CFS BANCORP INC - 10-K Annual Report

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

COMMISSION FILE NO.: 0-24611

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

DELAWARE 35-2042093
(State or other jurisdiction of (I.R.S. Employer
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 month (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. [ ]

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, 2004, the aggregate value of the 12,290,934 shares of Common
Stock of the Registrant outstanding on such date, which excludes 708,157 shares
held by all directors and executive officers of the Registrant as a group, was
approximately $153.5 million. This figure is based on the last known trade price
of $13.25 per share of the Registrant's Common Stock on June 30, 2004.

Number of shares of Common Stock outstanding as of March 11, 2005:
12,382,322

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive proxy statement for the Annual Meeting of
Stockholders to be held on April 26, 2005 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) is
a registered unitary savings and loan holding company and was organized in March
1998 to facilitate the July 1998 conversion of its subsidiary, Citizens
Financial Services, FSB (the Bank or Citizens Financial), from a
federally-chartered mutual savings bank to a federally-chartered stock savings
bank (Conversion). In conjunction with the Conversion, the Company completed an
initial public offering. The Company and the Bank are subject to oversight and
examination by the Office of Thrift Supervision (OTS). See
"Regulation -- Regulation of Savings and Loan Holding Companies."

The Company's primary assets consist of the outstanding shares of common
stock of the Bank 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. 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.

The Bank was originally organized in 1934 and conducts its business from
its executive offices in Munster, Indiana, as well as 24 banking centers located
in Lake and Porter Counties in northwest Indiana and Cook, DuPage and Will
Counties in Illinois. The Bank also has an Operations Center located in
Highland, Indiana which is dedicated to its Customer Call Center and other back
office operations.

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 FRB, legislative tax policies and governmental budgetary matters. The Bank's
revenue has been largely dependent on net interest income, which is the
difference between interest earned on interest-bearing assets
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and the interest expense paid on interest-bearing liabilities. However, the Bank
continues to focus 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, DC 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 an internet website at
www.cfsbancorp.com. The Company makes 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 on its website 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.

MARKET AREA AND COMPETITION

Citizens Financial maintains 24 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.

The Bank has historically concentrated its efforts in the market
surrounding its offices and has in recent years broadened that market into the
Midwestern United States 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 other non-depository financial institutions such
as brokerage firms and insurance companies.

LENDING ACTIVITIES

General. Citizens Financial originates commercial and retail loans.
Included in the Bank's commercial loan portfolio are commercial real estate,
construction and land development, and commercial and industrial loans. The
retail loan portfolio includes single-family residential mortgage loans, home
equity loans and lines

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of credit (together, HELOCs) and other consumer loans including auto loans.
Since the Conversion, the Bank shifted its lending emphasis, increasing its
involvement in commercial loans, while concurrently reducing its originations of
single-family residential mortgage loans.

The Bank's lending strategy is to diversify its portfolio in an effort to
limit risks associated with any particular loan type or industry while building
a quality loan portfolio. The Bank has established specific collateral
concentration limits in a manner that will not hamper its lenders in the pursuit
of new business in a variety of sectors.

The Bank's commercial 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 loan products,
its emphasis remains on originating adjustable-rate loans, which management
believes will better control its interest rate risk.

The Bank utilizes secondary market standards for underwriting single-family
residential mortgage loans which facilitates its ability to sell these loans
into the secondary market. Secondary market requirements place limitations on
debt to income ratios and loan size among other factors. As part of the
underwriting process, the Bank evaluates, among other things, the customers'
credit history, income, employment stability, repayment capacity and collateral.

The Bank utilizes a Risk-Based Lending (RBL) approach for underwriting
HELOCs and other consumer loans. The RBL approach employed by the Bank evaluates
the borrower's credit score, debt-to-income ratio and the loan's collateral
value. Borrowers with a higher credit score generally qualify for a lower
interest rate.

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 FRB, legislative tax policies and governmental budgetary matters.

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 approval authorities. All new loans are reviewed by the full Board of
Directors of Citizens Financial as part of its monthly review of the Loan
Committee minutes.

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 $19.0 million in the case of the Bank at December 31,
2004), 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. 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 is also required to monitor its 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 is required by regulation to
limit its aggregate loans to any corporate group to 50% of Tier 1 capital. At
December 31, 2004, Tier 1 capital was $120.1 million. Citizens Financial's two
largest corporate group relationships at December 31, 2004 equaled $40.9 million
and $24.1 million, respectively. Both of these relationships are below the group
limit of $60.1 million and are performing in accordance with their terms.

COMMERCIAL AND CONSTRUCTION LENDING

General. In recent years, the Company's strategy has changed with respect
to its loan portfolio as the Company has significantly increased its emphasis on
originating commercial loans. The Company 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 relationships with the

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businesses in their communities and to tailor business development plans based
on the needs of that specific area. While the commercial lending group develops
business relationships within its market area, they also pursue commercial
lending opportunities outside the Bank's market area through participations with
other financial institutions.

Commercial Real Estate. The majority of the Bank's commercial loan
portfolio is made up of loans secured by commercial real estate, including
multi-family residential loans. These loans generally have 3 to 10 year terms
with an amortization period of 25 years or less. The interest rates on these
loans are generally fixed for the first five years followed by a one time
adjustment which then becomes the fixed-rate of the loan for the remaining term.
The Bank has also offered loans with a fixed interest rate for an initial three
or five year period and which then adjusts annually to a designated index such
as one-year U.S. Treasury obligations adjusted to a constant maturity (CMT) plus
a stipulated margin for the remainder of the term. Commercial real estate loans
generally have shorter terms to maturity and higher yields than the Bank's
single-family residential mortgage loans. Upon closing, the Bank usually
receives fees of between 0.5% and 1.0% of the principal loan balance. These
loans are typically subject to prepayment penalties. The Bank generally obtains
personal guarantees of the borrower's principals as additional security for any
commercial real estate loans.

Citizens Financial evaluates various aspects of commercial real estate loan
transactions in an effort to mitigate credit risk. 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, market position, location and physical condition. In addition, the
Bank also performs sensitivity analysis on cash flow, vacancy trends 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
generally imposed a debt coverage ratio (the ratio of net income before payment
of debt service to debt service) of not less than 110% for commercial real
estate 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 new commercial real estate loan transactions. All appraisal
reports and any necessary environmental site assessments are reviewed by the
Bank before the loan closes.

Commercial real estate lending entails substantially different risks
compared to single-family residential lending because such loans often involve
large loan balances to single borrowers and because the payment experience on
these 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 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.

The Bank also invests, on a participating basis, in commercial real estate
loans originated by other lenders. In these transactions, the Bank reviews such
loans utilizing the same credit policies applicable to loans it originates.

The Bank's commercial real estate loans are secured by hotels, medical
office facilities, multi-family residential buildings, churches, small office
buildings, strip shopping centers and other commercial uses. These loans are
usually originated in amounts of less than $15.0 million, and as of December 31,
2004, the average size of the Bank's commercial real estate loans was
approximately $1.1 million.

Construction and Land Development Loans. The Bank currently offers
construction loans for commercial real estate and multi-family residential
properties along with construction loans to local residential builders. The
Bank's construction portfolio also includes construction/permanent,
single-family residential loans which, by their terms, will convert to permanent
mortgage loans upon the completion of their construction. At the time of
conversion, these loans will become part of the Bank's single-family residential
mortgage loan portfolio.

The Bank also 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

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the lesser of 75% of its appraised value or 75% of its cost and are typically
made for a period of up to three 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 is 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 primarily provides residential and commercial
construction lending within the Midwestern United States.

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.

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.

At December 31, 2004, the average size of the Bank's construction and land
development loans was approximately $810,000.

Commercial and Industrial Loans. The Bank also originates commercial loans
that are secured by business assets other than real estate and secured and
unsecured operating lines of credit. These types of loans undergo an
underwriting process similar to the other types of commercial lending the Bank
offers; however, these loans tend to be riskier in nature since the repayment is
based on the cash flows of the business operation. As of December 31, 2004, the
average size of the Bank's commercial and industrial loans was approximately
$250,000.

RETAIL LENDING

General. The Bank's retail lending program includes single-family
residential loans, HELOCs, auto loans and other consumer loans. The Bank's
primary focus continues to be on originating variable-rate retail products,
primarily through its HELOC programs and by retaining any variable-rate
single-family residential loans while selling most fixed-rate loans originated
with servicing released. The Bank's retail lenders are responsible for
originating its retail loans. The retail lenders are also assisted by the Bank's
branch origination program and call center within its market area.

Single-Family Residential Loans. 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.

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
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and interest by the maturity date. 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 Bank's fixed-rate loans are generally originated under terms,
conditions 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, 2004, $60.1 million,
or 21.6% of the Bank's single-family residential mortgage loans, were fixed-rate
loans. During 2004, the Bank sold approximately $13.2 million of fixed-rate
loans with servicing released.

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 then adjust annually to a CMT plus a stipulated
margin. The Bank's ARMs 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 ARMs 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, 2004, $218.1
million, or 78.4% of the Bank's single-family residential mortgage loans, were
adjustable-rate loans.

While the Bank has focused on providing ARMs 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 ARM also
increases 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 generally are less than the risks associated with holding long-term
fixed-rate loans.

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 ARMs, the increased emphasis over the
past few years on growing the Bank's commercial lending portfolio has reduced
the proportion of single-family residential loans to total loans.

The Bank's single-family residential 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.

HELOC. The majority of the Bank's home equity products are HELOCs which
are structured as a variable-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, the most creditworthy customers
may qualify to receive up to 100% LTV. There is a higher risk associated with
this type of lending since the HELOCs are typically secured by a second
mortgage. The Bank looks to the borrower's credit history as an indication of
risk and as a factor in establishing the interest rate on the loan or line of
credit.

Other Loans. Citizens Financial's other retail loans consist primarily of
consumer loans, loans secured by deposit accounts and auto loans. The Bank is
not actively marketing its consumer loans and offers them primarily as a service
to its existing customers.

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SECURITIES ACTIVITIES

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,

- minimal credit risk, and

- flexibility.

The Company's investment policy permits investments in various types of
securities including obligations of the U.S. Treasury, federal agencies,
government sponsored entities, 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. The Company currently does not participate
in hedging programs, interest rate swaps, or other activities involving the use
of off-balance sheet derivative instruments.

The Company evaluates securities for other-than-temporary (OTT) impairment
on a quarterly basis, and more frequently when economic or market concerns
warrant additional evaluations. In evaluating the possible impairment of
securities, consideration is given to the length of time and the extent to which
the fair value has been less than cost, the financial conditions and near-term
prospects of the issuer, and the intent and ability of the Company to retain its
investment in the issuer for a period of time sufficient to allow for any
anticipated recovery in fair value. In analyzing an issuer's financial
condition, the Company may consider whether the securities are issued by the
federal government or its agencies, whether downgrades by bond rating agencies
have occurred, and the results of reviews of the issuer's financial condition.
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.

If management determines that an investment security has experienced an OTT
decline in value, the loss is recognized in the income statement. Any recoveries
related to the value of these securities are recorded as an unrealized gain (as
other comprehensive income in stockholders' equity) and not recognized in income
until the security is ultimately sold.

The Company currently utilizes an outside investment advisor for developing
and monitoring an investment strategy designed to maximize the portfolio's total
return while maintaining acceptable levels of risk. The Company currently
employs a strategy that maximizes total returns by proactively managing where
securities are purchased and held along the yield curve. An inherent byproduct
of this strategy is the recognition of realized gains and losses. These gains
and losses should be looked upon as part of the portfolio's overall total
return.

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 FHLB 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. The Bank considers its
checking, money market and savings accounts to be its core deposits. 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.
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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 currently utilize the services of deposit brokers. The Bank
traditionally has relied on customer service and convenience in marketing its
deposit products. The Bank has implemented an initiative to attract core
deposits in all markets by offering various limited-time promotions for new
deposit accounts. As the need for funds warrant, the Bank may continue to use
certificate of deposit promotions in new markets to build its customer base.

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 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. These advances are made in accordance with several
different credit programs, each of which has its own interest rate and range of
maturities.

TRUST ACTIVITIES

The Company also provides limited fiduciary services through the Bank's
Trust Department primarily for convenience to its existing customers. Services
offered include fiduciary services for trusts and estates and land trusts. Prior
to December 31, 2004, the Trust Department maintained 23 trust/fiduciary
accounts with an aggregate principal balance of $1.0 million at such date. The
Trust Department also administered 44 beneficiary-managed land trusts in Indiana
during 2004. Gross revenue from the Trust Department for the year ended December
31, 2004 was $12,000.

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, estates and guardianships.

Most of the significant operations of the Trust Department have been
outsourced to a third-party trust company as of December 31, 2004. It is
anticipated that all further trust prospects, with the exception of Indiana land
trusts, will be referred to the third-party trust company for which the Bank
will receive a referral fee. The Bank anticipates that it will continue to
provide trust services for Indiana land trusts as needed in the future.
Executive management of the Trust Department is provided by the Bank's Senior
Vice President -- Corporate Counsel, subject to direction by the Trust
Committee.

SUBSIDIARIES

During 2004, the Bank had one active, wholly-owned subsidiary, CFS
Holdings, Ltd. (CFS Holdings). This subsidiary 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 investment securities and performs a significant amount of the Bank's
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 $4.7 million for the year ended December 31, 2004 compared to $3.7
million and $5.2 million for the years ended December 31, 2003 and 2002,
respectively. Operating expenses of this subsidiary were $68,000 for the year
ended December 31, 2004 compared to $58,000 and $61,000 for the years ended
December 31, 2003 and 2002, respectively.

Prior to 2003, the Bank had two other subsidiaries which are no longer
active. These subsidiaries were CFS Insurance Agency, Inc. (CFS Insurance) and
CFS Investment Services, Inc. (CFS Investments). 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. In August 2002, the Bank
entered into an agreement to outsource this activity and discontinued providing
these services directly through CFS Investment Services. The outsourcing allowed
the Bank to recognize commission income on the sale of these products while
reducing the operating expenses associated with this subsidiary.
9

CFS Insurance was an independent insurance brokerage subsidiary which
offered a full line of insurance products to the general public. 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. In 2004, the Bank sold the building to a third party
for a profit of $220,000.

EMPLOYEES

Citizens Financial had 327 full-time equivalent employees at December 31,
2004. 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.

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
10

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 FRB 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 enforces auditing, quality control and independence standards and is
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 or willfully violate this certification requirement. In addition,
under the Act, counsel is 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 accelerated 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

11

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)
U.S. generally accepted accounting principles and filed with the SEC reflect all
material correcting adjustments that are identified by a RPAF in accordance with
U.S. generally accepted accounting principles and the rules and regulations of
the SEC. Pursuant to the regulations of the SEC and its Exemptive Order dated
November 30, 2004, the Company anticipates that management's annual report and
the related attestation report of the Company's RPAF will be timely filed as an
amendment to this Annual Report on Form 10-K. See Item 9A of this Form 10-K
below.

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. 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, and 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
12

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 9.24%, and its total
risk-based capital ratio was 12.23% at December 31, 2004. 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.

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, 2004, 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
13

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 Bank Insurance
Fund-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 $139,000, or 0.015%, of
its insured deposits for the year ended December 31, 2004.

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.

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

14

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.

ITEM 2. PROPERTIES

OFFICES AND PROPERTIES

The following table sets forth certain information relating to Citizens
Financial's offices at December 31, 2004. In addition, the Bank maintains 31
automated teller machines (ATMs), with 26 of such ATMs at the Bank's branch
offices.

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

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

(3) This full service branch facility located in a local grocery store chain
closed on January 22, 2005.

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

(5) Operations Center.

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

16

$26.0 million of remaining supervisory goodwill. Even excluding supervisory
goodwill, however, the Bank exceeded the capital requirements of FIRREA at such
date. As of January 1, 1994, the Bank adopted Financial Accounting Standards
Board (FASB) Statement No. 72, Accounting for Certain Acquisitions of Banking or
Thrift Institutions. Upon the adoption of this change in accounting principle,
the Bank wrote down the remaining balance of the goodwill.

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 was
filed 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 damages case went to trial in June 2004 and concluded in
early July 2004.

The Bank sought damages of more than $20.0 million based on the report and
testimony of its expert witness. The Government's position was that the Bank
suffered no compensable damage as a result of the breach. On March 7, 2005, the
Court of Claims' judge entered judgment in favor of the Government holding that
the Bank was not entitled to recover any damages. The Court of Claims also ruled
that the Government is entitled to recover certain costs from the Bank with
respect to one claim that the Bank had voluntarily dismissed during the
proceeding. At this time, the Company has no information regarding the amount of
cost that the Government may seek to recover from the Bank. Management of the
Company is currently reviewing its options and has 60 days from the date of the
trial court's decision in which to file an appeal. The Bank's cost, including
attorneys' fees, experts' fees, and related expenses of the litigation was
approximately $1.4 million, $183,000 and $258,000 in 2004, 2003 and 2002,
respectively.

The Bank is also in litigation to foreclose on its loans made to a golf
course. The loans total $2.2 million. As a result of the Bank's foreclosure
proceedings, the current owners of the property have attempted to avoid the
foreclosure and collection on the debt and have further counterclaimed for
damages, due to the Bank's alleged bad faith and breach of an alleged oral
agreement with current ownership. While the Bank believes these claims to be
without merit, the loss to the Bank could be substantial in the event the
borrowers prevail on their counterclaim. At this stage, the opposing party has
not made a formal demand for a specific amount of damages. Thus, the Bank cannot
with any certainty determine the total amount at risk or what the amount of any
potential loss might be.

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.

17

PART II.

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES

(a) The Company's common stock is traded on the NASDAQ National Market
under the symbol "CITZ". As of December 31, 2004, there were 12,385,322 shares
of common stock outstanding which was held by 2,285 stockholders of record. The
following table sets forth the quarterly share price and dividends paid per
share during each quarter of 2004 and 2003.

The information for equity compensation plans is incorporated by reference
from Item 12 of this Form 10-K.

(b) Not applicable.

(c) During the fourth quarter of 2004, the Company did not repurchase any
shares of its common stock.

ITEM 6. SELECTED FINANCIAL DATA

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(1) The Company's efficiency ratio is a percentage of non-interest expense to
the sum of net interest income and non-interest income excluding gains or
losses on the sale of securities and assets.

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

OVERVIEW

During the fourth quarter of 2004, the Company restructured certain of its
FHLB borrowings to reduce interest costs in future years, shorten the duration
of its liabilities, reduce repricing risk, and eliminate the callable feature.
In the debt restructuring, the Company prepaid $400.0 million of its callable
fixed-rate borrowings and replaced that debt with $325.0 million of new
non-callable FHLB borrowings. The Company structured the transaction in a manner
it initially believed, based on its analysis and discussions with the Company's
independent registered public accounting firm, would allow for extinguishment of
debt accounting pursuant to Emerging Issues Task Force No. 96-19, Debtor's
Accounting for a Modification or Exchange of Debt Instruments (EITF 96-19).
Extinguishment of debt accounting would have resulted in the recognition of
$42.0 million in prepayment penalties associated with the restructuring in the
fourth quarter of 2004 as a charge to non-interest expense and significantly
reduced the Company's interest expense in future periods. Subsequent to December
31, 2004, it was determined that the technical requirements for extinguishment
of debt accounting of EITF 96-19 were not satisfied. As a result, the Company
recognized $9.8 million on the early extinguishment of debt as a charge to
non-interest expense during the fourth quarter of 2004 and deferred the
remaining $32.2 million prepayment penalty in accordance with EITF 96-19. During
the fourth quarter of 2004, the Company amortized as an adjustment to the cost
of the new borrowings $2.1 million of interest expense. The remaining $30.1
million of prepayment penalties as of December 31, 2004 will be

20

recognized in interest expense as an adjustment to the cost of the Company's
borrowings in future periods. The increase in interest expense related to the
remaining prepayment penalties is expected to be $14.4 million, $9.6 million,
$4.5 million, $1.5 million and $200,000 in the years ended December 31, 2005,
2006, 2007, 2008 and 2009, respectively. Although the accounting for this
transaction under EITF 96-19 did not allow the Company to reduce its interest
costs immediately, the Company anticipates the restructuring will have a
positive overall effect in future periods by, among other things, improving the
Company's interest rate risk profile.

During the year ended December 31, 2004, the financial services industry
continued to be impacted by the low interest rate environment. The Company was
able to make strides in increasing its net interest margin by effectively
managing its cost of deposits and redeploying certain lower yielding
interest-earning assets into higher yielding loans. The Company's net interest
income before the provision for losses on loans improved during 2004 to $30.1
million compared to $27.7 million for 2003, an increase of 8.6%. The Company's
net interest margin increased 13.9% to 2.13% for the year ended December 31,
2004 from 1.87% for 2003.

As discussed below, the composition of the Company's loan portfolio has
changed significantly in recent years. The amounts of the Company's commercial
real estate, construction and land development and commercial and industrial
loans have become the predominant types of loans in the Company's loan
portfolio. These types of loans amounted to 60.7%, in the aggregate, of the
total loan portfolio at December 31, 2004 compared to 28.0% at December 31,
2000. See "Changes in Financial Position -- Loan Portfolio Composition" in this
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" below. Commercial loans are generally deemed to involve a greater
degree of risk than single-family residential mortgage loans. During the year
ended December 31, 2004, the Company's charge-offs of commercial real estate,
construction and land development and commercial and industrial loans amounted
to $5.7 million in the aggregate, or 92.2% of total charge-offs for the year.
While the company believes the amount of its allowance for losses on loans at
December 31, 2004 is appropriate, no assurance can be given that additional
charge-offs and or provisions to the allowance for losses on loans may not be
required in the future.

The Company increased its provision for losses on loans by $6.6 million in
2004 compared to 2003, primarily as a result of increased impairment allocations
related to eight loans. In addition, the Company's financial results for 2004
were also adversely impacted by the following:

- legal expenses of $1.4 million related to the Company's goodwill
litigation;

- a $1.0 million impairment of a trust preferred security deemed to be
other than temporarily impaired during the year;

- the write-down of $421,000 in viatical receivables held by the Bank that
were determined to be impaired; and

- an increase in loan collection expenses of $300,000 compared to 2003.

The Company also incurred an additional $1.0 million in compensation
expense related to the resignation of a senior executive officer. This increase,
however, was partially offset by an overall decrease of $1.1 million in pension
related expenses during 2004 as compared to 2003.

CRITICAL ACCOUNTING POLICIES

The Company's consolidated financial statements are prepared in accordance
with U.S. generally accepted accounting principles, which require the Company to
establish various accounting policies. Certain of these accounting policies
require management to make estimates, judgments or assumptions that could have a
material effect on the carrying value of certain assets and liabilities. The
judgments and assumptions used by management are based on historical experience,
projected results, internal cash flow modeling techniques and other factors
which management believes are reasonable under the circumstances.

The Company's significant accounting policies are presented in Note 1 to
the consolidated financial statements included in Item 8 of this Annual Report
on Form 10-K. These policies along with the disclosures
21

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 Company maintains an allowance for
losses on loans at a level management believes is sufficient to absorb credit
losses inherent in the loan portfolio. The allowance for losses on loans
represents the Company's estimate of probable incurred losses in the loan
portfolio at each balance sheet date and is based on the review of available and
relevant information.

One component of the allowance for losses on loans contains allocations for
probable inherent but undetected losses within various pools of loans with
similar characteristics pursuant to Statement of Financial Accounting Standards
No. (SFAS) 5, Accounting for Contingencies. This component is based in part on
certain loss factors applied to various loan pools as stratified by the Company.
In determining the appropriate loss factors for these loan pools, management
considers historical charge-offs and recoveries; levels of and trends in
delinquencies, impaired loans and other classified loans; concentrations of
credit within the commercial loan portfolios; volume and type of lending; and
current and anticipated economic conditions.

The second component of the allowance for losses on loans contains
allocations for probable losses that have been identified relating to specific
borrowing relationships pursuant to SFAS 114, Accounting by Creditors for
Impairment of a Loan. This component of the allowance for losses on loans
consists of expected losses resulting in specific credit allocations for
individual loans not considered within the above mentioned loan pools. The
analysis on each loan involves a high degree of judgment in estimating the
amount of the loss associated with the loan, including the estimation of the
amount and timing of future cash flows and collateral values.

Loan losses are charged off against the allowance, while recoveries of
amounts previously charged off are credited to the allowance. The Company
assesses the adequacy of the allowance for losses on loans on a quarterly basis
and adjusts the allowance for losses on loans by recording a provision for
losses on loans in an amount sufficient to maintain the allowance at an
appropriate level. The evaluation of the adequacy of the allowance for losses on
loans is inherently subjective as it requires estimates that are susceptible to
significant revision as more information becomes available or as future events
occur. To the extent that actual outcomes differ from management estimates, an
additional provision for losses on loans could be required that could adversely
affect earnings or the Company's financial position in future periods. In
addition, various regulatory agencies, as an integral part of their examination
processes, periodically review the provision for losses on loans for Citizens
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.

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.

22

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(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 are based on historical costs.

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

23

RATE/VOLUME ANALYSIS

The following table details 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 (changes in volume multiplied by prior rate); and (iii)
changes in rate/volume (changes in rate multiplied by changes in volume).

RESULTS OF OPERATIONS

YEAR ENDED DECEMBER 31, 2004 COMPARED TO YEAR ENDED DECEMBER 31, 2003

Net Income. The Company recognized a net loss for the year ended December
31, 2004 of $6.6 million, or a $0.57 loss per share, compared to net income of
$3.5 million, or $0.30 per diluted share ($0.31 per basic share), for the year
ended December 31, 2003. The net loss was primarily a result of a $9.8 million
charge to non-interest expense related to the Company's $400.0 million debt
restructure which occurred during the fourth quarter of 2004 and an increase in
the provision for losses on loans to $8.9 million from $2.3 million for the year
ended December 31, 2003.

Also adversely impacting the Company's results for the year ended December
31, 2004 were the following:

- legal expenses of $1.4 million related to the Company's goodwill
litigation;

- a $1.0 million impairment of a trust preferred security deemed to be
other than temporarily impaired during the year;

24

- the write-down of $421,000 in viatical receivables held by the Bank that
were determined to be impaired; and

- an increase in loan collection expenses of $300,000 compared to 2003.

The Company also incurred an additional $1.0 million in compensation
expense related to the resignation of a senior executive officer. However, this
increase was partially offset by an overall decrease of $1.1 million in pension
related expenses during 2004 as compared to 2003.

Net Interest Income. Net interest income before the provision for losses
on loans is the principal source of earnings for the Company and consists of
interest income received on loans and investment securities less interest
expense paid 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.

The Company's net interest margin, which is net interest income as a
percentage of average interest-earning assets, for the year ended 2004 improved
13.9% to 2.13% from 1.87% for 2003. The Company's net interest income before the
provision for losses on loans for the year ended December 31, 2004 totaled $30.1
million and represented an 8.6% increase from $27.7 million for the year ended
December 31, 2003. The increase in the net interest income and the net interest
margin for the year was mainly the result of effective management of the cost of
deposits combined with the redeployment of lower yielding other interest-earning
assets into higher yielding loans. Although the Company refinanced its FHLB debt
at lower fixed-rates, the amortization of a portion of the prepayment penalties
negatively impacted the net interest margin for the year ended December 31,
2004. The Company expects the net interest margin to continue to be adversely
impacted as a direct result of the amortization through interest expense of the
remaining prepayment penalty during 2005 and in future years.

Interest Income. The Company reported total interest income of $69.0
million for the year ended December 31, 2004 compared to $71.4 million for the
year ended December 31, 2003. The decrease was primarily due to a 4.9% decrease
in average interest-earning assets during 2004 from 2003 which was partially
offset by a slight increase of 8 basis points in the yield of average
interest-earning assets. The Company was able to redeploy certain lower yielding
interest-earning assets into higher yielding loans throughout 2004 as well as
use some of the repayments received on lower yielding assets to prepay a portion
of its FHLB borrowings.

During the year ended December 31, 2004 compared to the previous year, the
Company's average loan balances increased $33.3 million or 3.5% while the
average balance of the Company's other interest-earning assets (including the
Company's money market accounts, federal funds sold and interest-bearing bank
deposits) decreased $107.6 million or 60.0%.

Interest Expense. During 2004, the Company proactively managed its cost of
interest-bearing deposits and borrowings and reduced interest expense by $4.8
million or 10.9% as compared to 2003. Total interest expense amounted to $38.9
million for the year ended December 31, 2004 compared to $43.7 million for the
year ended December 31, 2003. Interest expense on deposits decreased 25.7% to
$12.8 million during 2004 from 2003 primarily as a result of a 42 basis point
reduction in the average rate paid on total deposits coupled with a $47.4
million decrease in the average balance of total deposits. The Company continues
to focus on increasing core deposits as a means of managing its total cost of
deposits.

Interest expense on borrowings during 2004 decreased by $343,000 from 2003
primarily as a result of the overall lower average level of debt during 2004.
Included in interest expense in 2004 is the amortization of $2.1 million in
prepayment penalties recognized as a result of the debt restructuring completed
in the fourth quarter of 2004. The Company expects that the fourth quarter
restructuring of the FHLB advances will continue to impact interest expense as
the remaining prepayment penalties are amortized as an adjustment to the cost of
the new borrowings. Additional interest expense related to the amortization of
the remaining prepayment penalties is expected to be $14.4 million, $9.6
million, $4.5 million, $1.5 million and $200,000 in the years ended December 31,
2005, 2006, 2007, 2008 and 2009, respectively.

25

Provision for Losses on Loans. The Company's provision for losses on loans
was $8.9 million for the year ended December 31, 2004 compared to $2.3 million
in 2003. The $6.6 million increase in the provision was mainly the result of the
Company's increased impairment allocation for impaired loans coupled with an
increase in the amount of loan charge-offs during 2004.

During 2004, the Company identified eight impaired loans with a total
aggregate balance of $31.9 million. The aggregate required impairment allocation
was $10.3 million, an increase from the previous allocation of $3.8 million for
these loans. Each of these eight loans was reviewed for impairment based upon
updated information received in conjunction with its overall evaluation of the
adequacy of the allowance for losses on loans. This updated information
identified either a change in the borrower's ability to perform their loan
obligations or in the estimated value of the collateral. See additional
information regarding the increases in the provision included in the "Allowance
for Losses on Loans" section below in this "Management's Discussion and Analysis
of Financial Condition and Results of Operations" section.

Non-Interest Income. The Company's service charges and other fees
increased by $615,000 or 8.9% for the full year of 2004 compared to 2003. The
increases were primarily related to service charges generated by the Company's
Overdraft Protection Privilege product provided to both retail and business
customers. In 2004, the Company was able to realize a full year of income
related to its Business Overdraft Privilege which was introduced in July 2003.
The Company also increased the number of non-interest bearing checking accounts
by approximately 15% since December 31, 2003 which added to the increase in
service charges and other fees on deposit accounts. During the fourth quarter of
2004, the Company also realized a $220,000 gain on the sale of land and an
office building. Prior to the sale, the building was leased to a company that
acquired the assets of the CFS Insurance Agency, Inc. in November 2002.

The improvements in service charges and other fees in the 2004 periods were
more than offset by changes in the amount of net realized gains on sales of
securities and losses realized in the cost basis of one impaired security in
2004 compared to 2003. Net realized gains on sales of securities were $719,000
for the year ended December 31, 2004 compared to $1.9 million for 2003. During
2004, the Company also recorded an impairment write-down of $1.0 million related
to the other than temporary impairment of one trust preferred security that had
an original cost basis of $1.1 million.

Non-Interest Expense. The Company's non-interest expense for the year
ended December 31, 2004 totaled $46.6 million compared to $34.0 million for the
year ended December 31, 2003. The majority of this increase relates to the $9.8
million of prepayment penalties that were expensed during 2004 as part of the
Company's restructuring of its FHLB borrowings.

Exclusive of the prepayment penalties, the most significant changes in the
Company's non-interest expense in 2004 compared to 2003 were in professional
fees, which increased $991,000; data processing costs, which increased $477,000;
and other general and administrative expenses, which increased $784,000. The
increase in professional fees was due primarily to $1.4 million of legal
expenses incurred during 2004 in connection with the Company's goodwill case
that went to trial during the year. The increased data processing charges
related to the conversion to a new processor. The increase in other general and
administrative costs was primarily due to charges relating to the write-down of
the carrying value of certain viatical receivables by $421,000 to $537,000. An
increase in loan collection expense of $300,000 was also a factor in the
increase in other general and administrative costs. The Company also incurred
$1.0 million of compensation expense relating to the resignation of a senior
executive officer during 2004. This increase in compensation expense was
partially offset by a $1.1 million decrease in pension expense for 2004 as
compared to 2003.

Income Tax Expense. The Company's income tax benefit for the year ended
December 31, 2004 totaled $7.2 million. The recognition during the year ended
December 31, 2004 of income tax benefits was a significant change from the
income tax expense incurred during 2003. The significant shift from income tax
expense to income tax benefits during 2004 was the result of the pre-tax losses
combined with the application of available tax credits, the effects of permanent
tax differences on the Company's pre-tax earnings and the reversal of tax
accruals no longer considered necessary. The available tax credits and permanent
tax differences are expected to have a favorable impact on income tax expense
throughout 2005.

26

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 which
prevailed throughout 2003 caused 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 17.5% from the year ended December 31, 2002.

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. The Company's average interest rate spread was 1.56%
and 1.88% for the years ended December 31, 2003 and 2002, respectively. The
Company's net interest margin was 1.87% and 2.22% during the years ended
December 31, 2003 and 2002, respectively.

The Company's net interest income for the year ended December 31, 2003
totaled $27.7 million and represented a $5.9 million decrease from $33.6 million
for the year ended December 31, 2002. The decrease in net interest income in
2003 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 $71.4
million for the year ended December 31, 2003 compared to $86.7 million for the
year ended December 31, 2002. The $15.3 million or 17.6% decrease was primarily
due to a $31.6 million decrease in average interest-earning assets as well as a
decrease in the average yield on interest-earning assets of 91 basis points for
the year ended December 31, 2003 as compared to 2002.

The average balances of 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
low interest rate environment during 2003, the Company 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 $50.7 million or 5.5% while the
average balance of the Company's securities portfolio decreased $72.0 million or
18.8%.

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 core 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
an 86 basis point reduction in the average rate paid on interest-bearing
deposits coupled with a $22.3 million decrease in the average balance of
interest-bearing 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 was 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.

27

Non-Interest Income. The Company reported non-interest income of $12.8
million for the year ended December 31, 2003 compared to $12.2 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 service charges and other fees, and

- $1.6 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 the sale of the Company's insurance agency that were realized during 2002.

The increase in service charges and other fees during 2003 was mainly
realized from the Company's popular Overdraft Protection Privilege offered to
both retail and business checking customers.

The Company also realized $651,000 of commission income during 2003, which
was 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.

Non-Interest Expense. The Company reported non-interest expense of $34.0
million for the year ended December 31, 2003 compared to $33.7 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 through March
2003.

Professional fees were $1.8 million for the year ended December 31, 2003
compared to $1.3 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,

- improve the processing and underwriting for the Company's Home Equity
Lines of Credit (HELOC) program and implementation of our HELOC equity
access card, and

- implement new software designed to streamline and enhance the processing
and underwriting of retail loans.

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.

CHANGES IN FINANCIAL CONDITION

General. During the year ended December 31, 2004, the Company's total
assets decreased by $254.6 million to $1.31 billion from $1.57 billion at
December 31, 2003. The significant changes in the composition of the Company's
balance sheet during the year ended December 31, 2004 include a:

- net decrease in cash and cash equivalents of $139.7 million,

- net decrease in securities of $124.1 million,

28

- net decrease in total deposits of $115.3 million, and

- net decrease in FHLB borrowings of $131.9 million.

The decrease in total assets was a direct result of a decrease in
certificates of deposit and FHLB borrowings. During 2004, certificates of
deposit decreased $145.9 million due to managed runoff of above market rate
certificates as they reached maturity. Partially offsetting the decrease in
certificates was an increase in core deposits of $30.6 million. The Company has
continued to focus on obtaining lower costing core deposits through its
promotional efforts and retail incentive programs.

During 2004, the Bank repaid $406.5 million of fixed-rate FHLB borrowings,
of which $400.0 million was repaid and replaced with $325.0 million of new FHLB
borrowings during the fourth quarter of 2004. Subsequent to the debt
restructuring, an additional $20.0 million was repaid by the Company during the
fourth quarter of 2004. The Company incurred $42.0 million of prepayment
penalties related to the debt restructuring, of which, $32.2 million is being
deferred as an adjustment to the carrying value of the total debt outstanding
and will be recognized in interest expense as an adjustment to the cost of the
borrowings over their remaining life. See further discussions related to these
transactions in the "Borrowed Funds" section below in this "Management's
Discussion and Analysis of Financial Condition and Results of Operations."

Loan Portfolio Composition. The following table sets forth the composition
of the Bank's loans receivable, net of unearned fees, and the percentage of
loans by category as of the dates indicated.

During the year ended December 31, 2004, the Company originated over $50.0
million of new loans within its commercial real estate portfolio which were more
than offset by loan repayments, charge-offs and transfers to other real estate
owned. The Company purchased total commercial real estate participations of $3.6
million which was more than offset by $9.1 million of commercial real estate
participations sold. The Company's construction and land development loan
portfolio increased as a result of over $129.0 million of originations and $47.0
million of participations purchased. The Company's construction and land
development loans had $87.6 million of available credit under construction loans
and land development lines of credit as of December 31, 2004. The Company's
commercial and industrial loan portfolio also increased due to new fundings of
over $21.0 million and participations purchased of $22.5 million. Both the
construction and land development and the commercial and industrial loan
portfolios were also impacted by principal repayments.

29

During 2004, the Company's single-family residential loan portfolio
continued to decline as repayments more than offset new originations of over
$29.0 million. The Bank also sold $13.2 million of fixed-rate single-family
residential mortgage loans with servicing released during 2004. The continued
decline in single-family residential loans since 2001 in each of the last three
years is primarily due to the high levels of refinancing and prepayments
experienced throughout the industry. Given the lower interest rate environment
during the past three years, the Company focused on originating more
variable-rate products, including HELOCs. Total HELOCs originated during 2004
were over $86.0 million and were partially offset by repayments. As of December
31, 2004, the Company had $70.3 million in unused HELOCs. The Company's other
loans consist mainly of $6.7 million in participations purchased for indirect
auto loans during 2004 which were offset by repayments on all consumer loans.

As reflected in the preceding table, the Company's portfolio of commercial
real estate loans has increased significantly in recent years. At December 31,
2004, these loans represented 40.1% of the company's total loan portfolio. In
addition, the Company's construction and land development loans and commercial
and industrial loans have increased and, at December 31, 2004, represented 14.7%
and 5.9%, respectively, of the Company's total loan portfolio. These types of
commercial loans are all generally deemed to have a higher degree of risk than
single-family residential mortgage loans because repayment of the loans often
depends on the successful operation of the project or business or the successful
completion of the construction project. Local and general economic conditions,
supply and demand, the abilities of the borrower to manage the creditor's
operations, and many other factors, affect the borrower's ability to repay.

Included in the Company's commercial and construction loan portfolio is an
aggregate of $122.9 million or 12.4% of the Company's total loan portfolio, of
loans to the hotel and motel industry. The Company has no other concentrations
of loans to any industry exceeding 10% of its total loan portfolio. The hotel
and motel business is very competitive and the success of the hotel and motel
operators and their ability to repay loans is dependent on local and general
economic conditions among other factors. See further discussions related to the
Company's commercial and construction portfolio charge-offs and non-performing
assets in the "Allowance for Losses on Loans" and the "Non-Performing Assets"
sections below in this "Management's Discussion and Analysis of Financial
Condition and Results of Operations."

Contractual Principal Repayments and Interest Rates. The following table
sets forth scheduled contractual amortization of the Bank's loans at December
31, 2004, 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 scheduled repayments and no stated maturity, and
overdraft loans are reported as due in one year or less.

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

(1) Gross loans receivable does not include deferred fees of $2.5 million as of
December 31, 2004.

(2) Of the $873.7 million of loan principal repayments contractually due after
December 31, 2005, $222.0 million have fixed interest rates and $651.7
million have variable interest rates which reprice from one month up to five
years.

30

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.

ALLOWANCE FOR LOSSES ON LOANS

The allowance for losses on loans is maintained at a level believed
adequate by management to absorb estimated probable loan losses. Management's
periodic evaluation of the adequacy of the allowance is based on the Company's
past loan loss experience, known and inherent losses in the portfolio,
evaluations of real estate collateral, composition of the loan portfolio,
current economic conditions and levels of non-performing and other classified
loans. Loans which are determined to be uncollectible are charged off against
the allowance for losses on loans and recoveries of loans that were previously
charged off are credited to the allowance. See further analysis in the "Critical
Accounting Policies" previously discussed in this "Management's Discussion and
Analysis of Financial Condition and Results of Operations" as well as Note 1 to
the consolidated financial statements.

The Company's charge-off policy varies with respect to the category of and
specific circumstances surrounding each loan under consideration. The Company
records charge-offs on the basis of management's ongoing evaluation of
collectibility.

As of December 31, 2004, the Bank's allowance for losses on loans amounted
to $13.4 million or 48.25% and 1.35% of the Bank's non-performing loans and
total loans receivable, respectively. The Bank's provision for losses on loans
amounted to $8.9 million for the year ended December 31, 2004 and $2.3 million
for 2003. Management of the Company believes that, as of December 31, 2004, the
allowance for losses on loans was adequate.

As of December 31, 2004, the Company had eight impaired loans with
aggregate outstanding balances of $25.1 million with impairment allocation
related to these loans of $6.4 million. Six of the impaired loans are commercial
real estate loans, of which three are secured by hotels and total $20.5 million
with aggregate impairment allocations of $4.1 million. The other three impaired
commercial real estate loans are secured by a golf course and total $3.5 million
with an impairment allocation of $1.5 million. The two remaining impaired loans
are commercial loans, of which one is secured by business assets and the other
by improved land. These two loans total $1.2 million with an aggregate
impairment allocation of $751,000.

31

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

Net charge-offs for 2004 totaled $6.0 million, or 0.6% of average loans
outstanding, as compared to $594,000 or 0.06% of average loans outstanding for
2003. Gross charge-offs in 2004 of $6.2 million relate primarily to commercial
loans and include a:

- $1.8 million charge-off during the second quarter of 2004 on a $4.5
million commercial real estate loan secured by a motel prior to this loan
being transferred to other real estate owned and sold for $2.7 million
during the same quarter;

- $1.7 million partial charge-off during the fourth quarter of 2004 on a
loan secured by a hotel in the Chicago metropolitan area; and

32

- $1.2 million partial charge-off during the fourth quarter of 2004 on a
commercial construction loan secured by an apartment complex.

Both of these loans with partial charge-offs are non-performing loans. See
additional disclosure related to these loans within the "Non-Performing Assets"
section of this "Management's Discussion and Analysis of Financial Condition and
Results of Operations" section.

Allocation of the Allowance for Losses on Loans. The Bank allocates its
allowance for losses on loans by loan category. Various percentages are assigned
to the loan categories based on their historical loss factors and management's
analysis of their relative risks. The following table shows the allocation of
the allowance for losses on loans by loan type for each of the last five years:

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. Late charges are
generally assessed after 15 days with additional efforts being 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 other 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). 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.

33

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 contains information on loans that are 60 to 89 days delinquent.
For the periods presented, the Bank had no loans earning interest that are
greater than 90 days delinquent.

34

Non-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 at any of the
below-referenced dates.

During 2004, the non-performing commercial real estate loans increased from
December 31, 2003 primarily as a result of the following:

- One loan totaling $8.8 million as of December 31, 2004 secured by a hotel
in Michigan and was transferred to non-accrual status during the third
quarter of 2004. As of December 31, 2004, this loan was considered an
impaired loan with an estimated impairment allocation of $811,000. During
December 2004, Bank management negotiated a forbearance agreement to
obtain additional collateral of a total of 15 acres of land along with
the borrower's hiring a hotel consultant to assist with the hotel's
operation.

- One loan totaling $8.7 million secured by a hotel in the Chicago
metropolitan area was transferred to non-accrual during the second
quarter of 2004 and was subsequently written-down through an impairment
allocation to a balance of $7.0 million as of December 31, 2004. The loan
was still considered impaired and has a remaining estimated impairment
allocation of $1.8 million as of December 31, 2004. During December 2004,
Bank management negotiated a forbearance agreement extending the maturity
of the loan through May 2005 when the loan is required to be paid off. In
conjunction with the forbearance agreement, the borrower placed the title
of the property in escrow. The borrowers have the opportunity for a 120
day extension if they pay additional funds on the loan. Should the loan
not be paid off at maturity under the terms of the forbearance agreement,
the title to the property is to be transferred to the Bank. During the
first quarter of 2005, the borrowers filed for reorganization under
Chapter 11 of the Bankruptcy Code.

35

- Two loans totaling $2.2 million were transferred to non-accrual status
during the second quarter of 2004. These loans are secured by a golf
course in Indiana. The Bank has filed a foreclosure action; however, the
current owners have filed a countersuit against the Bank. See "Legal
Proceedings" for more details. Based on the collateral values, the
Company believes there is little risk of loss related to the outstanding
balance of these loans as of December 31, 2004.

Partially offsetting the above increases in non-performing commercial real
estate loans, the Bank foreclosed on and transferred a $2.7 million motel loan
to other real estate owned prior to it being sold for $2.7 million during the
second quarter of 2004. Also, the Bank received the full payoff during the
second quarter of 2004 of a $3.8 million loan secured by a strip mall that was
transferred to non-performing status during the fourth quarter of 2003.

The decrease in non-performing loans related to construction and land
development related to the full payoff of two loans totaling $3.5 million in the
aggregate and the $1.2 million partial charge-off of a non-performing commercial
construction loan secured by an apartment complex. The amount charged off on
this loan was equal to the impairment allocation identified at the end of the
third quarter of 2004.

The interest income that would have been recorded during the year ended
December 31, 2004, 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
$1.8 million. The actual amount of interest recorded as income (on a cash basis)
on such loans during the period amounted to $357,000.

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, 2004, the Bank had an aggregate of $41.9 million of
classified assets, 81% of which were classified substandard and 19% of which
were classified as doubtful, compared to $43.0 million of classified assets as
of December 31, 2003.

SECURITIES

As of December 31, 2003, all of the Company's investment securities were
classified as available-for-sale. 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.

36

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 GSE securities at December 31, 2002 were callable
securities. The Company held no callable GSE securities at December 31, 2004
or December 31, 2003. The Company also held no commercial paper at December
31, 2004.

The decrease in total securities from December 31, 2003 to December 31,
2004 was primarily a result of the Company selling approximately $60.0 million
of securities available-for-sale during the fourth quarter of 2004 in
conjunction with the restructuring of its FHLB debt in order to fund the
prepayment penalties incurred in the restructuring. The remainder of the decline
related to the sale of securities during the second quarter of 2004 as the
Company took advantage of a steep yield curve to reposition its investment
portfolio.

During 2004, management identified one impaired trust preferred security.
Write-downs to fair value of $1.0 million were made during 2004 when the issuer
first deferred an interest payment during the second quarter of 2004 and again
when the issuer announced the continuation of interest deferral on the trust
preferred securities coupled with the sale of a significant portion of the
issuer's assets, continuing restructuring objectives, and regulatory
restrictions on the issuer. As of December 31, 2004, the new carrying value of
this trust preferred security was $90,000, which was equal to its market value.

Management does not believe any remaining individual unrealized loss as of
December 31, 2004 represents an other-than-temporary (OTT) impairment. The
unrealized losses reported for agency securities, mortgage-backed securities and
collateralized mortgage obligations are, in their entirety, on securities issued
by the federal government, its agencies or GSEs, including the Federal National
Mortgage Association (FNMA), the Federal Home Loan Mortgage Corporation (Freddie
Mac) and the Government National Mortgage Association (GNMA), and in
management's belief, are attributable to changes in interest rates and the
resultant change in the shape of the yield curve. The unrealized losses
associated with equity securities relate to one issuance. Management believes
that the unrealized loss is specifically related to the changes in interest
rates and the resultant change in the shape of the yield curve.

37

The following table sets forth certain information regarding the maturities
and weighted average yield of the Company's securities as of December 31, 2004.
The amounts listed in the table are based on carrying value and the yield is
calculated based on amortized cost.

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

(1) The Company's mortgage-backed securities and collateralized mortgage
obligations are amortizing in nature. As such, the maturities presented in
the table for these securities are based on historical and estimated
prepayment rates for the underlying mortgage collateral. The estimated
average lives may differ from actual principal cash flows since cash flows
include prepayments and scheduled principal amortization.

(2) Security is impaired; therefore, the Company has not calculated a related
yield.

(3) Other securities include equity securities which have no stated maturity
date and are not included in the average months to maturity.

DEPOSITS

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

Total deposits at December 31, 2004 decreased from total deposits at
December 31, 2003 primarily due to a decrease of certificates of deposit of
$145.9 million in the aggregate which was primarily a result of managed runoff
of above-market-rate certificates as they reached maturity. The majority of
these certificates

38

were originated during 2003 when the Company offered above-market-rate
short-term certificates on new money deposits to attract new customers. While
the Company did not offer similar promotions during 2004, it may continue to use
these types of promotions from time to time to build its customer base.

Partially offsetting the decrease in certificates of deposit during 2004
was an increase in core deposits of $30.6 million. The Company continues to
manage its interest expense on deposits by effectively managing the cost of its
deposits and by focusing on obtaining low cost core deposits through promotional
efforts and retail incentive programs.

The following table sets forth the amount and remaining maturities of the
Bank's certificates of deposit at December 31, 2004.

As of December 31, 2004, the aggregate amount of outstanding time
certificates of deposit in amounts greater than or equal to $100,000 was $90.6
million. The following table presents the maturity of these time certificates of
deposit.

39

BORROWED FUNDS

A summary of the Company's borrowed funds at December 31, 2004 and 2003 is
as follows:

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

(1) These advances are amortizing borrowings and are listed by their contractual
maturity.

During the third quarter of 2004, the Company repaid $6.5 million of
advances maturing in 2008 which bore a 5.26% fixed interest rate and recognized
a $485,000 charge to other non-interest expense. During the fourth quarter of
2004, the Company repaid $400.0 million of callable fixed-rate advances with an
average cost of 5.92% and an average remaining term of 64.2 months. These
prepaid advances were replaced with $325.0 million of new non-callable FHLB
advances. These new advances included an aggregate $271.0 million of
non-callable fixed-rate FHLB advances with an average cost of 3.64% and an
average term of 34.3 months in a laddered portfolio with maturities ranging from
21 to 60 months. The new borrowings also included $54.0 million of short-term
variable-rate borrowings, of which, $20.0 million was repaid on December 31,
2004.

The Company paid $42.0 million of prepayment penalties related to the
prepaid advances and recognized $9.8 million on the early extinguishment of debt
as a charge to non-interest expense during the fourth quarter of 2004. The
remaining $32.2 million of prepayment penalties is being deferred as an
adjustment to the carrying value of the borrowings and will be recognized in
interest expense as an adjustment to the cost of the new borrowings over their
remaining life. The increase in interest expense related to the remaining
prepayment penalties is expected to be $14.4 million, $9.6 million, $4.5
million, $1.5 million and $200,000 in the years ended December 31, 2005, 2006,
2007, 2008 and 2009, respectively.

CAPITAL RESOURCES

Stockholders' equity at December 31, 2004 was $147.9 million as compared to
$156.0 million at December 31, 2003. The decrease was primarily due to a:

40

- $6.6 million net loss;

- $1.3 million increase in unrealized losses on available-for-sale
securities, net of tax;

- $4.9 million declaration of cash dividends during 2004; and

- $869,000 of repurchases of the Company's common stock during 2004.

Partially offsetting the above decreases in stockholders' equity, the Company
also realized during 2004:

- $1.4 million of common stock that vested under the Company's Recognition
and Retention Plan;

- $1.7 million of shares earned under the Company's Employee Stock
Ownership Plan; and

- $2.3 million of stock option exercises.

For the year ended December 31, 2004, the Company repurchased 61,713 shares
of its common stock at an average price of $14.08 per share pursuant to the
share repurchase program announced in March 2003. Since its initial public
offering in 1998, the Company has repurchased an aggregate of 11,592,616 shares
of its common stock at an average price of $11.75 per share. As of December 31,
2004, the Company has 1,180,156 of shares remaining to be repurchased under its
current share repurchase program.

At December 31, 2004, the Bank was deemed to be well capitalized based on
its internal calculations with tangible and core regulatory capital ratios of
9.24% and a risk-based capital ratio of 12.23%.

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-related
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 and other corporate funding requirements.

At December 31, 2004, the Company had cash and cash equivalents of $38.1
million which was a decrease of $139.7 million from December 31, 2003. The
decrease was mainly caused by decreases in total deposits and borrowed money of
$115.3 million and $101.7 million, respectively. In addition, the Company
utilized $42.0 million of cash to pay the prepayment penalties associated with
its fourth quarter of 2004 debt restructuring and loan originations, net of
principal payments received, utilized $16.3 million of liquidity. These
decreases were partially offset by a net decrease in securities of $124.1
million.

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 cash and cash equivalents and
dividends from the Bank. Under OTS regulations, without prior approval, the
dividends from
41

the Bank are limited to the extent of the Bank's cumulative earnings for the
year plus the net earnings (adjusted by prior distributions) of the prior two
calendar years. On a parent company-only basis, for the year ended December 31,
2004, the Company received $2.9 million in dividends from the Bank. At December
31, 2004, the parent company had $11.9 million in cash on hand and $337,000 of
securities available-for-sale.

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, 2004, the Bank was deemed well-
capitalized. See Note 12 in the consolidated financial statements for more
information on the Bank's regulatory capital.

Contractual Obligations. The following table presents significant fixed
and determinable contractual obligations to third parties by payment date as of
December 31, 2004.

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

(1) Does not include interest expense at the weighted-average stated rate of
3.55% for the periods presented.

See the "Borrowed Funds" section 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
Note 4 in the consolidated financial statements for further discussion related
to the Company's operating leases.

The Company also has commitments to fund certificates of deposit which are
scheduled to mature within one year or less. These deposits total $264.3 million
at December 31, 2004. Based on historical experience and the fact that these
deposits are at current market rates, 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 third 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.

42

The following table details the amounts and expected maturities of
significant commitments as of December 31, 2004.

The above listed commitments do not necessarily represent future cash
requirements, in that certain of 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 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 had 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 utilized and has no intention of
utilizing 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 accounting principles generally
accepted in the United States, 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. Monetary items, such as cash, loans and
deposits, are those assets and liabilities which are or will be converted into a
fixed number of dollars regardless of changes in prices. As a result, changes in
interest rates generally have a more significant impact on a financial
institution's performance than general inflation. Over short periods of time,
interest rates may not necessarily move in the same direction or in the same
magnitude as inflation.

43

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Bank, like other financial institutions, is subject to interest rate
risk (IRR). This risk relates to changes in market interest rates which could
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, 2004, the Bank had approximately $733.7 million of
adjustable-rate loans in its portfolio. Second, the Bank's securities portfolio
consists of securities that have expected average lives of five years or less at
time of purchase. At December 31, 2004, the modified duration of the securities
portfolio was less than two years. 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, 2004, the Bank had $490.2 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 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 sheets contracts, if any, for compliance
with Board approved tolerance limits.

44

The table below presents, as of December 31, 2004 and 2003, 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 2004 and 2003 in accordance with OTS
regulations. As illustrated in the table, the Bank's NPV in the base case (0
basis point change) increased $23.4 million from $138.2 million at December 31,
2003 to $161.6 million at December 31, 2004. The primary reason for the increase
was a reduction in the effective duration of the Bank's liabilities resulting
from the restructuring of the Company's FHLB advances completed in the fourth
quarter of 2004. See further discussion regarding this restructure in the
"Borrowed Money" section. At December 31, 2004, the Bank's overall sensitivity
to interest rate risk has decreased in each of the assumed change in interest
rate scenarios compared to December 31, 2003.

As modeled above, the Bank's NPV increases nominally with an increase in
interest rates of 100 basis points while the NPV decreases in each of the other
rate scenarios. The relatively small percentage change in the Bank's NPV in each
of the rate scenarios indicates the price sensitivity of the Bank's assets
reasonably matches the price sensitivity of the Bank's liabilities. At December
31, 2004 and December 31, 2003, 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 Company only assets and
liabilities would increase NPV nominally at all levels.

45

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders
CFS Bancorp, Inc.,
Munster, Indiana

We have audited the accompanying consolidated statement of condition of CFS
Bancorp, Inc. as of December 31, 2004, and the related consolidated statements
of income, changes in stockholders' equity, and cash flows for the year then
ended. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit.

We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
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
audit provides a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
CFS Bancorp, Inc. at December 31, 2004, and the results of its operations and
its cash flows for the year then ended, in conformity with U.S. generally
accepted accounting principles.

/s/ Crowe Chizek and Company LLC

Oak Brook, Illinois
March 11, 2005

46

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTANT

Board of Directors and Stockholders
CFS Bancorp, Inc.

We have audited the accompanying consolidated statement of condition of CFS
Bancorp, Inc. (the Company) as of December 31, 2003, and the related
consolidated statements of income, changes in stockholders' equity, and cash
flows for each of the two 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 standards of the Public
Accounting Oversight Board (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 the consolidated results of its operations and
its cash flows for each of the two years in the period ended December 31, 2003,
in conformity with U.S. generally accepted accounting principles.

/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

See accompanying notes.
51

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004

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 (the Bank or Citizens
Financial). 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.

The Company provides financial services through its offices in northwest
Indiana and the suburban areas south of Chicago. Its primary deposit products
are checking, savings and money market accounts as well as certificates of
deposit. Its primary lending products are commercial and construction loans and
retail loans. Substantially all loans are secured by specific items of
collateral including commercial and residential real estate, business assets and
consumer assets. Commercial loans are expected to be repaid from cash flow from
business operations. The customers' ability to repay their loans is dependent on
the general economic conditions in the area and the underlying collateral.

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 one
active subsidiary, CFS Holdings, Ltd. The Bank also has the following inactive
subsidiaries: CFS Insurance Agency, Inc., CFS Investment Services, Inc., and
Suburban Mortgage Services, Inc. All significant intercompany accounts and
transactions have been eliminated in consolidation.

USE OF ESTIMATES

The preparation of the consolidated financial statements in conformity with
U.S. generally accepted accounting principles requires management to make
estimates and assumptions based on available information. These estimates and
assumptions affect the amounts reported in the consolidated financial statements
and the disclosures provided. The allowance for losses on loans and fair values
of financial instruments are particularly subject to change.

CASH FLOWS

Cash and cash equivalents include cash, interest-bearing deposits in other
financial institutions under 90 days, and federal funds sold. Generally, federal
funds sold are purchased and sold for one-day periods. Net cash flows are
reported for customer loan and deposit transactions, interest-bearing deposits
in other financial institutions and federal funds sold.

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 when management has the positive 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 holding gains and losses, net of tax, reported in other comprehensive
income. Other securities such as Federal Home Loan Bank stock are carried at
cost. The Company has no trading account securities.

52

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Interest income includes amortization of purchase premiums or discounts.
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. Gains and losses on sales are recorded on the trade date and determined
using the specific identification method.

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

LOANS

Loans that management has the intent and ability to hold for the
foreseeable future or until maturity or payoff are reported at the principal
balance outstanding, net of unearned interest, deferred loan fees and costs, and
portions charged off. Interest income on loans is accrued on the active unpaid
principal balance. Loans held-for-sale, if any, are carried at the lower of
aggregate cost or market value.

Interest income is not accrued on loans which are delinquent 90 days or
more, or for loans which management believes, after giving consideration to
economic and business conditions and collection efforts, collection of interest
is doubtful. Past due status is based on the contractual terms of the loan. In
all cases, loans are placed on nonaccrual or charged-off at an earlier date if
collection of principal or interest is considered doubtful.

All interest accrued but not received for loans placed on nonaccrual is
reversed against interest income. Interest received on such loans is accounted
for on the cash-basis until qualifying for return to accrual.

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 Company maintains an allowance for losses on loans at a level
management believes is sufficient to absorb credit losses inherent in the loan
portfolio. The allowance for losses on loans represents the Company's estimate
of probable incurred losses in the loan portfolio at each balance sheet date and
is based on the review of available and relevant information.

One component of the allowance for losses on loans contains allocations for
probable inherent but undetected losses within various pools of loans with
similar characteristics pursuant to Statement of Financial Accounting Standards
No. (SFAS) 5, Accounting for Contingencies. This component is based in part on
certain loss factors applied to various loan pools as stratified by the Company.
In determining the appropriate loss factors for these loan pools, management
considers historical charge-offs and recoveries; levels of and trends in
delinquencies, impaired loans and other classified loans; concentrations of
credit within the commercial loan portfolios; volume and type of lending; and
current and anticipated economic conditions.

The second component of the allowance for losses on loans contains
allocations for probable losses that have been identified relating to specific
borrowing relationships pursuant to SFAS 114, Accounting by Creditors for
Impairment of a Loan. This component of the allowance for losses on loans
consists of expected losses resulting in specific credit allocations for
individual loans not considered within the above mentioned

53

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

loan pools. The analysis on each loan involves a high degree of judgment in
estimating the amount of the loss associated with the loan, including the
estimation of the amount and timing of future cash flows and collateral values.

Loan losses are charged off against the allowance, while recoveries of
amounts previously charged off are credited to the allowance. The Company
assesses the adequacy of the allowance for losses on loans on a quarterly basis
and adjusts the allowance for losses on loans by recording a provision for
losses on loans in an amount sufficient to maintain the allowance at an
appropriate level. The evaluation of the adequacy of the allowance for losses on
loans is inherently subjective as it requires estimates that are susceptible to
significant revision as more information becomes available or as future events
occur. To the extent that actual outcomes differ from management estimates, an
additional provision for losses on loans could be required that could adversely
affect earnings or the Company's financial position in future periods. In
addition, various regulatory agencies, as an integral part of their examination
processes, periodically review the provision for losses on loans for Citizens
Financial 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.

OTHER REAL ESTATE OWNED

Other real estate owned is comprised of property acquired through a
foreclosure proceeding or acceptance of a deed in lieu of foreclosure. Other
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.

OFFICE PROPERTIES AND EQUIPMENT

Land is carried at cost. Office properties and equipment are stated at cost
less accumulated depreciation. Buildings and related components are depreciated
using the straight-line method with useful lives ranging from 30 to 40 years.
Furniture, fixtures and equipment are depreciated using the straight-line method
with useful lives ranging from 3 to 15 years. Leasehold improvements are
amortized over the life of the lease.

BANK-OWNED LIFE INSURANCE

The Bank has purchased life insurance policies on certain of its employees.
The Bank-owned life insurance is recorded at its cash surrender value, or the
amount that can be realized.

GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill results from business acquisitions and represents the excess of
the purchase price over the fair value of acquired tangible assets and
liabilities and identifiable intangible assets. Goodwill is assessed at least
annually for impairment and any such impairment is recognized in the period
identified.

Other intangible assets consist of core deposit intangible assets arising
from branch acquisitions. They are initially measured at fair value and then are
amortized on a straight-line basis over their estimated useful lives.

LONG-TERM ASSETS

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

54

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

LOAN COMMITMENTS AND RELATED FINANCIAL INSTRUMENTS

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

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 Company's 1998 Recognition and Retention
Plan (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 was
estimated using the Black-Scholes option value model with the following
assumptions:

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.

For additional details on the Company's stock-based compensation plans, see
Note 9 to the consolidated financial statements.

55

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

INCOME TAXES

Income tax expense (benefit) is the total of the current year income tax
due or refundable and the change in deferred tax assets and liabilities.
Deferred tax assets and liabilities are the expected future tax amounts for the
temporary differences between carrying amounts and tax bases of assets and
liabilities, computed using enacted tax rates. A valuation allowance, if needed,
reduces deferred tax assets to the amount expected to be realized. Deferred tax
assets are recognized for net operating losses that expire between 2016 and 2024
because the benefit is more likely than not to be realized.

EMPLOYEE STOCK OWNERSHIP PLAN (ESOP)

The cost of shares issued to the ESOP, but not yet allocated to
participants, is shown as a reduction of stockholders' equity. Compensation
expense is based on the market price of shares as they are committed to be
released to participant accounts. Dividends on both allocated shares and
unearned shares reduce debt and accrued interest.

EARNINGS PER SHARE

Basic earnings per common share (EPS) is net income divided by the
weighted-average number of common shares outstanding during the period. ESOP
shares not committed to be released and RRP shares which have not vested are not
considered to be outstanding for purposes of calculating EPS. The basic EPS
calculation excludes the dilutive effect of all common stock equivalents.
Diluted EPS includes the dilutive effect of additional potential common shares
issuable under stock options. The Company's potentially dilutive common shares
represent shares issuable under its stock option and vested RRP plans. Such
common stock equivalents are computed based on the treasury stock method using
the average market price for the period.

COMPREHENSIVE INCOME

Comprehensive income consists of net income and other comprehensive income.
Other comprehensive income includes unrealized gains and losses on securities
available for sale which are also recognized as separate components of equity.

56

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

PENDING ACCOUNTING PRONOUNCEMENTS

SHARED-BASED PAYMENT

In December 2004, the FASB issued SFAS 123, Revised, Share-Based
Payment,which requires all public companies to record compensation cost for
stock options and other awards provided to employees in return for employee
service. The cost of the options is measured at the fair value of the options
when granted, and this cost is to be expensed over the employee service period,
which is normally the vesting period of the options granted. This statement will
apply to awards granted or modified after the first quarter or year beginning
after June 15, 2005. Compensation cost will also be recorded for prior options
granted prior to this date that vest after the date of adoption. The Company
plans to adopt this statement as of July 1, 2005. The effect on the Company's
results of operations will depend on the level of future option grants and the
calculation of the fair value of the options granted at such future date, as
well as the vesting periods provided, and so cannot currently be predicted for
future awards. Existing options that will vest after the Company adopts SFAS
123, Revised, are expected to result in additional compensation expense as
indicated in the table below.

ACCOUNTING FOR CERTAIN LOANS OR DEBT SECURITIES ACQUIRED IN A TRANSFER

In December 2003, the American Institute of Certified Public Accountants
issued Statement of Position 03-3 (SOP 03-3), Accounting for Certain Loans or
Debt Securities Acquired in a Transfer. SOP 03-3 requires that a valuation
allowance for loans acquired in a transfer, including in a business combination,
reflect only losses incurred after acquisition and should not be recorded at
acquisition. It applies to any loan acquired in a transfer that showed evidence
of credit quality deterioration since it was made. SOP 03-3 became effective for
loans or debt securities acquired in fiscal years beginning after December 15,
2004. The effect of this new standard on the Company's financial position and
results of operations is not expected to be material upon adoption.

LOSS CONTINGENCIES

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

RESTRICTIONS ON CASH

Cash on hand or on deposit with the Federal Reserve Bank of $10.3 million
and $9.4 million, respectively was required to be maintained in order to meet
regulatory reserve and clearing requirements as of December 31, 2004 and 2003.

57

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

DIVIDEND RESTRICTION

Banking regulations require maintaining certain regulatory capital levels
at the Bank and also limit the amount of dividends payable by the Bank to the
Company. These regulations may affect the amount of cash dividends which the
Company may pay to stockholders in future periods.

FAIR VALUE OF FINANCIAL INSTRUMENTS

Fair values of financial instruments are estimated using relevant market
information and other assumptions, as more fully disclosed in Note 14 below.
Fair value estimates involve uncertainties and matters of significant judgment
regarding interest rates, credit risk, prepayments, and other factors,
especially in the absence of broad markets for particular items. Changes in
assumptions or in market conditions could significantly affect the estimates.

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, and investment services through an outsource partner.
Revenues for the significant products and services are disclosed separately in
the consolidated statements of income.

RECLASSIFICATIONS

Some items in the prior year financial statements were reclassified to
conform to the current presentation.

2. SECURITIES

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

58

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following table provides information as to the amount of gross gains
and losses realized through the sales of available-for-sale securities:

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

In conjunction with the 2003 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.

The amortized cost and fair value of securities at December 31, 2004, 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.

59

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Securities pledged to secure public deposits as of December 31, 2004 and
2003 had carrying amounts of $1.6 million and $1.7 million, respectively. At
year end 2004 and 2003, there were no holdings of securities of any one issuer,
other than the U.S. Government, its agencies, and government sponsored entities,
in an amount greater than 10% of stockholders' equity.

Securities with unrealized losses as of December 31, 2004 and 2003,
aggregated by investment category and length of time that individual securities
have been in a continuous unrealized loss position, are presented in the
following tables.

The Company evaluates securities for other-than-temporary (OTT) impairment
on a quarterly basis, and more frequently when economic or market concerns
warrant additional evaluations. Consideration is given to the length of time and
the extent to which the fair value has been less than cost, the financial
conditions and near-term prospects of the issuer, and the intent and ability of
the Company to retain its investment in the issuer for a period of time
sufficient to allow for any anticipated recovery in fair value. In analyzing an
issuer's financial condition, the Company may consider whether the securities
are issued by the federal government or its agencies, whether downgrades by bond
rating agencies have occurred, and the results of reviews of the issuer's
financial condition.

If management determines that an investment experienced an OTT decline in
value, the loss is recognized in the income statement. Any recoveries related to
the value of these securities are recorded as an unrealized gain (as other
comprehensive income in stockholders' equity) and not recognized in income until
the security is ultimately sold. During 2004, management identified one trust
preferred security with an OTT impairment of $1.0 million.

60

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Management does not believe any remaining individual unrealized loss as of
December 31, 2004 represents an OTT impairment. The unrealized losses reported
for agency securities, mortgage-backed securities and collateralized mortgage
obligations are, in their entirety, on securities issued by the federal
government, its agencies or government sponsored entities (GSEs), including the
Federal National Mortgage Association (FNMA), the Federal Home Loan Mortgage
Corporation (Freddie Mac) and the Government National Mortgage Association
(GNMA), and in management's belief, are attributable to changes in interest
rates and the resultant change in the shape of the yield curve. The unrealized
losses associated with the equity relates to one issuance. Management believes
that the unrealized loss is specifically related to the changes in the interest
rates and resultant change in the shape of the yield curve.

3. LOANS RECEIVABLE

Loans receivable, net of unearned fees, consist of the following:

The Bank's lending activities have been concentrated primarily within its
market area as well as the Midwestern United States.

At December 31, 2004 and 2003, the Company had $3.4 million and $3.4
million of loans held for sale.

At December 31, 2004 and 2003, the Company serviced $14.3 million and $10.8
million, respectively, of loans for others.

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

61

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Impaired loans were as follows:

Total nonperforming loans as of December 31, 2004 and 2003 were $27.7
million and $22.7 million, respectively. There were no loans past due greater
than 90 days still on accrual as of December 31, 2004 and 2003. Of the total
impaired loans as of December 31, 2004 and 2003, $16.1 million and $4.7 million,
respectively, were on nonaccrual.

4. OFFICE PROPERTIES AND EQUIPMENT

Office properties and equipment are summarized as follows:

Depreciation expense charged to operations in 2004, 2003 and 2002,
approximated $1.5 million, $1.5 million and $1.8 million, respectively.

62

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

OPERATING LEASES

At December 31, 2004, 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, 2004, have initial or remaining noncancelable lease
terms in excess of one year.

Rental expense charged to operations in 2004, 2003 and 2002, amounted to
approximately $675,000, $405,000 and $605,000, respectively, including amounts
paid under short-term cancelable leases.

5. GOODWILL AND INTANGIBLE ASSETS

As of December 31, 2004 and 2003, the Company had $1.2 million of goodwill
which was acquired through the Company's 2003 acquisition of a bank branch in
Illinois. The goodwill was not impaired during either 2004 or 2003.

The Company also acquired core deposit intangibles in conjunction with the
same bank branch acquisition. The intangible assets acquired amounted to
$325,000 in cost. For the years ended December 31, 2004 and 2003, the
amortization expense related to these intangibles was $65,000 and $16,000,
respectively.

Estimated amortization expense for each of the next four years is as
follows:

63

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

6. DEPOSITS

Deposits and interest rate data are summarized as follows:

The aggregate amount of deposits in denominations of greater than $100,000
was $228.1 million and $232.6 million at December 31, 2004 and 2003,
respectively. Deposits in excess of $100,000 generally are not federally
insured.

64

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

7. BORROWED MONEY

Borrowed money consists of the following:

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

As of December 31, 2004, the Company had two lines of credit with a maximum
of $25.0 million and $15.0 million, respectively, in unsecured overnight federal
funds. During 2004, these lines were used for liquidity purposes. As of December
31, 2004, these lines had a zero balance. The maximum amount borrowed during the
year ended December 31, 2004 was $15.0 million and the weighted-average rate
paid was 1.93%.

Interest expense on borrowed money totaled $26.1 million, $26.4 million and
$27.4 million for the years ended December 31, 2004, 2003 and 2002,
respectively.

8. 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, 2004, 2003 and 2002 was $200,000, $1.6 million
and $889,000, respectively. Asset and plan benefit information is not available
for participating associations on an individual basis.

Benefits were frozen under the defined benefit pension plan 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 allows for employee
contributions up to 12% of their compensation, which are matched equal to 50% of
the first 6% of the compensation contributed. Plan

66

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

expense for the years ended December 31, 2004, 2003 and 2002 was $239,000,
$230,000 and $252,000, respectively.

Effective January 1, 2005, the Company's match under this plan will no
longer be distributed as an addition to the employees' contributions. In
accordance with the amended plan documents, the match will be paid out on an
annual basis as shares distributed through the Company's Employee Stock
Ownership Plan. Any distribution through the ESOP will be made under the
original specified percentage of employee contributions and will constitute
future expense under the ESOP plan.

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. This plan was frozen in 2003 along
with the Company's pension plan. There was no expense related to this plan in
2004. Expenses related to this plan for the years ended December 31, 2003 and
2002, were $29,000 and $87,000, respectively.

Effective January 1, 2005, the Company approved the Directors' Deferred
Compensation Plan (DDCP) for compensation paid to non-executive directors of the
Company and its affiliates. Under the plan, a director who elects to participate
in the DDCP may elect to defer all or any part of the compensation earned by the
director for services as a director until a designated time, the director's
death or cessation of service as a director. The DDCP also allows the directors
to receive common stock of the Company in lieu of the cash compensation that
would otherwise be payable to them. The Company will accrue a liability for any
obligation under these plans beginning in 2005. There has been no expense
incurred for the deferred directors' fees prior to this plan taking effect.

9. 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 qualified 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 was $1.7 million for each of the three
years ended December 31, 2004, 2003 and 2002. ESOP shares not committed to be
released are not considered outstanding for purposes of computing EPS. The Bank
made contributions to the ESOP plan in order to pay down the loan outstanding
totaling $1.3 million for each of the three years ended December 31, 2004, 2003
and 2002.

Effective January 1, 2005, the ESOP plan was amended to allow for the
distribution of the Company's 401(k) match to be made by distributing shares
from the ESOP to the employees. This distribution will be made on an annual
basis in conjunction with the annual allocations of the ESOP.

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

67

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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, 2004, 2003 and 2002, were $47,000,
$72,000 and $86,000, 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. On April 1, 2004, the remaining 1,050 shares were granted to two
participants.

The following table summarizes shares of Company's common stock within the
RRP at December 31, 2004:

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 from the date of grant 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' equity. Compensation expense under
this plan for the years ended December 31, 2004, 2003 and 2002 was $1.4 million,
$1.3 million and $1.5 million, respectively.

The Company has stock option plans under which shares of Company common
stock are reserved for the grant of both incentive and non-qualified 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.

68

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following is a combined analysis of the stock option activity for each
of the three years ended December 31, 2004, 2003 and 2002.

At December 31, 2004, there were 230,845 shares available for future
grants. The weighted average exercise price of stock options exercised during
2004 was $9.49. The weighted average exercise price of options forfeited during
2004 was $14.13. The fair value of stock options granted during 2004 was $3.27
per share. Assumptions for fair value of option grants are included in Note 1.

Options outstanding at December 31, 2004 were as follows:

69

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

10. 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:

70

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 earnings at December 31, 2004 include approximately $12.5 million, for
which no provision for income taxes has been made. If in the future this portion
of retained earnings 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.

At December 31, 2004, the Company had federal and state net operating
losses of $28.5 million and $34.4 million, respectively, which are being carried
forward to reduce future taxable income. The carryforwards expire between 2016
and 2024.

11. 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.

12. 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

71

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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 defined in the
regulations. As of December 31, 2004, the Bank met all capital adequacy
requirements to which it is subject.

As of December 31, 2004, the Bank is categorized 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, 2004, the Bank's adjusted
total assets were $1.3 billion and its risk-weighted assets were $1.1 billion.

72

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

13. COMMITMENTS

The above listed commitments do not necessarily represent future cash
requirements, in that these commitments often expire without being drawn upon.
All commitments to extend credit or to purchase loans expire within the
following year. Letters of credit expire at various times through 2014.

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, 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 letters of credit and credit enhancements provided by the Company are
considered financial guarantees under FASB Interpretation 45 Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others and are carried in the aggregate at a fair
value of $564,000 as of December 31, 2004.

14. 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

73

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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.

No fair value disclosure is required with respect to certain financial
instruments and all nonfinancial instruments. Accordingly, the aggregate fair
value amounts presented do not represent the underlying value of the Company.

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

The carrying amount is the estimated fair value for cash and cash
equivalents, Federal Home Loan Bank stock, and accrued interest receivable and
payable. Securities fair values are based on quotes received from a third-party
pricing source.

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.

The fair value of checking, savings, and money market accounts 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.

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)

15. EARNINGS PER SHARE

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

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

(1) Assumes exercise of dilutive stock options and also a portion of the
unearned awards under the RRP.

16. 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:

17. 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

75

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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. Even
excluding supervisory goodwill, however, the Bank exceeded the capital
requirements of FIRREA at such date. As of January 1, 1994, the Bank adopted
FASB Statement No. 72, Accounting for Certain Acquisitions of Banking or Thrift
Institutions. Upon the adoption of this change in accounting principle, the Bank
wrote down the remaining balance of the goodwill.

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 was
filed 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 damages case went to trial in June 2004 and concluded in
early July 2004.

The Bank sought damages of more than $20.0 million based on the report and
testimony of its expert witness. The Government's position was that the Bank
suffered no compensable damage as a result of the breach. On March 7, 2005, the
Court of Claims' judge entered judgment in favor of the Government holding that
the Bank was not entitled to recover any damages. The Court of Claims also ruled
that the Government is entitled to recover certain costs from the Bank with
respect to one claim that the Bank had voluntarily dismissed during the
proceeding. At this time, the Company has no information regarding the amount of
costs that the Government may seek to recover from the Bank. Management of the
Company is currently reviewing its options and has 60 days from the date of the
trial court's decision in which to file an appeal. The Bank's cost, including
attorneys' fees, experts' fees, and related expenses of the litigation was
approximately $1.4 million, $183,000 and $258,000 in 2004, 2003 and 2002,
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.

76

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, 2004 and 2003 and condensed statement of
income and cash flows for the three years ended December 31, 2004 for CFS
Bancorp, Inc., the parent company.

CONDENSED STATEMENTS OF CONDITION
(PARENT COMPANY ONLY)

CONDENSED STATEMENTS OF INCOME
(PARENT COMPANY ONLY)

77

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

CONDENSED STATEMENTS OF CASH FLOWS
(PARENT COMPANY ONLY)

78

CFS BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

19. QUARTERLY FINANCIAL DATA (UNAUDITED)

During the third quarter of 2004, the Company's provision for losses on
loans was $6.2 million as compared to $500,000 for the third quarter of 2003.
This increase was a direct result of increased impairment allocations for eight
impaired loans. In addition, the Company's financial results were adversely
impacted by the following:

- additional compensation expense of $1.0 million incurred as a result of a
resignation of a senior executive officer;

- an additional $585,000 OTT impairment in the cost basis of a trust
preferred security;

- the write-down of $421,000 in viatical receivables held by the Bank that
were determined to be impaired;

- additional legal expenses of $381,000 related to the Company's goodwill
litigation; and

- an increase in loan collection expenses of $231,000 compared to the third
quarter of 2003.

The Company's results during the fourth quarter of 2004 were negatively
impacted by a $9.8 million charge to non-interest expense related to the early
extinguishment of debt that was incurred in conjunction with the Bank's
restructuring of its high fixed-rate FHLB debt. In addition, the Company also
amortized through interest expense $2.1 million of the deferred premium on the
early extinguishment of debts during the fourth quarter of 2004.

79

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

None.

ITEM 9A. CONTROLS AND PROCEDURES

Management evaluated, with the participation of the Company's Chief
Executive Officer and Chief Financial Officer, the effectiveness of its
disclosure controls and procedures (as defined in Rules 13a - 15(e) or
15(d) - 15(e) under the Securities Exchange Act of 1934, as amended) as of the
end of the period covered by this report. Based on such evaluation, the Chief
Executive Officer and Chief Financial Officer have concluded that the Company's
disclosure controls and procedures are designed to ensure that information
required to be disclosed by the Company in the reports that it files or submits
under the Securities Exchange Act of 1934 is recorded, processed, summarized and
reported within the time periods specified in the SEC's rules and regulations
and are operating in an effective manner.

Under the terms and provisions of the Securities Exchange Commission's
Exemptive Order dated November 30, 2004, the Company will file its Management's
Annual Report on Internal Control Over Financial Reporting as required by Item
308(a) of Regulation S-K and the related Attestation Report of the Registered
Public Accounting Firm as required by Item 308(b) of Regulation S-K within the
required 45 day period after March 16, 2005 as an amendment to this Form 10-K.

ITEM 9B. OTHER INFORMATION

Not applicable.

80

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 25, 2005 (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 the Proxy Statement.

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 AND
RELATED STOCKHOLDER MATTERS.

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, 2004.

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 ACCOUNTANT 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.

PART IV

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.

(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.

81

(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.(1)
3.2 Bylaws of CFS Bancorp, Inc.(1)
4.0 Form of Stock Certificate of CFS Bancorp, Inc.(1)
10.1 Employment Agreement entered into between Citizens Financial
Services, FSB and Thomas F. Prisby(2)
10.2 Employment Agreement entered into between Citizens Financial
Services, FSB and James W. Prisby(2)
10.3 Employment Agreement entered into between CFS Bancorp, Inc.
and Thomas F. Prisby(2)
10.4 Employment Agreement entered into between CFS Bancorp, Inc.
and James W. Prisby(2)
10.5 CFS Bancorp, Inc. Amended and Restated 1998 Stock Option
Plan(3)
10.6 CFS Bancorp, Inc. Amended and Restated 1998 Recognition and
Retention Plan and Trust Agreement(3)
10.7 CFS Bancorp, Inc. 2003 Stock Option Plan(4)
10.8 Employment Agreement entered into between Citizens Financial
Services, FSB and Charles V. Cole(5)
10.9 Employment Agreement entered into between Citizens Financial
Services, FSB and Thomas L. Darovic(5)
10.10 Employment Agreement entered into between CFS Bancorp, Inc.
and Charles V. Cole(5)
10.11 Employment Agreement entered into between CFS Bancorp, Inc.
and Thomas L. Darovic(5)
10.12 Separation Agreement entered into between Citizens Financial
Services, FSB, CFS Bancorp and James W. Prisby(6)
10.13 Employment Agreement entered into between Citizens Financial
Services, FSB and Zoran Koricanac
10.14 Employment Agreement entered into between CFS Bancorp, Inc.
and Zoran Koricanac
10.15 Amended and Restated Supplemental ESOP Benefit Plan of CFS
Bancorp, Inc. and Citizens Financial Services, FSB
10.16 CFS Bancorp, Inc. Directors' Deferred Compensation Plan
23.0 Consent of Ernst & Young LLP
23.1 Consent of Crowe Chizek and Company LLC
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

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

(1) 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.

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

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

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

(5) Incorporated by Reference from the Company's annual report on Form 10-K for
the year ended December 31, 2003.

(6) Incorporated by Reference from the Company's report on Form 10-Q for the
quarterly period ended September 30, 2004.

82

SIGNATURES

In accordance with 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.