, 1997,
assessment rates for both SAIF-insured institutions and BIF-insured institutions
ranged from 0% of insured deposits for well-capitalized institutions with minor
supervisory concerns to 0.27% of insured deposits for undercapitalized
institutions with substantial supervisory concerns. The Bank's deposit insurance
premiums totaled $154,000, or 0.016%, of its insured deposits for the year ended
December 31, 2003.

The FDIC may terminate the deposit insurance of any insured depository
institution, including the Bank, if it determines after a hearing that the
institution has engaged or is engaging in unsafe or unsound practices, is in an
unsafe or unsound condition to continue operations, or has violated any
applicable law, regulation, order or any condition imposed by an agreement with
the FDIC. It also may suspend deposit insurance temporarily during the hearing
process for the permanent termination of insurance, if the institution has no
tangible capital. If insurance of accounts is terminated, the accounts at the
institution at the time of the termination, less subsequent withdrawals, shall
continue to be insured for a period of six months to two years, as determined by
the FDIC. There are no pending proceedings to terminate the deposit insurance of
the Bank.

26

Community Reinvestment Act and the Fair Lending Laws. Savings institutions
have a responsibility under the Community Reinvestment Act (CRA) and related
regulations of the OTS to help meet the credit needs of their communities,
including low and moderate-income neighborhoods. In addition, the Equal Credit
Opportunity Act and the Fair Housing Act (together, Fair Lending Laws) prohibit
lenders from discriminating in their lending practices on the basis of
characteristics specified in those statutes. An institution's failure to comply
with the provisions of CRA could, at a minimum, result in regulatory
restrictions on its activities, and failure to comply with the Fair Lending Laws
could result in enforcement actions by the OTS, as well as other federal
regulatory agencies and the Department of Justice. The Bank received a
satisfactory rating during its latest CRA examination in 2003.

Safety and Soundness Guidelines. The OTS and the other federal banking
agencies have established guidelines for safety and soundness, addressing
operational and managerial, as well as compensation matters for insured
financial institutions. Institutions failing to meet these standards are
required to submit compliance plans to their appropriate federal regulators. The
OTS and the other agencies have also established guidelines regarding asset
quality and earnings standards for insured institutions.

Change of Control. Subject to certain limited exceptions, no company can
acquire control of a savings association without the prior approval of the OTS,
and no individual may acquire control of a savings association if the OTS
objects. Any company that acquires control of a savings association becomes a
savings and loan holding company subject to extensive registration, examination
and regulation by the OTS. Conclusive control exists, among other ways, when an
acquiring party acquires more than 25% of any class of voting stock of a savings
association or savings and loan holding company, or controls in any manner the
election of a majority of the directors of the company. In addition, a
rebuttable presumption of control exists if, among other things, a person
acquires more than 10% of any class of a savings association or savings and loan
holding company's voting stock (or 25% of any class of stock) and, in either
case, any of certain additional control factors exist.

Companies subject to the Bank Holding Company Act of 1956, as amended, that
acquire or own savings associations are no longer defined as savings and loan
holding companies under the HOLA and, therefore, are not generally subject to
supervision and regulation by the OTS. OTS approval is no longer required for a
bank holding company to acquire control of a savings association, although the
OTS has a consultative role with the FRB in examination, enforcement and
acquisition matters.

TAXATION

FEDERAL TAXATION

General. The Company and the Bank are subject to federal income taxation
in the same general manner as other corporations with some exceptions discussed
below. The following discussion of federal taxation is intended only to
summarize certain pertinent federal income tax matters and is not a
comprehensive description of the tax rules applicable to the Bank. The Bank's
federal income tax returns have been closed without audit by the IRS through
1996.

The Company files consolidated tax returns with the Bank. Accordingly, it
is anticipated that any cash distributions made by the Company to its
stockholders will be treated as cash dividends and not as a non-taxable return
of capital to stockholders for federal and state tax purposes.

Method of Accounting. For federal income tax purposes, the Bank reports
its income and expenses on the accrual method of accounting and uses a tax year
ending December 31 for filing its consolidated federal income tax returns. The
Small Business Protection Act of 1996 (1996 Act) eliminated the use of the
reserve method of accounting for bad debts by large savings institutions,
effective for taxable years beginning after 1995.

Bad Debt Reserves. Prior to the 1996 Act, the Bank was permitted to
establish a reserve for bad debts and to make annual additions to the reserve.
These additions could, within specified formula limits, be deducted in arriving
at taxable income. As a result of the 1996 Act, large savings associations must
use the

27

specific charge-off method in computing their bad debt deduction beginning with
their 1996 federal tax return. In addition, the federal legislation requires the
recapture (over a six year period with a deferral of one or two years if certain
requirements were met) of the excess of tax bad debt reserves at December 31,
1995 over those established as of December 31, 1987. As of December 31, 2003,
the Bank's bad debt reserve was fully recaptured.

Taxable Distributions and Recapture. Prior to the 1996 Act, bad debt
reserves created prior to January 1, 1988 were subject to recapture into taxable
income if the Bank failed to meet certain thrift asset and definitional tests,
made certain excess distributions to, or redemption of, shareholders, or changed
to a bank charter. Under current law, pre-1988 reserves are subject to recapture
only if the Bank makes certain non-dividend distributions or redemptions or
ceases to maintain a bank charter.

At December 31, 2003, the total federal pre-1988 reserve was approximately
$12.5 million for the Bank. This reserve reflects the cumulative effects of
federal tax deductions by the Bank for which no federal income tax provision has
been made.

Minimum Tax. The Code imposes a minimum tax at a rate of 20% on a base of
regular taxable income plus certain tax adjustments and preferences (alternative
minimum taxable income or AMTI). The minimum tax is payable to the extent such
tax is in excess of the regular tax. This excess is the alternative minimum tax
(AMT). Net operating losses can offset no more than 90% of AMTI. Payments of AMT
may be used as credits against regular tax liabilities in future years subject
to certain limitations. The Bank has not been subject to the AMT, nor does it
have any such amounts available as credits for carryover.

Corporate Dividends-Received Deduction. The Company may exclude from its
income 100% of dividends received from the Bank as a member of the same
affiliated group of corporations. The corporate dividends-received deduction is
80% in the case of dividends received from corporations, the stock of which the
corporate recipient owns 20% or more but generally less than 80%, and
corporations which own less than 20% of the stock of a corporation distributing
a dividend may deduct only 70% of dividends received or accrued on their behalf.

STATE AND LOCAL TAXATION

Indiana State Taxation. The Company and the Bank are subject to an 8.5%
franchise tax, imposed by the State of Indiana, on the net income of financial
(including thrift) institutions, exempting them from the current gross income,
supplemental net income and intangible taxes. Net income for franchise tax
purposes is federal taxable income before net operating loss deductions and
special deductions, adjusted for certain items, including Indiana income taxes,
property taxes, charitable contributions, tax-exempt interest and bad debts.
Other applicable Indiana taxes include sales, use and property taxes. Beginning
in 1999, the Company and the Bank can apportion income outside of Indiana.

Illinois State Taxation. For Illinois income tax purposes, the Company and
the Bank are taxed at a rate of 7.3% of Illinois taxable income. For these
purposes, "Illinois Taxable Income" generally means federal taxable income,
subject to certain adjustments (including the addition of interest income on
state and municipal obligations and the exclusion of interest income on United
States Treasury obligations) and apportionment. The exclusion of income on
United States Treasury obligations has the effect of reducing the Illinois
taxable income of the Bank.

Delaware State Taxation. As a Delaware corporation not earning income in
Delaware, the Company is exempt from Delaware corporate income tax but is
required to file an annual report with and pay an annual franchise tax to the
State of Delaware. The tax is imposed as a percentage of the capital base of the
Company with an annual maximum of $165,000.

28

ITEM 2. PROPERTIES

OFFICES AND PROPERTIES

The following table sets forth certain information relating to Citizens
Financial's offices at December 31, 2003. In addition, the Bank maintains 28
automated teller machines (ATMs), with 26 of such ATMs at the Bank's branch
offices.

(Table continued on next page) (Footnotes on following page)

29

- ---------------

(1) Full service branch facility located in a local grocery store chain.

(2) Deposits included with office located at 162nd Street.

(3) Includes 3,570 square feet of space currently under lease to third party.

(4) Scheduled to open May 2004.

(5) Former site of Insurance and Investment Center currently under a five year
lease (expiring in 2008) with purchaser of insurance agency assets as
lessor.

(6) Operations Center.

(7) Former branch location, currently leased on a monthly basis as an ATM site.

ITEM 3. LEGAL PROCEEDINGS

LEGAL PROCEEDINGS

In 1983, with the assistance of the Federal Savings and Loan Insurance
Corporation (FSLIC) as set forth in an assistance agreement (Assistance
Agreement), the Bank acquired First Federal Savings and Loan Association of East
Chicago, East Chicago, Indiana (East Chicago Savings), and Gary Federal Savings
and Loan Association, Gary, Indiana (Gary Federal). The FSLIC-assisted
supervisory acquisitions of East Chicago Savings and Gary Federal were accounted
for using the purchase method of accounting which resulted in supervisory
goodwill (the excess of cost over the fair value of net assets acquired), an
intangible asset, of $52.9 million, compared to $40.2 million of goodwill as
reported on a generally accepted accounting principles basis. Such goodwill was
included in the Bank's regulatory capital. The Assistance Agreement relating to
the Bank's acquisitions of East Chicago Savings and Gary Federal provided for
the inclusion of supervisory goodwill as an asset on the Bank's balance sheet,
to be amortized over 35 years for regulatory purposes and includable in
regulatory capital. Pursuant to the regulations adopted by the OTS to implement
the Financial Institutions Reform, Recovery and Enforcement Act of 1989
(FIRREA), the regulatory capital requirement for federal savings banks was
increased and the amount of supervisory goodwill that could be included in
regulatory capital decreased significantly. At September 30, 1989, the Bank had
approximately

30

$26.0 million of remaining supervisory goodwill. However, even excluding
supervisory goodwill, the Bank exceeded the capital requirements of FIRREA at
such date.

On May 13, 1993, the Bank filed suit against the U.S. government seeking
damages and/or other appropriate relief on the grounds, among others, that the
government had breached the terms of the Assistance Agreement. The suit is
pending in the United States Court of Federal Claims and is titled Citizens
Financial Services, FSB, v. United States (Case No. 93-306-C). The Bank was
granted summary judgment on its breach of contract claim, leaving for trial the
issue of damages. The case is currently scheduled for trial in June 2004.

The Bank is seeking damages of more than $20.0 million based on the report
of its expert witness. The Government has contended that the Bank suffered no
compensable damage as a result of the breach. The Bank is unable to predict the
outcome of its claim against the United States and the amount of damages that
may be awarded to the Bank, if any, in the event that a judgment is rendered in
the Bank's favor. Consequently, no assurances can be given as to the results of
this claim or the timing of any proceedings in relation thereto. The cost,
including attorneys' fees, experts' fees and related expenses, of the litigation
was approximately $183,000, $258,000 and $436,000 in 2003, 2002 and 2001,
respectively.

Other than the above-referenced litigation, the Company is involved in
routine legal proceedings occurring in the ordinary course of business, which,
in the aggregate, are believed to be immaterial to the financial condition of
the Company.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

PART II.

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

The Company's common stock is traded on the NASDAQ market System under the
symbol "CITZ". As of December 31, 2003, there were 12,200,015 shares of common
stock outstanding which was held by 2,373 stockholders of record. The following
table sets forth the quarterly share price and dividends paid per share during
each quarter of 2003 and 2002.

31

ITEM 6. SELECTED FINANCIAL DATA

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

OVERVIEW

During the year ended December 31, 2003, the financial services industry
experienced a record low interest rate environment. The Company felt the impact
of this low rate environment through unprecedented refinancing and prepayment
activity in both the loan and securities portfolios which in turn decreased the
Company's realized yields on interest-bearing assets.

In addition, while interest expense also decreased during the year, the
interest expense on the Company's FHLB fixed-rate advances continued to
adversely impact the Company's net interest rate margin. The average cost of
these advances for the year ended December 31, 2003 was 5.98% and significantly
impacted the Company's cost of interest-bearing liabilities. While the advances
can be prepaid, the Company would incur a substantial penalty which is
calculated based on the present value of the future cash flows at current
interest rates. As of December 31, 2003, the Company estimated the prepayment
penalty to be $54.7 million to pay off the aggregate advances. Should interest
rates increase, the Company expects the estimated prepayment penalties to
decrease. Until then, the cost of these borrowings are expected to significantly
impact future earnings.

In its efforts to mitigate the effects of the low interest rate
environment, the Company continued its strong effort to develop and enhance
programs to support commercial and small business growth by hiring six new
commercial loan officers and seven credit administration professionals to
bolster the rapidly growing commercial lending function. The commercial real
estate and multi-family residential loan portfolios grew 17.8% from December 31,
2002 to December 31, 2003. The compression of the net interest margin also
caused many in the industry, including the Company, to look for other, non-rate
sensitive ways to increase income. The Company increased non-interest income
through fees from its Overdraft Protection Program (ODP) and commissions from
its alternative investment program as a way to offset the impact from low
interest rates.

Non-interest expense for the year ended December 31, 2003 was adversely
affected by a $1.3 million contribution to the Company's defined benefit pension
plan which was made to keep the plan appropriately funded and to avoid
significantly higher estimated contributions in future years. Even after this
contribution, compensation and employee benefits in 2003 remained relatively
flat at 2.0% of average assets. Also included in non-interest expense is the
$1.3 million amortization related to the cost of the Company's RRP. The Company
amortized the costs of this plan over the five year vesting period. In May 2004,
the plan will be fully vested and the Company should realize a decrease in
non-interest expense related to the RRP.

33

Lower pre-tax income and tax planning efforts resulted in a reduction of
total income tax expense to $601,000 for the year ended December 31, 2003 from
$3.0 million in 2002. The effective tax rates dropped to 14.5% of pre-tax income
compared to 29.2% for 2002. The Company estimates that its effective rate for
2004 should return to previous levels.

CRITICAL ACCOUNTING POLICIES

The Company's consolidated financial statements are prepared in accordance
with accounting principles generally accepted in the United States and follow
general practices within the industry in which it operates. Application of these
principles requires management to make estimates or judgments that affect the
amounts reported in the financial statements and accompanying notes. These
estimates are based on information available as of the date of the financial
statements; accordingly, as this information changes, the financial statements
could reflect different estimates or judgments. Certain policies inherently have
a greater reliance on the use of estimates, and as such have a greater
possibility of producing results that could be materially different than
originally reported. Estimates or judgments are necessary when assets and
liabilities are required to be recorded at fair value, when a decline in the
value of an asset not carried on the financial statements at fair value warrants
an impairment write-down or valuation reserve to be established, or when an
asset or liability needs to be recorded contingent upon a future event. Carrying
assets and liabilities at fair value inherently results in more financial
statement volatility. The fair values and the information used to record
valuation adjustments for certain assets and liabilities are based either on
quoted market prices or are provided by other third-party sources, when
available. When third-party information is not available, valuation adjustments
are estimated in good faith by management primarily through the use of internal
cash flow modeling techniques.

The most significant accounting policies followed by the Company are
presented in Note 1 to the consolidated financial statements. These policies
along with the disclosures presented in the other financial statement notes and
in this management's discussion and analysis, provide information on how
significant assets and liabilities are valued in the financial statements and
how those values are determined. Management views critical accounting policies
to be those which are highly dependent on subjective or complex judgments,
estimates and assumptions, and where changes in those estimates and assumptions
could have a significant impact on the financial statements. Management
currently views the determination of the allowance for losses on loans to be a
critical accounting policy.

Allowance for Losses on Loans. The allowance for losses on loans
represents management's estimates of probable credit losses inherent in the loan
portfolio which is the largest asset type on the consolidated balance sheet.
Estimating the amount of the allowance for losses on loans requires significant
judgment using estimates such as the amount and timing of expected future cash
flows on impaired loans, estimated losses on pools of homogeneous loans based on
historical loss experience, and consideration of current economic trends and
conditions, all of which may be susceptible to significant change. Loan losses
are charged off against the allowance, while recoveries of amounts previously
charged off are credited to the allowance. The Company establishes provisions
for losses on loans, which are charged to operations, in order to maintain the
allowance for losses on loans at a level which is deemed appropriate to absorb
losses inherent in the portfolio.

In determining the appropriate level of the allowance for losses on loans,
management considers:

- past and anticipated loss experience,

- evaluations of real estate collateral,

- current and anticipated economic conditions,

- volume and type of lending, and

- levels of non-performing and other classified loans.

The amount of the allowance is based on estimates, and ultimate losses may
vary from such estimates. Management assesses the allowance for losses on loans
on a quarterly basis and makes appropriate provisions to maintain the allowance
at an appropriate level. The actual determination of the total provision is the

34

combination of specific reserves, which may be established from time to time on
individual classified assets and a general reserve that is based in part on
certain ratios applied to various loan pools as stratified by the Company
considering historical charge-offs and delinquency levels. To the extent that
actual outcomes differ from management estimates, an additional provision for
loan losses could be required that could adversely affect earnings or financial
position in future periods. In addition, various regulatory agencies, as an
integral part of their examination processes, periodically review the Bank's
provision for losses on loans and the carrying value of its other non-performing
assets, based on information available to them at the time of their
examinations. Any of these agencies could require the Bank to make additional
provisions for losses on loans in the future.

Additionally, the Company engages an independent third party to review its
commercial loans and commercial real estate loans every four to six months. The
recommendations of this review are reviewed and compared to the Company's asset
classification, and adjustments are made as deemed appropriate by management.

CHANGES IN FINANCIAL CONDITION

General. During the year ended December 31, 2003, the Company's total
assets decreased by $15.3 million to $1.57 billion from $1.58 billion at
December 31, 2002. The significant changes in the composition of the Company's
balance sheet during the year ended December 31, 2003 include a:

- net decrease in cash and cash equivalents of $31.9 million,

- net decrease in securities of $29.3 million,

- net increase in loans receivable of $41.2 million,

- net increase in total deposits of $21.5 million, and

- repayment of $30.9 million in advances from the FHLB.

The shift between securities and loans receivable is a direct result of the
Company continuing its strategy to shift its assets from lower yielding
securities to higher yielding commercial loans. Management is focused on
developing its commercial relationships in its efforts to not only increase
total yield on assets but to also provide an additional source of low cost
funding through commercial deposits. The Company is also reinvesting excess
funds in relatively low yielding assets with estimated average durations of two
years or less as well as overnight funds with the expectation that they will be
readily available for investment in higher yielding assets when the interest
rate cycle turns upward.

The increase in deposits for the year was mainly a result of third and
fourth quarter promotions for above-market-rate short term certificates of
deposit which were offered as part of the Bank's efforts to increase market
share and build customer relationships. At December 31, 2003, the Company had
approximately $134.1 million outstanding in certificates of deposit with an
average cost of 2.82% from these promotions which will reprice during the first
two quarters of 2004. As the Company continues to expand into new markets, it
may use similar promotions during 2004 to build market share and add new
customer relationships. The Company has not, and does not intend to, utilize any
other source of brokered deposits for building its deposit base in the future.

Stockholders' equity decreased during the year ended December 31, 2003 by
$4.7 million primarily due to:

- $9.3 million in repurchases of 659,841 shares of the Company's common
stock for treasury through the Company's share repurchase program, and

- $4.8 million of dividends declared on the Company's common stock during
2003.

35

The above decreases in stockholders' equity were partially offset by:

- 2003 net income of $3.5 million,

- a $1.0 million increase in accumulated other comprehensive income
resulting from an increase in the market value of securities, net of tax,

- $1.7 million from exercised stock options,

- $1.7 million in shares earned for the Company's employee stock ownership
plan (See Note 11 in the consolidated financial statements in Item 8 of
this Form 10-K), and

- $1.3 million of shares held by the Company's retention and retirement
plan becoming vested and issued to plan participants (See Note 11 to the
consolidated financial statements).

During 2003, the Company repurchased 659,841 shares of its common stock at
an average price of $14.05 per share pursuant to the share repurchase program
announced in July 2002. In 1999, the Company began aggressively repurchasing
shares to reduce its excess capital and earn a more competitive return on equity
(ROE). Since its initial public offering, the Company has repurchased an
aggregate of 11,530,903 shares of its common stock at an average price of $11.74
per share. At December 31, 2003, the Company has 1,241,869 of shares remaining
for repurchase in its current share repurchase program.

At December 31, 2003, the Bank continues to maintain a strong capital
structure with tangible and core regulatory capital ratios of 8.46% and a
risk-based capital ratio of 13.04%.

AVERAGE BALANCES, NET INTEREST INCOME, YIELDS EARNED AND RATES PAID

The table on the following page provides information regarding (i) the
Company's interest income recognized from interest-earning assets and their
related average yields; (ii) the amount of interest expense realized on
interest-bearing liabilities and their related average rates; (iii) net interest
income; (iv) interest rate spread; and (v) net interest margin. Information is
based on average daily balances during the indicated periods.

36

- ---------------

(1) The average balance of loans receivable includes non-performing loans,
interest on which is recognized on a cash basis.

(2) Average balances of securities available-for-sale are based on historical
costs.

(3) Includes money market accounts, federal funds sold and interest-earning bank
deposits.

(4) Consists primarily of demand deposit accounts.

RATE/VOLUME ANALYSIS

The following table sets forth the effects of changing rates and volumes on
the Company's net interest income. Information is provided with respect to (i)
effects on interest income attributable to changes in rate (changes in rate
multiplied by prior volume); (ii) effects on interest income attributable to
changes in volume

37

(changes in volume multiplied by prior rate); and (iii) changes in rate/volume
(changes in rate multiplied by changes in volume).

RESULTS OF OPERATIONS

The Company's results are affected by the interest rate environment which
continued even lower during 2003 from 2002 as the financial services industry
experienced record low interest rates. The low interest rate environment impacts
both interest income and interest expense.

YEAR ENDED DECEMBER 31, 2003 COMPARED TO YEAR ENDED DECEMBER 31, 2002

Net Income. Net income for the year ended December 31, 2003 was $3.5
million, or $0.30 per diluted share ($0.31 per basic share), compared to $7.2
million, or $0.58 per diluted share ($0.60 per basic share), for the year ended
December 31, 2002. The historically low interest rate environment continued in
2003 causing further deterioration in the Company's net interest margin. Net
interest income for the year ended December 31, 2003 decreased by $5.9 million
or 18% from the previous year.

The Company's results for the year ended December 31, 2003 were also
adversely affected by a $1.3 million contribution to the Company's defined
benefit pension plan to keep the plan appropriately funded and to avoid
significantly higher estimated contributions in future years. As with many
pension plans, the Company's plan had been adversely affected by three years of
declining investment returns and record low interest rates which caused the
level of funded benefits to drop significantly.

Net interest income. Net interest income is the principal source of
earnings for the Company and consists of interest income on loans and investment
securities less interest expense on deposits and borrowed funds. Net interest
income is a function of the Company's interest rate spread (which is the
difference between the average yield earned on the Company's interest-earning
assets and the average rate paid on its interest-bearing liabilities) and the
relative amounts of interest-earning assets and interest-bearing liabilities.

38

The Company's average interest rate spreads were 1.54% and 1.82% for the years
ended December 31, 2003 and 2002, respectively. The Company's net interest
margin (which is net interest income as a percentage of average interest-earning
assets) was 1.86% and 2.20% during the years ended December 31, 2003 and 2002,
respectively.

The Company's net interest income for the year ended December 31, 2003
totaled $27.6 million and represented a $5.9 million decrease from $33.5 million
for the year ended December 31, 2002. The decrease in net interest income was
due primarily to the combined effects of the low interest rate environment and
lower average balances of interest-earning assets for the year ended December
31, 2003 compared to the year ended December 31, 2002.

Interest Income. The Company reported total interest income of $71.3
million for the year ended December 31, 2003 compared to $86.6 million for the
year ended December 31, 2002. The $15.3 million or 17.7% decrease was primarily
due to a $33.8 million decrease in total interest-earning assets as well as a
decrease in the average yield on interest-earning assets of 90 basis points for
the year ended December 31, 2003 as compared to 2002.

The Company's interest-earning assets continued to decline during 2003 as a
result of unprecedented refinancing activity which caused significant rate
reductions within the loan portfolio and accelerated amortization of premiums on
its mortgage-backed securities portfolio. Given the continuing low interest rate
environment, the Company has reinvested these funds predominantly in relatively
low yielding assets with estimated average durations of two years or less as
well as overnight funds with the expectation that they will be readily available
for investment in higher yielding assets when the interest rate cycle turns
upward. During 2003, the Company made considerable progress in its strategy to
transfer assets from lower yielding securities to higher yielding loans. During
the year ended December 31, 2003 compared to the previous year, average loan
balances increased $51.7 million or 5.6% while the average balance of the
Company's securities portfolio decreased $57.3 million or 14.7%. The Company
believes it has made significant progress in positioning the balance sheet to
take advantage of the next interest rate cycle.

Interest Expense. In contrast to the adverse impact on the asset side of
the balance sheet, the low interest rate environment in 2003 provided some
positive opportunities on the funding side. The Company proactively managed its
funding costs throughout 2003 by aggressively lowering the interest rate paid on
its non-maturity deposits which historically have not been rate sensitive. Total
interest expense amounted to $43.7 million for the year ended December 31, 2003
compared to $53.1 million for the year ended December 31, 2002. The $9.4 million
or 17.7% reduction in interest expense during 2003 was primarily the result of a
90 basis point reduction in the rate paid on total deposits coupled with a $10.1
million decrease in the average balance of total deposits.

Provision for Losses on Loans. The Company's provision for losses on loans
was $2.3 million for the year ended December 31, 2003 compared to $2.0 million
in 2002. The increase in provision is a result of the Company's increased
emphasis on growing the commercial real estate and multi-family residential loan
portfolios which are generally deemed to involve more risk of loss than
single-family residential real estate loans. This change in emphasis has
resulted in an increase in the allowance for losses on loans. The Company's
allowance for losses on loans to total loans was 1.06% and 0.92% at December 31,
2003 and 2002, respectively.

The Company's non-performing loans were $22.7 million at December 31, 2003
compared to $15.3 million at December 31, 2002, which represents an increase of
$7.4 million. The primary changes in non-performing loans by category included:

- a decrease in non-performing single-family residential loans of
approximately $1.7 million,

- an increase in non-performing commercial real estate, multi-family
residential and other commercial loans of approximately $6.3 million, and

- an increase in non-performing construction and land development loans of
$2.9 million.

The increase in non-performing commercial real estate, multi-family
residential and construction and land development loans was primarily due to
three loans with aggregate carrying values of $8.9 million which
39

were transferred to non-accrual status in the fourth quarter of 2003. The
Company believes that these three loans are fully collateralized, and its risk
of loss, if any, is minimal on these loans. The ratio of the Company's allowance
for losses on loans to non-performing loans was 46.0% at December 31, 2003
compared to 56.6% at December 31, 2002.

Although management believes that the Company's allowance for losses on
loans was adequate at December 31, 2003 based on available facts and
circumstances, there can be no assurances that additions will not be necessary
in the future. Any such additional provisions for losses on loans would
adversely affect the Company's results of operations.

Non-Interest Income. The Company reported non-interest income of $11.8
million for the year ended December 31, 2003 compared to $11.3 million for the
year ended December 31, 2002. The primary reasons for the increase in
non-interest income in 2003 compared to 2002 were a:

- $1.2 million increase in fees on deposit accounts, and

- $1.5 million increase in net gains on the sale of securities,

which were partially offset compared to the Company's results in 2002 by the
absence of insurance commissions of $1.2 million and the $1.1 million net gain
on sale of insurance agency that were realized during 2002.

The increase in deposit fees during 2003 was mainly realized from the
Company's popular ODP for retail and business checking customers. During the
first full year of the program, the Company has 83% of its retail and 69% of its
small business accounts enrolled in the program which provides a discretionary
service or courtesy overdraft in case the customer's account becomes overdrawn.
Normal overdraft fees and charges still apply under this program.

The Company also realized $651,000 of commission income during the first
full year of outsourcing its alternative investment program. Through this
program the Company's third party outsourcing partner sold nearly $36 million of
tax deferred annuities and other investments as an alternative investment to our
depositors during this low-rate environment. Management expects continued
increases in overdraft fee income from its ODP program as well as increased
commission fee income from annuity sales through its outsourcing arrangement.

Non-Interest Expense. The Company reported non-interest expense of $32.9
million for the year ended December 31, 2003 compared to $32.7 million for the
year ended December 31, 2002.

While the Company's salary expense remained relatively stable during 2003
compared to 2002, compensation and employee benefits expense increased as a
result of a $1.3 million payment to the Company's defined benefit pension plan
during the fourth quarter of 2003. As with many pension plans, the Company's
plan was adversely affected by three years of declining investment returns and
record low interest rates which caused the level of funded benefits to drop
significantly. The voluntary contribution was made to keep the plan funded at a
level deemed appropriate. The Company froze the benefits associated with this
plan in March 2003. Although no further benefits will accrue while the freeze
remains in place, the freeze does not reduce the benefits accrued to date. Even
though the benefits are frozen, the Company will review the funding level and
will continue to make necessary contributions to keep the plan appropriately
funded.

Professional fees were $1.8 million for the year ended December 31, 2003
compared to $1.4 million for 2002. The increase in professional fees was mainly
the result of the Company hiring independent third parties to:

- perform an information systems technology assessment which led to the
decision to move forward to upgrade our core data processor and helped
prioritize additional technology systems and upgrades needed over the
next few years,

- improve the process and underwriting for the Company's Home Equity Lines
of Credit (HELOC) program which led to a successful implementation of our
HELOC equity access card, and

40

- implement an automated processing and underwriting program within the
residential loan processing system to provide the Company with a tiered
pricing model which will lead to an improved yield and turnaround time
thus making the Company more competitive in originating residential
mortgages.

Income Tax Expense. The Company's income tax expense amounted to $601,000
and $3.0 million for the years ended December 31, 2003 and 2002, respectively.
The Company's effective tax rates were 14.5% and 29.2% for the years ended
December 31, 2003 and 2002, respectively. The significant decrease in income tax
expense was a result of lower pre-tax income, the application of available tax
credits and the effects of permanent tax differences on the lower pre-tax
earnings. The Company estimates that its effective rate for 2004 should return
to previous levels.

YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001

Net Income. The Company reported net income of $7.2 million for the year
ended December 31, 2002 compared to net income of $11.2 million for the year
ended December 31, 2001. The Company's net interest income for the year ended
December 31, 2002 decreased $4.3 million from the year ended December 31, 2001.

For the year ended December 31, 2002, results of operations were affected
by:

- lower average balances of interest-earning assets, which is comprised
primarily of loans and securities, as the result of continued accelerated
repayments on mortgage loans and mortgage-backed securities in the low
interest rate environment;

- higher interest-earning assets in 2002 compared to 2001 as the Company
emphasized the origination of commercial real estate, multi-family
residential and construction and land development loans,

- the realization of a $1.1 million gain on the sale of the insurance
agency assets; and

- the absence of a $2.0 million gain on the sale of two LaPorte County Bank
branches recognized in 2001.

Net Interest Income. The Company's average interest rate spreads were
1.82% and 1.83% for the years ended December 31, 2002 and 2001, respectively.
The Company's net interest margin was 2.20% and 2.36% during the years ended
December 31, 2002 and 2001, respectively.

The Company's net interest income amounted to $33.5 million for the year
ended December 31, 2002 compared to $37.8 million for the year ended December
31, 2001. The 11.4% decrease from 2001 to 2002 was a result of the:

- reduction in the ratio of average interest-earning assets to average
interest-bearing liabilities to 110.96% in 2002 from 112.09% in 2001, and

- utilization of $14.6 million of cash in 2002 for the Company's stock
repurchase program.

Interest Income. The Company reported total interest income of $86.6
million for the year ended December 31, 2002 compared to $108.1 million for the
year ended December 31, 2001. The $21.5 million or 19.9% decrease was primarily
due to:

- a $69.4 million decrease in the average balances of securities from
$457.8 million in 2001 to $388.4 million in 2002,

- a reduction of 148 basis points in the average yield earned on
securities,

- the average balances of real estate loans decreasing by $37.2 million to
$883.3 million in 2002 from $920.5 million in 2001, and

- a reduction of 66 basis points in the yield earned on real estate loans.

41

Interest Expense. Total interest expense amounted to $53.1 million for the
year ended December 31, 2002 compared to $70.3 million in 2001. The $17.2
million or 24.5% reduction in interest expense during 2002 compared to 2001 was
primarily the result of a 154 basis point reduction in the rate paid on total
deposits coupled with a $25.8 million decrease in the average balance of total
deposits.

Provision for Losses on Loans. The Company's provision for losses on loans
was $2.0 million for the year ended December 31, 2002 compared to $1.2 million
in 2001. The Company increased its emphasis on construction and land development
loans, multi-family residential real estate loans, commercial loans, and
commercial real estate loans, all of which are generally deemed to involve more
of an inherent risk of loss than single-family residential real estate loans.
This change in emphasis was the primary reason for the increase in the allowance
for losses on loans since 2001. The Company's allowance for losses on loans to
total loans was 0.92% at December 31, 2002 compared to 0.86% at December 31,
2001.

The Company's non-performing loans were $15.3 million at December 31, 2002
compared to $13.9 million at December 31, 2001. The primary changes in
non-performing loans when comparing 2002 to 2001 were an overall decrease in
non-performing single-family residential loans of approximately $1.3 million and
an increase in non-performing commercial real estate loans. The increase in
non-performing commercial real estate loans was primarily due to one loan of
approximately $3.9 million on a motel, which became non-performing in the third
quarter of 2002. The ratio of the Company's allowance for losses on loans to
non-performing loans was 56.6% at December 31, 2002 compared to 55.2% at
December 31, 2001.

Non-Interest Income. The Company reported non-interest income of $11.3
million for the year ended December 31, 2002 compared to $10.7 million for the
year ended December 31, 2001. The net increase was the result of:

- a $1.1 million gain recognized on the sale of the Company's insurance
agency assets in December 2002;

- the $1.5 million increase in deposit fees in 2002 compared to 2001; and

- the absence of a $2.0 million gain on the sale of two branch offices
recognized in 2001.

The increase in deposit fees was a result of a re-evaluation of operations
which was completed in 2001.

Also realized in 2002 was the sale of the insurance agency. In conjunction
with the sale, the Company changed its delivery method of investments by
discontinuing the offer of non-deposit products through its subsidiary. Instead,
this activity was outsourced through a third party. Both the investment and
insurance subsidiaries had provided marginally incremental profit and loss
results to the Company in recent years.

Non-Interest Expense. The Company reported non-interest expense of $32.7
million and $31.4 million for the years ended December 31, 2002 and 2001,
respectively.

Compensation and employee benefits, the largest single component of
non-interest expense, was $20.1 million for the year ended December 31, 2002
compared to $19.0 million for the year ended December 31, 2001. While the
Company's salary expense was held flat in 2002 compared to 2001, salary expense
levels were offset by increases in employee benefits expenses related to the
Company's pension plan and ESOP plan.

After being fully funded for several years, funding was resumed for the
pension plan year beginning July 1, 2001 and ending June 30, 2002. Pension
expense was $889,000 for the calendar year ending December 31, 2002 compared to
$134,000 for 2001. ESOP expense is recorded based on the shares to be allocated
for the year to participants in the plan multiplied by the average share price
for the year. The average share price for 2002 increased to $14.07. As a result,
$177,000 of additional ESOP expense was recorded in 2002 compared to 2001.

Also included in compensation and employee benefits expense was $1.5
million in 2002 compared to $1.4 million in 2001 from the Company's Recognition
and Retention Plan approved by the shareholders in February 1999.

42

Data processing expense amounted to $1.7 million for the year ended
December 31, 2002 compared to $1.4 million for the year ended December 31, 2001.
Data processing expense for 2002 included additional costs of outsourcing some
of the processing associated with a new proof of deposit system implemented in
2001.

Income Tax Expense. The Company's income tax expense amounted to $3.0
million and $4.8 million for the years ended December 31, 2002 and 2001,
respectively. The Company's effective rates were 29.2% and 30.0% for the years
ended December 31, 2002 and 2001. The Company has implemented several tax
strategies in the past few years that have resulted in significant reductions in
its effective tax rates.

LIQUIDITY AND COMMITMENTS

The Company's liquidity, represented by cash and cash equivalents, is a
product of operating, investing and financing activities. The Company's primary
historical sources of funds are:

- deposits,

- scheduled payments of amortizing loans and mortgage-backed securities,

- prepayments and maturities of outstanding loans and mortgage-backed
securities,

- maturities of investment securities and other short-term investments,

- funds provided from operations, and

- borrowings from the FHLB.

Scheduled payments from the amortization of loans, mortgage-backed
securities, maturing investment securities, and short-term investments are
relatively predictable sources of funds, while deposit flows and loan
prepayments are greatly influenced by market interest rates, economic conditions
and competitive rate offerings. In addition, the Company invests excess funds in
federal funds sold and other short-term interest-earning assets which provide
liquidity to meet lending requirements. At December 31, 2003, the Company had
cash and cash equivalents of $178.2 million which was a decrease of $31.9
million from December 31, 2002.

Liquidity management is both a daily and long-term function. Excess
liquidity is generally invested in short-term investments such as
interest-bearing deposits and federal funds sold. On a longer-term basis, the
Company invests funds not used for maintaining and expanding the loan portfolio
in securities, historically mortgage-backed securities. Given the current low
interest rate environment, the Company is investing these funds predominantly in
relatively low yielding assets with estimated average durations of two years or
less with the expectation that the funds will be readily available for
investment in higher yielding assets when the interest rate market turns upward.
The Company uses its sources of funds primarily to meet its ongoing commitments,
fund loan commitments, pay maturing certificates of deposit and savings
withdrawals, and maintain a securities portfolio. The Company anticipates that
it will continue to have sufficient funds to meet its current commitments.

The liquidity needs of the parent company, CFS Bancorp, Inc., consist
primarily of operating expenses, dividend payments to stockholders and stock
repurchases. The primary sources of liquidity are securities available-for-sale
and dividends from the Bank. On a parent company-only basis, at December 31,
2003, the Company had $7.4 million in securities available-for-sale and, for the
year ended December 31, 2003 received $4.8 million in dividends from the Bank.
However, these sources can also be supplemented by fees assessed by the Company
to the Bank.

Under certain banking regulations, the Bank is required to file a notice
or, under certain circumstances, an application with the OTS prior to paying any
dividends to the Company. In addition, the Bank is required to maintain certain
regulatory capital requirements. At December 31, 2003, the Bank was
well-capitalized. See Note 9 in the consolidated financial statements for more
information on the Bank's regulatory capital.

43

Contractual Obligations. The following table presents significant fixed
and determinable contractual obligations to third parties by payment date as of
December 31, 2003.

See Note 7 in the consolidated financial statements for further discussion
surrounding the Company's FHLB advances. The Company's operating lease
obligations reflected above include the future minimum rental payments, by year,
required under the lease terms for premises and equipment. Many of these leases
contain renewal options, and certain leases provide options to purchase the
leased property during or at the expiration of the lease period at specific
prices. See also to Note 4 in the consolidated financial statements for further
discussion related to the Company's operating leases.

The Company also has commitments to fund maturing certificates of deposit
which are scheduled to mature within one year or less. These deposits total
$421.2 million at December 31, 2003. Based on historical experience, management
believes that a significant portion of the maturing deposits will remain with
the Bank.

Off-Balance-Sheet Obligations. The Company is a party to financial
instruments with off-balance-sheet risk in the normal course of business to meet
the financing needs of its customers. These financial instruments involve, to
varying degrees, elements of credit risk in excess of the amount recognized in
the balance sheet. The Company's exposure to credit loss in the event of
non-performance by the other party to the financial instrument for commitments
to extend credit and letters of credit is represented by the contractual
notional amount of those instruments. The Company uses the same credit policies
in making commitments and conditional obligations as it does for
on-balance-sheet instruments.

The following table details the amounts and expected maturities of
significant commitments as of December 31, 2003.

Commitments to extend credit, including loan commitments, lines of credit
and letters of credit do not necessarily represent future cash requirements, in
that these commitments often expire without being drawn upon.

Letters of credit include credit enhancements which are related to the
issuance by municipalities of taxable and nontaxable revenue bonds. The proceeds
from the sale of such bonds are loaned to for-profit and not-for-profit
companies for economic development projects. In order for the bonds to receive a
triple-A rating

44

which provides for a lower interest rate, the FHLB-IN issues, in favor of the
bond trustee, an Irrevocable Direct Pay Letter of Credit for the account of the
Bank. Since the Bank, in accordance with the terms and conditions of a
Reimbursement Agreement between the FHLB-IN and the Bank, would be required to
reimburse the FHLB-IN for draws against the Letter of Credit, these facilities
are analyzed, appraised, secured by real estate mortgages, and monitored as if
the Bank funded the project initially.

The Company has not used, and has no intention of using, any significant
off-balance sheet financing arrangements for liquidity purposes. In addition,
the Company has not had, and has no intention to have, any significant
transactions, arrangements or other relationships with any unconsolidated,
limited purpose entities that could materially affect the Company's liquidity or
capital resources. The Company has not traded in and has no intention of trading
in derivatives or commodity contracts.

IMPACT OF INFLATION AND CHANGING PRICES

The consolidated financial statements and related financial data presented
herein have been prepared in accordance with generally accepted accounting
principles, which require the measurement of financial position and operating
results generally in terms of historical dollars, without considering changes in
relative purchasing power over time due to inflation. Unlike most industrial
companies, virtually all of the Company's assets and liabilities are monetary in
nature. As a result, interest rates generally have a more significant impact on
a financial institution's performance than does the effect of inflation.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Bank, like other financial institutions, is subject to interest rate
risk (IRR). IRR refers to the risk that changes in market interest rates might
adversely affect net interest income or the net portfolio value (NPV) of its
assets, liabilities, and off-balance sheet contracts. IRR is primarily the
result of an imbalance between the price sensitivity of the Bank's assets and
its liabilities. These imbalances can be caused by differences in the maturity,
repricing, and coupon characteristics of assets and liabilities as well as
options (such as loan prepayment options).

The Bank maintains a written Asset/Liability Management Policy that
establishes written guidelines for the asset/liability management function,
including the management of net interest margin, interest rate risk, and
liquidity. The Asset/Liability Management Policy falls under the authority of
the Board of Directors who in turn assigns its formulation, revision, and
administration to the Asset/Liability Committee (ALCO). The ALCO meets monthly
and consists of certain senior officers of the Bank and one outside director.
The results of the monthly meetings are reported to the Board of Directors. The
primary duties of the ALCO are to develop reports and establish procedures to
measure and monitor IRR, verify compliance with Board-approved IRR tolerance
limits, take appropriate actions to mitigate those risks, monitor and discuss
the status and results of implemented strategies and tactics, monitor the Bank's
capital position, review the current and prospective liquidity positions, and
monitor alternative funding sources.

While maintaining its interest rate spread objectives, the Bank attempts to
reduce interest rate risk with a variety of strategies designed to maintain what
the Bank believes to be an appropriate relationship between its assets and
liabilities. First, the Bank emphasizes real estate mortgage loans and
commercial loans with adjustable interest rates or fixed rates of interest for
an initial term of three or five years, that convert to an adjustable rate based
on the one, three and five-year constant maturity of United States Treasury
obligations as the index after the initial terms and for subsequent adjustment
periods. At December 31, 2003, the Bank had approximately $715.8 million of
adjustable-rate loans in its portfolio. Second, the Bank's mortgage-backed
securities portfolio is made up primarily of securities that have expected
average lives of five years or less at time of purchase. Third, the Bank has a
substantial amount of savings, demand deposit and money market accounts which
the Bank believes may be less sensitive to changes in interest rates than
certificate accounts. At December 31, 2003, the Bank had $456.4 million of these
types of accounts.

The Bank utilizes the OTS NPV model as its primary method of monitoring its
exposure to IRR. The NPV represents the excess of the present value of expected
cash flows from assets over the present value of expected cash flows from
liabilities. The NPV model estimates the sensitivity of the Bank's NPV over a
series

45

of instantaneous and sustained parallel shifts in interest rates. On a quarterly
basis, the ALCO reviews the calculations of NPV as adjusted for expected cash
flows from off-balance sheet contracts, if any, for compliance with
Board-approved tolerance limits.

The table below presents, as of December 31, 2003 and 2002, an analysis of
the Bank's IRR as measured by changes in NPV for instantaneous and sustained
parallel shifts in the yield curve in 100 basis point (1%) increments, up to 300
basis points and down 100 basis points in 2003 and 2002 in accordance with OTS
regulations. As illustrated in the table, the Bank's NPV in the base case (0
basis point change) increased $18.3 million from $119.9 million at December 31,
2002 to $138.2 million at December 31, 2003. The primary reason for the increase
was a reduction in the effective duration of the Bank's fixed-rate certificates
of deposit and long-term borrowings.

As modeled above, a decrease in interest rates of 100 basis points would
have an adverse impact on the Bank's NPV while an increase in interest rates of
100 basis points would have a positive impact on the NPV. As rates begin to rise
up to 100 basis points, the adverse change in the value of the Bank's assets is
more than offset by the positive change in the value of the its liabilities. As
rates rise beyond 100 basis points, the depreciation in the value of the Bank's
assets is not offset by the change in the value of its liabilities. This is
indicated by the negative 5.3% and negative 14.0% change in the +200 and +300
basis points scenarios, respectively, at December 31, 2003. At December 31, 2003
and December 31, 2002, the Bank was within the Board-approved tolerance limits
in each rate scenario.

This NPV model is a static model and does not consider potential
adjustments of strategies by management on a dynamic basis in a volatile rate
environment in order to protect or conserve equity values. As such, actual
results may vary from the modeled results. The above analysis includes the
assets and liabilities of the Bank only. Inclusion of Holding Company assets and
liabilities would increase NPV nominally at all levels.

46

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

REPORT OF INDEPENDENT AUDITORS

Board of Directors and Stockholders
CFS Bancorp, Inc.

We have audited the accompanying consolidated statements of condition of
CFS Bancorp, Inc. (the Company) as of December 31, 2003 and 2002, and the
related consolidated statements of income, changes in stockholders' equity, and
cash flows for each of the three years in the period ended December 31, 2003.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.

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

In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of CFS Bancorp,
Inc. as of December 31, 2003 and 2002, and the consolidated results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2003, in conformity with accounting principles generally accepted
in the United States.

/s/ Ernst & Young LLP

Chicago, Illinois
February 27, 2004

47

CFS BANCORP, INC.

CONSOLIDATED STATEMENTS OF CONDITION

See accompanying notes.

48

CFS BANCORP, INC.

CONSOLIDATED STATEMENTS OF INCOME

See accompanying notes.

49

CFS BANCORP, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

See accompanying notes.

50

CFS BANCORP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

51

CFS BANCORP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS -- (CONTINUED)

See accompanying notes.

52

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

ORGANIZATION

CFS Bancorp, Inc. (including its consolidated subsidiaries, the Company) is
a Delaware corporation, incorporated in March 1998 for the purpose of becoming
the holding company for Citizens Financial Services, FSB (Bank). The Company is
headquartered in Munster, Indiana. The Bank is a federal savings bank offering a
full range of financial services to customers who are primarily located in
Northwest Indiana and the south and southwest Chicagoland area. The Bank is
principally engaged in the business of attracting deposits from the general
public and using such deposits to originate residential and commercial mortgage
loans as well as other types of consumer and commercial loans.

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts and transactions
of the Company and its wholly-owned subsidiary, the Bank. The Bank has the
following subsidiaries: CFS Insurance Agency, Inc., CFS Investment Services,
Inc., CFS Holdings, Ltd., and Suburban Mortgage Services, Inc. All significant
intercompany accounts and transactions have been eliminated in consolidation.
Certain reclassifications have been made to the 2002 and 2001 consolidated
financial statements to conform to the 2003 presentation.

USE OF ESTIMATES

The preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the amounts reported in
the consolidated financial statements and accompanying notes. Actual results
could differ from those estimates.

CASH AND CASH EQUIVALENTS

Cash and cash equivalents include amounts due from depository banks and
federal funds sold. Generally, federal funds sold are purchased and sold for
one-day periods.

SECURITIES

Management determines the classification of securities at the time of
purchase. Debt securities are classified as held-to-maturity and carried at
amortized cost if management has the intent and ability to hold the securities
to maturity. Securities not classified as held-to-maturity are classified as
available-for-sale and are carried at fair value, with the unrealized gains and
losses, net of tax, included in accumulated other comprehensive income. The
Company has no trading account securities.

The amortized cost of debt securities is adjusted for amortization of
premiums and accretion of discounts to maturity, or in the case of
mortgage-related securities, over the estimated life of the security using the
level-yield method. Such amortization is included in interest income from
securities. A decline in the market value of any available-for-sale or
held-to-maturity security below amortized cost that is deemed to be other-than-
temporary (OTT) results in a charge to earnings thereby establishing a new cost
basis for the security. Gains and losses on sales of securities are determined
by specifically identifying the carrying amount of the security sold.

LOANS

Loans are carried at the principal amount outstanding, net of unearned
income, including net deferred loan origination and commitment fees, and
portions charged off. Interest on loans is recorded as income as

53

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

borrowers' payments become due. Interest on loans is not accrued on loans which
are 90 days or more past due, or for loans which management believes, after
giving consideration to economic and business conditions and collection efforts,
collection of interest is doubtful. Loans held-for-sale, if any, are carried at
the lower of aggregate cost or market value.

LOAN FEES AND COSTS

Loan origination and commitment fees and direct loan origination costs are
deferred and amortized as an adjustment of the related loan's yield. The Company
is accreting these amounts over the contractual life of the related loans.
Remaining deferred loan fees and costs are reflected in income upon sale or
repayment of the loan.

ALLOWANCE FOR LOSSES ON LOANS

The allowance for losses on loans is maintained at a level believed
adequate by management to absorb losses inherent in the loan portfolio.
Management's determination of the adequacy of the allowance for losses on loans
is based on an evaluation of the portfolio and, among other things, the
borrowers' ability to repay, estimated collateral values, prior loss experience,
growth and composition of the portfolio, assessment of individual problem loans,
and current economic events in specific industries and regions including
unemployment levels, regulatory guidance and general economic conditions.
Determination of the allowance for losses on loans is inherently subjective as
it requires significant estimates, including the amounts and timing of expected
future cash flows on impaired loans, estimated losses on pools of homogeneous
loans based on historical loss experience, and consideration of current economic
trends, all of which may be susceptible to significant change. Loan losses are
charged off against the allowance, while recoveries of amounts previously
charged off are credited to the allowance. A provision for losses on loans is
expensed based on management's periodic evaluation of the factors previously
mentioned. Future changes to the allowance may be necessary based on changes in
economic conditions, financial condition of borrowers, and loan loss experience.

Management considers a loan to be impaired when it is probable that the
Company will be unable to collect all amounts due according to the contractual
terms of the note agreement, including principal and interest. Loans subject to
impairment valuation are defined as non-accrual and restructured loans exclusive
of homogeneous loans such as single-family residential and consumer loans.
Specific allowances are established for impaired loans for which the recorded
investment in the loan exceeds the value of the loan. The value of the loan is
determined based on the fair value of the collateral, if the loan is
collateral-dependent, at the present value of expected future cash flows
discounted at the loan's effective interest rate or at the observable market
price of the impaired loan. Interest income on impaired loans is recorded when
cash is received and only if principal is considered to be fully collectible.

Commercial loans and loans secured by real estate are generally charged off
to the extent principal and interest due exceed the net realizable value of the
collateral with the charge-off occurring when the loss is reasonably
quantifiable. Consumer loans are subject to mandatory charge-off at a specific
date, typically at the end of the month in which the loan becomes 120 days past
due.

REAL ESTATE OWNED

Real estate owned is comprised of property acquired through a foreclosure
proceeding or acceptance of a deed in lieu of foreclosure. Real estate owned is
recorded at fair value at the date of foreclosure. After foreclosure, valuations
are periodically performed by management, and the real estate is carried at the
lower of cost or fair value minus estimated costs to sell.

54

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

OFFICE PROPERTIES AND EQUIPMENT

Office properties and equipment are stated at cost less accumulated
depreciation. Provisions for depreciation of office properties and equipment are
computed using the straight-line method over the estimated useful lives of the
related assets. Long-lived assets are periodically evaluated for impairment.

EARNINGS PER SHARE

Basic earnings per common share (EPS) is computed by dividing net income by
the weighted-average number of common shares outstanding for the period.
Employee Stock Ownership Plan (ESOP) shares not committed to be released and
Recognition and Retention Plan (RRP) shares which have not vested are not
considered to be outstanding. The basic EPS calculation excludes the dilutive
effect of all common stock equivalents. Diluted EPS reflects the potential
dilution that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock. The Company's potentially
dilutive common shares represent shares issuable under its stock option and RRP
plans. Such common stock equivalents are computed based on the treasury stock
method using the average market price for the period.

STOCK-BASED COMPENSATION

The Company accounts for its stock options in accordance with Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB
No. 25). Under APB No. 25, as the exercise price of the Company's employees'
stock options which have been granted equals the market price of the underlying
stock on the date of grant, no compensation expense is recognized. Compensation
expense for shares granted under the RRP is ratably recognized over the period
of service, usually the vesting period, based on the fair value of the stock on
the date of grant.

Pursuant to Financial Accounting Standards Board (FASB) Statement No. 123,
Accounting for Stock-Based Compensation, as amended (FAS No. 123), pro forma net
income and pro forma earnings per share are presented in the following table as
if the fair value method of accounting for stock-based compensation plans had
been utilized. The effects of applying FAS No. 123 in this pro forma disclosure
are not indicative of future amounts.

The fair value of the option grants for the years ended December 31, 2003,
2002 and 2001 was estimated using the Black-Scholes option value model, with the
following assumptions: dividend yield of approximately 3.0% in 2003, 2.8% in
2002 and 3.6% in 2001; expected volatility of 28.3% in 2003, 30.2% in 2002 and
30.2% in 2001; risk-free interest of 3.63%, 3.60% and 5.03%, for 2003, 2002 and
2001, respectively; and an original expected life of ten years for all options
granted.

55

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options that have no vesting restrictions
and are fully transferable. Option valuation models such as the Black-Scholes
require the input of highly subjective assumptions including the expected stock
price volatility. The Company's stock options have characteristics significantly
different from traded options and, inasmuch as changes in the subjective input
assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.

For additional details on the Company's stock-based compensation plans, see
Note 11 to the consolidated financial statements.

INCOME TAXES

The Company provides for deferred tax assets and liabilities, which
represent the difference between the financial statement and tax basis of assets
and liabilities and are measured using the enacted tax rates and laws applicable
to periods when the differences are expected to reverse. Deferred taxes arise
because certain transactions affect the determination of taxable income for tax
return purposes differently than for book purposes. Current tax expense is
provided based upon the actual tax liability incurred for tax return purposes.

COMPREHENSIVE INCOME

Comprehensive income is the total of reported net income and all other
revenues, expenses, gains, and losses that under accounting principles generally
accepted in the United States are not included in net income. The Company
includes unrealized gains or losses, net of tax, on securities
available-for-sale in other comprehensive income.

SEGMENT REPORTING

Operating segments are components of a business about which separate
financial information is available and that are evaluated regularly by the chief
operating decision-maker in deciding how to allocate resources and assessing
performance. Public companies are required to report certain financial
information about operating segments in interim and annual financial statements.
Senior management evaluates the operations of the Company as one operating
segment, community banking, due to the materiality of the banking operation to
the Company's financial condition and results of operations, taken as a whole.
As a result, separate segment disclosures are not required. The Company offers
the following products and services to external customers: deposits, loans,
mortgage-related services, investment services, and trust services. Revenues for
the significant products and services are disclosed separately in the
consolidated statements of income.

NEW ACCOUNTING PRONOUNCEMENTS

Guarantees

In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45),
Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. This interpretation expands the
disclosures to be made by a guarantor in its financial statements about its
obligations under certain guarantees and requires the guarantor to recognize a
liability for the fair value of an obligation assumed under a guarantee. FIN 45
clarifies that a guarantor is required to recognize, at the inception of a
guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. The disclosure requirements of FIN 45 were effective for
the Company as of December 31, 2002 and require disclosure of the nature of the
guarantee, the maximum potential amount of future payments that the guarantor
could be required to make under the guarantee, and the current amount of the
liability, if any, for the guarantor's obligations under the guarantee. The
recognition requirements of FIN 45 are to be applied

56

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

prospectively to guarantees issued or modified after December 31, 2002.
Significant guarantees that have been entered into by the Company are disclosed
in Note 14 to the consolidated financial statements. The Company's adoption of
FIN 45 did not have a material impact on its results of operations, financial
position, or liquidity.

Consolidation of Variable Interest Entities

In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46),
Consolidation of Variable Interest Entities. The objective of this
interpretation is to provide guidance on how to identify a variable interest
entity (VIE) and determine when the assets, liabilities, noncontrolling
interest, and results of operations of a VIE need to be included in a company's
consolidated financial statements.

In December 2003, the FASB reissued FIN 46 with certain modifications and
clarifications. Application of this guidance was effective for interests in
certain VIEs commonly referred to as special-purpose entities (SPEs) as of
December 31, 2003. Application for all other types of entities is required for
periods ending after March 15, 2004, unless previously applied. The Company does
not expect the adoption of FIN 46 to have a material impact on its results of
operations, financial position, or liquidity because the Company has not
identified any VIEs.

Financial Instruments with Characteristics of both Liabilities and Equity

In May 2003, Statement of Financial Accounting Standards (SFAS) No. 150,
Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity was issued, establishing standards for how an issuer
classifies and measures certain financial instruments with characteristics of
both liabilities and equity. This statement requires that an issuer classify
certain financial instruments, which may previously have been classified as
equity, as a liability. This generally includes financial instruments which
either 1) require mandatory redemption at a specified time other than upon
liquidation or termination of the entity, 2) include an obligation to either
repurchase the issuer's equity shares or is indexed to such an obligation and
which may require settlement in cash or 3) require the issuance of a variable
number of the issuer's shares based on a monetary amount which is generally
unrelated to the value of those shares. The Statement was effective for the
Company as of July 1, 2003 and adoption did not have a material impact on the
Company's accounting and reporting.

57

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

2. SECURITIES

The amortized cost of securities available-for-sale and their fair values
are as follows:

At December 31, 2002 the Company had $15.3 million in callable agency
securities which had call features at amounts not less than par and were not
purchased with significant premiums or discounts.

The Company had no held-to-maturity securities as of December 31, 2003. The
amortized cost of securities held-to-maturity and their fair values at December
31, 2002 are below.

58

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following table presents the period of time for gross unrealized losses
and fair value by investment category at December 31, 2003.

If management determines that an investment experienced an
other-than-temporary (OTT) decline in value, the loss must then be recognized in
the income statement. Any security gains when the same securities recover in
value cannot be recognized in income. Instead, the recovery is recorded as an
unrealized gain (as other comprehensive income in stockholders' equity) and not
recognized in income until the security is ultimately sold. Indications of OTT
declines in value include prolonged periods of consistent unrealized losses or
deterioration in the financial condition or near-term prospects of the issuer.
Management evaluates its investments for OTT declines in value on an individual
basis.

Management does not believe any individual unrealized loss as of December
31, 2003 represents an OTT impairment. The unrealized losses reported for
participation certificates, collateralized mortgage obligations, and real estate
mortgage investment conduits are, in their entirety, on securities issued by
government-sponsored entities including the Federal National Mortgage
Association (FNMA), the Federal Home Loan Mortgage Corporation (Freddie Mac) and
the Government National Mortgage Association (GNMA) and are attributable to
changes in interest rates and the current low interest rate environment.

The unrealized losses associated with the trust preferred securities relate
to a single issue. This security is current in its payments, and there has been
no history of deferred payments.

Unrealized losses in equity securities relate to a variety of issues which
are not related to each other. One security was determined to be impaired during
the third quarter of 2003, and the Company recorded a $120,000 ($73,000 net of
tax) write-down on September 30, 2003 related to this security. No other
securities were deemed to be impaired at December 31, 2003.

Management monitors the Company's investments with gross unrealized losses
daily. The Company has the intent to recover the costs associated with these
securities but can give no assurance that losses will not be realized if it is
deemed that there will be a future economic benefit in realizing the loss.

59

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The amortized cost and fair value of securities at December 31, 2003, by
contractual maturity, are shown in the table below. Expected maturities may
differ from contractual maturities because borrowers may have the right to call
or prepay obligations with or without call or prepayment penalties. Securities
not due at a single maturity date are shown separately.

For the year ended December 31, 2003, gross gains and gross losses of
$469,000 ($299,000 net of taxes) and $1,000 ($600 net of taxes), respectively,
were recorded from sales of available-for-sale securities. The Company also
recorded a realized loss of $120,000 ($73,000 net of tax) related to OTT
impairment as discussed previously.

For the year ended December 31, 2002, gross gains and gross losses of
$740,000 ($524,000 net of taxes) and $441,000 ($312,000 net of taxes),
respectively, were recorded from sales of available-for-sale securities.

For the year ended December 31, 2001, gross gains and gross losses of
$739,000 ($517,000 net of taxes) and $140,000 ($98,000 net of taxes),
respectively, were recorded from sales of available-for-sale securities.

During 2003, the Company sold $15.3 million of held-to-maturity
mortgage-backed securities resulting in gross gains of $1.4 million ($874,000
net of tax). Market conditions were deemed optimal for selling these securities
and allowed the Company to reinvest the proceeds into structures with
anticipated higher total returns.

In conjunction with the sale of the above held-to-maturity securities, the
Company reclassified the remaining held-to-maturity portfolio totaling $3.2
million to available-for-sale as a reflection of its intent to hold all
investments as available-for-sale. The transfer of these securities to
available-for-sale resulted in $61,000 of additional unrealized gains as of
December 31, 2003.

60

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

3. LOANS RECEIVABLE

Loans receivable consist of the following:

The Bank's lending activities have been concentrated primarily within its
immediate geographic area as well as the geographic Midwest. The Bank generally
requires collateral on loans and loan-to-value ratios of no greater than 80%.

At December 31, 2003, 2002 and 2001, the Company serviced $10.8 million,
$16.8 million and $21.1 million, respectively, of loans for others.

61

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Activity in the allowance for losses on loans is summarized as follows:

4. OFFICE PROPERTIES AND EQUIPMENT

Office properties and equipment are summarized as follows:

Depreciation expense charged to operations in 2003, 2002 and 2001,
approximated $1.4 million, $1.7 million and $1.8 million, respectively.

62

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

OPERATING LEASES

At December 31, 2003, the Company and its subsidiaries were obligated under
certain noncancelable operating leases for premises and equipment, which expire
at various dates throughout the year 2008. Many of these leases contain renewal
options, and certain leases provide options to purchase the leased property
during or at the expiration of the lease period at specific prices. Some leases
contain escalation clauses calling for rentals to be adjusted for increased real
estate taxes and other operating expenses, or proportionately adjusted for
increases in the consumer or other price indices. The following summary reflects
the future minimum rental payments, by year, required under operating leases
that, as of December 31, 2003, have initial or remaining noncancelable lease
terms in excess of one year (dollars in thousands).

Year ended December 31:
2004............................................. $ 562
2005............................................. 546
2006............................................. 459
2007............................................. 215
2008............................................. 127
------
$1,909
======

Rental expense charged to operations in 2003, 2002 and 2001, amounted to
approximately $405,000, $605,000 and $640,000, respectively, including amounts
paid under short-term cancelable leases.

5. ACCRUED INTEREST RECEIVABLE

Accrued interest receivable consists of the following:

63

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

6. DEPOSITS

Deposits and interest rate data are summarized as follows:

Interest expense on deposits consists of the following:

The aggregate amount of deposits in denominations of greater than one
hundred thousand dollars was $232.6 million and $215.0 million at December 31,
2003 and 2002, respectively. Deposits in excess of one hundred thousand dollars
generally are not federally insured.

64

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

7. BORROWED MONEY

Borrowed money consists of the following:

Advances totaling $400.0 million with final maturities in 2010 contain call
dates in 2004. Advances totaling $6.5 million with final maturities in 2008
contain call dates in 2004.

The advances can be prepaid subject to a substantial penalty which is
calculated based on the present value of the future cash flows at current
interest rates. At December 31, 2003, the Company estimated the prepayment
penalty at $54.7 million to pay off the aggregate advances. Should interest
rates increase, the Company expects the estimated prepayment penalty to
decrease.

Pursuant to collateral agreements with the Federal Home Loan Bank of
Indianapolis (FHLB-IN), advances are secured by the following assets (dollars in
thousands):

Pursuant to collateral agreements with the Federal Home Loan Bank of
Chicago (FHLB-C), advances are secured by stock in the FHLB-C, FHLB corporate
notes with a carrying value of $15.0 million and certain mortgage-backed
securities having a carrying value of $2.8 million.

As of December 31, 2003, the Company had two lines of credit with a maximum
of $25.0 million and $15.0 million, respectively, in unsecured overnight federal
funds at the market rate for the purchase of federal funds at the time of
request. The line was not used in 2003.

The Company enters into sales of securities under agreements to repurchase
(repurchase agreements). These repurchase agreements are treated as financings,
and the obligations to repurchase securities sold are reflected as borrowed
funds in the consolidated statements of condition. The securities underlying
these

65

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

repurchase agreements continue to be reflected as assets of the Company. There
were no securities sold under agreements to repurchase at December 31, 2003 or
December 31, 2002.

Interest expense on borrowed money is summarized as follows:

8. INCOME TAXES

The income tax provision consists of the following:

A reconciliation of the statutory federal income tax rate to the effective
income tax rate is as follows:

66

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Significant components of deferred tax assets and liabilities are as
follows:

The Bank has qualified under provisions of the Internal Revenue Code, which
permitted it to deduct from taxable income an allowance for bad debts, which
differs from the provision for such losses charged to income. Accordingly,
retained income at December 31, 2003 includes approximately $12.5 million, for
which no provision for income taxes has been made. If in the future this portion
of retained income is distributed, or the Bank no longer qualifies as a bank for
tax purposes, income taxes may be imposed at the then applicable rates. If
income taxes had been provided, the deferred tax liability would have been
approximately $4.9 million.

9. REGULATORY CAPITAL

The principal source of cash flow for the Company is dividends from the
Bank. Various federal banking regulations and capital guidelines limit the
amount of dividends that may be paid to the Company by the Bank. Future payment
of dividends by the Bank is dependent upon individual regulatory capital
requirements and levels of profitability.

The Bank is subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum requirements can
initiate certain mandatory and possible additional discretionary actions by
regulators that, if undertaken, could have a direct material effect on the
Bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's assets,
liabilities, and certain off-balance-sheet items as calculated under regulatory
accounting practices. The Bank's capital amounts and classification are also
subject to quantitative judgments by the regulators about components, risk
weightings, and other factors.

Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios, set forth in the table
below of the total risk-based, tangible, and core capital, as

67

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

defined in the regulations. As of December 31, 2003, the Bank met all capital
adequacy requirements to which it is subject.

As of December 31, 2003, the most recent notification from the OTS
categorized the Bank as "well-capitalized" under the regulatory framework for
prompt corrective action. To be categorized as "well-capitalized," the Bank must
maintain minimum total risk-based, tangible, and core ratios as set forth in the
following table. There are no conditions or events since that notification that
management believes have changed the institution's category. At December 31,
2003, adjusted total assets were $1.55 billion and risk-weighted assets were
$1.09 billion.

10. EMPLOYEE BENEFIT PLANS

The Company participates in an industry-wide, multi-employer, defined
benefit pension plan, which covers all full-time employees who have attained at
least 21 years of age and completed one year of service. Calculations to
determine full-funding status are made annually as of June 30. Pension expense
for the years ended December 31, 2003, 2002 and 2001 was $1.6 million, $889,000
and $134,000, respectively. Asset and plan benefit information is not available
for participating associations on an individual basis.

The Retirement Plan benefits were frozen effective March 1, 2003. Although
no further benefits will accrue while the freeze remains in place, the freeze
does not reduce the benefits accrued to date. Even though the benefits are
frozen, the Company will review the funding level and will continue to make
necessary contributions to keep the plan adequately funded.

The Company also participates in a single-employer defined contribution
plan, which qualifies under section 401(k) of the Internal Revenue Code.
Participation eligibility in this plan is substantially the same as in the
aforementioned defined benefit pension plan. This plan called for a
discretionary contribution within specified limits and a matching Company
contribution equal to a specified percentage of employee contributions. Plan
expense for the years ended December 31, 2003, 2002 and 2001 was approximately
$230,000, $252,000 and $251,000, respectively.

The Company provides supplemental retirement benefits for certain senior
officers in the form of payments upon retirement, death, or disability. The
annual benefit is based on actuarial computations of existing plans without
imposing Internal Revenue Service limits. Expenses related to this plan for the
years ended December 31, 2003, 2002 and 2001, were $29,000, $87,000 and $97,000,
respectively.

68

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

11. STOCK-BASED BENEFIT PLANS

In 1998, the Company established an Employee Stock Ownership Plan (ESOP)
for the employees of the Company and the Bank. The ESOP is a qualifying pension
plan under Internal Revenue Service guidelines. It covers all full-time
employees who have attained at least 21 years of age and completed one year of
service. Upon formation, the ESOP borrowed $14.3 million from the Company and
purchased 1,428,300 shares of common stock. Expense is recognized based on the
fair value (average stock price) of shares scheduled to be released from the
ESOP trust. One-twelfth of the shares are scheduled to be released each year as
one-twelfth of the loan (principal and interest) is scheduled to be repaid each
year. Dividends on both allocated and unallocated shares are used to pay down
the loan. Expense related to this ESOP for the years ended December 31, 2003,
2002 and 2001 was $1.7 million, $1.7 million and $1.5 million, respectively.
ESOP shares not committed to be released are not considered outstanding for
purposes of computing EPS.

The following table summarizes shares of Company common stock held by the
ESOP:

The Company also provides supplemental retirement benefits for certain
senior officers under the ESOP. This benefit is also based on computations for
the existing plan exclusive of Internal Revenue Service limits. Expenses related
to this plan for the years ended December 31, 2003, 2002 and 2001, were $72,000,
$86,000 and $59,000, respectively.

In February 1999, the Company, with shareholder approval, established the
RRP, which is a stock-based incentive plan, and a stock option plan. The Bank
contributed $7.5 million to the RRP to purchase a total of 714,150 shares of
Company common stock. On April 1, 1999, the Compensation Committee of the Board
of Directors granted 707,000 shares under this plan to 92 participants. On April
1, 2003, the Compensation Committee also granted 21,000 shares to five
participants.

The following table summarizes shares of Company's common stock held by the
RRP at December 31, 2003:

Shares purchased by the plan................................ 714,150
Shares granted in 1999...................................... (707,000)
Shares forfeited in 1999.................................... 2,000
Shares forfeited in 2000.................................... 6,800
Shares forfeited in 2001.................................... 2,700
Shares forfeited in 2002.................................... 2,600
Shares granted in 2003...................................... (21,000)
Shares forfeited in 2003.................................... 800
--------
Shares available for grant December 31, 2003................ 1,050
========

The shares granted in the RRP vest to the participants at the rate of 20%
per year. As a result, expense for this plan is being recorded over a 60-month
period and is based on the market value of the Company's stock as of the date of
grant. The remaining unamortized cost of the RRP is reflected as a reduction in
stockholders'

69

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

equity. Expenses under this plan for the years ended December 31, 2003, 2002 and
2001 were $1.3 million, $1.5 million and $1.4 million, respectively.

The Company has stock option plans under which shares of Company common
stock are reserved for the grant of both incentive and nonincentive stock
options to directors, officers, and employees. The dates the options are first
exercisable and expire are determined by the Compensation Committee. The
exercise price of the options is equal to the fair market value of the common
stock on the grant date.

The following is a combined analysis of the stock option activity for each
of the three years ended December 31, 2003, 2002 and 2001.

At December 31, 2003, 1,039,539 stock options were exercisable with a range
in exercise price from $4.78 to $14.46. The weighted-average remaining
contractual life of the outstanding options was 6.0 years and the average
exercise price was $10.84. At December 31, 2003, there were 428,195 shares
available for future grants.

70

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

12. OTHER COMPREHENSIVE INCOME

The related income tax effect and reclassification adjustments to the
components of other comprehensive income for the periods indicated are as
follows:

13. EARNINGS PER SHARE

The following table sets forth the computation of basic and diluted
earnings per share:

71

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

14. COMMITMENTS

Credit enhancements are letter of credit facilities related to the issuance
by municipalities of taxable and nontaxable revenue bonds. The proceeds from the
sale of such bonds are loaned to for-profit and not-for-profit companies for
economic development projects. In order for the bonds to receive a triple-A
rating, and thus a lower interest rate, the FHLB-IN issues, in favor of the bond
trustee, an Irrevocable Direct Pay Letter of Credit (Letter of Credit) for the
account of the Bank. Since the Bank, in accordance with the terms and conditions
of a Reimbursement Agreement between the FHLB-IN and the Bank, would be required
to reimburse the FHLB-IN for draws against the Letter of Credit, these
facilities are analyzed, appraised, secured by real estate mortgages, and
monitored as if the Bank funded the project initially.

The Bank estimates that substantially all commitments will be funded or
will expire within one year. Letters of credit expire at various times through
2008.

15. RELATED PARTY DISCLOSURES

The Company has no material related party transactions which would require
disclosure. In compliance with applicable banking regulations, the Company may
extend credit to certain officers and directors of the Company and its
subsidiaries in the ordinary course of business under substantially the same
terms as comparable third-party lending arrangements.

16. LEGAL PROCEEDINGS

In 1983, with the assistance of the Federal Savings and Loan Insurance
Corporation (FSLIC) as set forth in an assistance agreement (Assistance
Agreement), the Bank acquired First Federal Savings and Loan Association of East
Chicago, East Chicago, Indiana (East Chicago Savings), and Gary Federal Savings
and

72

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Loan Association, Gary, Indiana (Gary Federal). The FSLIC-assisted supervisory
acquisitions of East Chicago Savings and Gary Federal were accounted for using
the purchase method of accounting which resulted in supervisory goodwill (the
excess of cost over the fair value of net assets acquired), an intangible asset,
of $52.9 million, compared to $40.2 million of goodwill as reported on a
generally accepted accounting principles basis. Such goodwill was included in
the Bank's regulatory capital. The Assistance Agreement relating to the Bank's
acquisitions of East Chicago Savings and Gary Federal provided for the inclusion
of supervisory goodwill as an asset on the Bank's balance sheet, to be amortized
over 35 years for regulatory purposes and includable in regulatory capital.
Pursuant to the regulations adopted by the OTS to implement the Financial
Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA), the
regulatory capital requirement for federal savings banks was increased and the
amount of supervisory goodwill that could be included in regulatory capital
decreased significantly. At September 30, 1989, the Bank had approximately $26.0
million of remaining supervisory goodwill. However, even excluding supervisory
goodwill, the Bank exceeded the capital requirements of FIRREA at such date.

On May 13, 1993, the Bank filed suit against the U.S. government seeking
damages and/or other appropriate relief on the grounds, among others, that the
government had breached the terms of the Assistance Agreement. The suit is
pending in the United States Court of Federal Claims and is titled Citizens
Financial Services, FSB, v. United States (Case No. 93-306-C). The Bank was
granted summary judgment on its breach of contract claim, leaving for trial the
issue of damages. The case is currently scheduled for trial in June 2004.

The Bank is seeking damages of more than $20.0 million based on the report
of its expert witness. The Government has contended that the Bank suffered no
compensable damage as a result of the breach. The Bank is unable to predict the
outcome of its claim against the United States and the amount of damages that
may be awarded to the Bank, if any, in the event that a judgment is rendered in
the Bank's favor. Consequently, no assurances can be given as to the results of
this claim or the timing of any proceedings in relation thereto. The cost,
including attorneys' fees, experts' fees, and related expenses of the litigation
was approximately $183,000, $258,000 and $436,000 in 2003, 2002 and 2001,
respectively.

Other than the above-referenced litigation, the Company is involved in
routine legal proceedings occurring in the ordinary course of business, which,
in the aggregate, are believed to be immaterial to the financial condition of
the Company.

17. FAIR VALUE OF FINANCIAL INSTRUMENTS

Disclosure of fair value information about financial instruments, whether
or not recognized in the consolidated statement of condition, for which it is
practicable to estimate their value, is summarized below. In cases where quoted
market prices are not available, fair values are based on estimates using
present value or other valuation techniques. Those techniques are significantly
affected by the assumptions used, including the discount rate and estimates of
future cash flows. In that regard, the derived fair value estimates cannot be
substantiated by comparison to independent markets and, in many cases, could not
be realized in immediate settlement of the instrument.

The fair value disclosure of certain financial instruments and all
nonfinancial instruments is not required. Accordingly, the aggregate fair value
amounts presented do not represent the underlying value of the Company.

73

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The carrying amounts and fair values of financial instruments consist of
the following:

SECURITIES

Fair values for securities are based on the lower of quotes received from
third-party brokers.

LOANS RECEIVABLE

The Company determined that for both variable-rate and fixed-rate loans,
fair values are estimated using discounted cash flow analyses, using interest
rates currently being offered for loans with similar terms and collateral to
borrowers of similar credit quality.

INVESTMENT IN BANK-OWNED LIFE INSURANCE

The fair value of Bank-owned life insurance is equal to its cash surrender
value.

DEPOSIT LIABILITIES

The fair value of demand deposits, savings accounts, and money market
deposits is the amount payable on demand at the reporting date. The fair value
of fixed-maturity certificates of deposit is estimated by discounting the future
cash flows using the rates currently offered for deposits of similar remaining
maturities.

BORROWED MONEY

The fair value of borrowed money is estimated based on rates currently
available to the Company for debt with similar terms and remaining maturities.

The fair value of the Company's off-balance sheet instruments is nominal.

74

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

18. CONDENSED PARENT COMPANY FINANCIAL STATEMENTS

The tables on the following pages represent the condensed statement of
financial condition as of December 31, 2003 and 2002 and condensed statement of
income and cash flows for the three years ended December 31, 2003 for CFS
Bancorp, Inc., the parent company.

CONDENSED STATEMENTS OF CONDITION
(PARENT COMPANY ONLY)

75

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

CONDENSED STATEMENTS OF INCOME

(PARENT COMPANY ONLY)

76

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

CONDENSED STATEMENTS OF CASH FLOWS

(PARENT COMPANY ONLY)

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.

ITEM 9A. CONTROLS AND PROCEDURES

Under the supervision and with the participation of management, including
the chief executive officer and chief financial officer, the Company has
evaluated the effectiveness of the disclosure controls and procedures (as
defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended
(Exchange Act)) as of December 31, 2003.

77

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Disclosure controls and procedures are controls and other procedures that
are designed to ensure that information required to be disclosed by the Company
in the reports that it files or submits under the Exchange Act is recorded,
processed, summarized and reported, within the time periods specified in the
Securities and Exchange Commission's rules and forms. Disclosure controls and
procedures include, without limitation, controls and procedures designed to
ensure that information required to be disclosed by the Company in the reports
that it files under the Exchange Act is accumulated and communicated to
management, including the chief executive officer and chief financial officer,
as appropriate to allow timely decisions regarding required disclosure.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

The information required herein is incorporated by reference from the
section of the Registrant's Proxy Statement which is expected to be filed on or
about March 26, 2004 (Proxy Statement) titled Information With Respect to
Nominees for Director, Continuing Directors and Executive Officers. Information
related to the Company's Code of Conduct and Ethics is incorporated by reference
from page 3 of Item 1 of the Form 10-K.

ITEM 11. EXECUTIVE COMPENSATION.

The information required herein is incorporated by reference from the
section of the Registrant's Proxy Statement titled Executive Compensation.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

The information required herein by Item 403 of Regulation S-K is
incorporated by reference from the section of the Registrant's Proxy Statement
titled Beneficial Ownership of Common Stock by Certain Beneficial Owners and
Management.

Equity Compensation Plan Information. The following table sets forth
certain information for all equity compensation plans and individual
compensation arrangements (whether with employees or non-employees, such as
directors), in effect as of December 31, 2003.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

The information required herein is incorporated by reference from the
section of the Registrant's Proxy Statement titled Transactions with Certain
Related Persons.

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

The information required herein is incorporated by reference from the
section of the Registrant's Proxy Statement titled Auditor Fees and Expenses.

78

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.

(a) Document filed as part of this Report.

(1) All schedules for which provision is made in the applicable
accounting regulation of the SEC are omitted because they are not
applicable or the required information is included in the Consolidated
Financial Statements or notes thereto.

(2)(a) The following exhibits are filed with the SEC as part of this
Form 10-K, and this list includes the Exhibit Index.

3.1 Certificate of Incorporation of CFS Bancorp, Inc.*
3.2 Bylaws of CFS Bancorp, Inc.*
4.0 Form of Stock Certificate of CFS Bancorp, Inc.*
10.1 Employment Agreement entered into between Citizens Financial
Services, FSB and Thomas F. Prisby**
10.2 Employment Agreement entered into between Citizens Financial
Services, FSB and James W. Prisby**
10.3 Employment Agreement entered into between Citizens Financial
Services, FSB and John T. Stephens**
10.4 Employment Agreement entered into between CFS Bancorp, Inc.
and Thomas F. Prisby**
10.5 Employment Agreement entered into between CFS Bancorp, Inc.
and James W. Prisby**
10.6 Employment Agreement entered into between CFS Bancorp, Inc.
and John T. Stephens**
10.7 CFS Bancorp, Inc. Amended and Restated 1998 Stock Option
Plan***
10.8 CFS Bancorp, Inc. Amended and Restated 1998 Recognition and
Retention Plan and Trust Agreement***
10.9 CFS Bancorp, Inc. 2003 Stock Option Plan****
10.10 Employment Agreement entered into between Citizens Financial
Services, FSB and Charles V. Cole
10.11 Employment Agreement entered into between Citizens Financial
Services, FSB and Thomas L. Darovic
10.12 Employment Agreement entered into between CFS Bancorp, Inc.
and Charles V. Cole
10.13 Employment Agreement entered into between CFS Bancorp, Inc.
and Thomas L. Darovic
23.0 Consent of Ernst & Young LLP
31.1 Rule 13a-14(a) Certification of Chief Executive Officer
31.2 Rule 13a-14(a) Certification of Chief Financial Officer
32.0 Section 1350 Certifications

- ---------------

* Incorporated by Reference from the Company's Registration Statement on Form
S-1 filed on March 26, 1998, as amended and declared effective on May 14,
1998.

** Incorporated by Reference from the Company's report on Form 10-Q for the
quarterly period ended June 30, 2003.

*** Incorporated by Reference from the Company's Definitive Proxy Statement for
the Annual Meeting of Stockholders filed on March 23, 2001.

**** Incorporated by Reference from the Company's Definitive Proxy Statement for
the Annual Meeting of Stockholders filed on March 31, 2003.

79

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(b) Reports filed on Form 8-K.

On October 20, 2003, the Company filed a Current Report on Form 8-K in
connection with the announcement of the retirement of the Chief Financial
Officer of the Company and the appointment of his successor.

On October 27, 2003, the Company filed a Current Report on Form 8-K
furnishing its report of earnings for the quarter ended September 30, 2003 under
Item 12.

On December 24, 2003, the Company filed a Current Report on Form 8-K in
connection with the announcement of its quarterly dividend.

80

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.

CFS BANCORP, INC.

By: /s/ THOMAS F. PRISBY
------------------------------------
Thomas F. Prisby
Chairman of the Board and
Chief Executive Officer

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.