CFS BANCORP INC - 10-Q Quarterly Report

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

FORM 10-Q

(Mark One)

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

For the quarterly period ended March 31, 2005.
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OR

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

For the transition period from to .
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Commission file number: 0-24611

CFS Bancorp, Inc.
(Exact name of registrant as specified in its charter)

Delaware 35-2042093
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)

707 Ridge Road, Munster, Indiana 46321
(Address of principal executive offices)

(219) 836-9990
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. YES [X] NO [ ]

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

The Registrant had 12,382,411 shares of Common Stock issued and outstanding as
of May 6, 2005.

CFS BANCORP, INC.

TABLE OF CONTENTS

2

CFS BANCORP, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

See accompanying notes.

3

CFS BANCORP, INC.
CONSOLIDATED STATEMENTS OF INCOME

See accompanying notes.

4

CFS BANCORP, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY

See accompanying notes.

5

CFS BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS

See accompanying notes.

6

CFS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1. BASIS OF FINANCIAL STATEMENTS PRESENTATION

The consolidated financial statements of CFS Bancorp, Inc. (including
its consolidated subsidiaries, the Company) as of March 31, 2005 and for the
three months ended March 31, 2005 and March 31, 2004 are unaudited; however, the
financial information reflects all adjustments (consisting only of normal
recurring adjustments), which are, in the opinion of management, necessary for a
fair presentation for the interim periods. The financial statements have been
prepared in conformity with U.S. generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and Article
10 of Regulation S-X.

The results of operations for the three months ended March 31, 2005 are
not necessarily indicative of the results expected for the full year ending
December 31, 2005. The accompanying consolidated financial statements do not
include information or footnotes necessary for a complete presentation of
financial condition, results of operations or cash flows in accordance with U.S.
generally accepted accounting principles. The March 31, 2005 consolidated
financial statements should be read in conjunction with the consolidated
financial statements and notes for the year ended December 31, 2004 included in
the Company's Annual Report on Form 10-K.

The preparation of 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 is particularly subject
to change.

Some items in the prior period financial statements were reclassified
to conform to the current period's presentation.

2. STOCK-BASED COMPENSATION

The Company accounts for its stock options in accordance with
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued by
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 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 (SFAS 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 SFAS No. 123 in this pro forma disclosure
are not indicative of future amounts of compensation expense to be recognized.

7

The Company did not grant any options during the three months ended
March 31, 2005 or 2004.

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.

3. 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:

8

4. EARNINGS PER SHARE

The following table sets forth the computation of basic and diluted
earnings per share for the three months ended March 31, 2005 and 2004:

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

For the quarter ended March 31, 2005, the Company had 301,000
anti-dilutive options which were not included in the above calculation. The
Company had no anti-dilutive options for the quarter ended March 31, 2004.

5. NEW ACCOUNTING PRONOUNCEMENTS

The Meaning of Other-Than-Temporary and Its Application to Certain Investments

In January 2003, the Emerging Issues Task Force (EITF) began a project
to provide additional guidance on when a market value decline on debt and
marketable equity securities should be considered other-than-temporary.
Currently, declines in market value that are considered to be
other-than-temporary require that a loss be recognized through the income
statement. In March 2004, the FASB ratified the consensus reached by the EITF in
Issue 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application
to Certain Investments" (EITF 03-1). EITF 03-1 provides guidance for determining
when an investment is considered impaired, whether impairment is
other-than-temporary, and measurement of an impairment loss. In September 2004,
the FASB issued FSP 03-1-1 which delayed the effective date for the measurement
and recognition guidance of Issue 03-1 due to additional proposed guidance. At
March 31, 2005, gross unrealized losses on available for sale securities were
$2.4 million. In addition, the Company recognized a $240,000 impairment during
the first quarter of 2005. See the discussion under the heading "Changes in
Financial Condition - Securities" in the Management's Discussion and Analysis of
Financial Condition and Results of Operations section in Item 2 of this Form
10-Q. The Company will continue to evaluate the impact of EITF 03-1. The amount
of other-than-temporary impairment to be recognized, if any, will be dependent
on market conditions, management's intent and ability to hold investments until
a forecasted recovery, and the finalization of the proposed guidance by the
FASB.

9

Share-Based Payment

In December 2004, the FASB issued SFAS No. 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 that vest, are granted or are modified after the first quarter
or year beginning after June 15, 2005.

On April 14, 2005, the SEC amended the compliance date for SFAS No.
123(R) from the beginning of the first interim or annual period that begins
after June 15, 2005 to the next fiscal year beginning after June 15, 2005. Early
adoption is permitted in periods in which financial statements have not yet been
issued. The Company expects to adopt SFAS No. 123(R) as of January 1, 2006. 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 No. 123(R) are expected to result in additional
compensation expense as indicated in the table below.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

FORWARD LOOKING STATEMENTS

When used in this Form 10-Q or future filings by the Company with the 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 operations, changes in the cost of funds, demand
for loan products and financial services, changes in accounting principles and

10

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.

OVERVIEW

The Company's net income totaled $266,000 or $0.02 per diluted share
for the quarter ended March 31, 2005. Net interest income before the provision
for losses on loans was $6.1 million and the Company's net interest margin was
2.00% for the same period. The Company's net income for the first quarter of
2005 was adversely affected by a charge to interest expense totaling $4.7
million ($2.9 million net of tax or $0.24 per diluted share) which reflects the
amortization of the deferred premium on the early extinguishment of debt
relating to the Company's fourth quarter 2004 restructuring of $400.0 million of
Federal Home Loan Bank (FHLB) borrowings. However, the restructuring reduced the
average contractual interest rates paid by the Company on its FHLB borrowings
and, on a cash basis, the Company's interest payments on such borrowings were
$3.4 million less ($2.1 million net of tax or $0.17 per diluted share) in the
quarter ended March 31, 2005 compared to the quarter ended March 31, 2004.

Total borrowings at the end of March 31, 2005 were $291.3 million which
is net of the unamortized premium on the early extinguishment of debt of $25.4
million. The weighted average contractual interest rate on the FHLB borrowings
as of March 31, 2005 was 3.65%, a substantial decrease from the weighted average
contractual interest rate of 5.92% as of March 31, 2004.

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 its Annual Report
on Form 10-K. These policies, along with the disclosures presented in the other
financial statement notes and in this management's discussion and analysis,
provide information on how significant assets and liabilities are valued in the
financial statements and how those values are determined. Management views
critical accounting policies to be those which are highly dependent on
subjective or complex judgments, estimates and assumptions, and where changes in
those estimates and assumptions could have a significant impact on the financial
statements. Management currently views the determination of the allowance for
losses on loans to be a critical accounting policy.

11

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 SFAS No. 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 No. 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 the Bank
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 following table 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.

12

(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 amortized costs.

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

(4) The 2005 period includes $28.1 million average unamortized deferred premium
on early extinguishment of debt which offsets total average FHLB borrowings
of $317.1 million. Interest expense on borrowings for the 2005 period
includes $4.7 million of amortization of the deferred premium on early
extinguishment of debt. The amortization of the deferred premium for the
2005 period increased the average cost of borrowings as reported to 10.67%
compared to an average contractual rate of 3.65%.

13

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

Net Income. The Company's net income for the first quarter of 2005 was
$266,000 (or $0.02 per diluted share) compared to $1.2 million (or $0.11 per
diluted share) reported during the comparable 2004 period. The Company's net
income during the first quarter of 2005 was adversely affected by a pre-tax
charge to interest expense of $4.7 million ($2.9 million net of tax or $0.24 per
diluted share) related to the amortization of the deferred premium on the early
extinguishment of debt. This amortization was partially offset by a $3.4 million
($2.1 million net of tax or $0.17 per diluted share) decrease in interest
expense as a result of the Company's lower contractual interest rates on the
restructured borrowings for the first quarter of 2005 as compared to the first
quarter of 2004.

Net Interest Income. Net interest income is the principal source of
earnings for the Company and consists of interest income earned on loans and
investment securities less interest

14

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 spread for the first quarter of 2005 was 1.55% as compared to 1.70% for
the first quarter of 2004.

The Company's net interest income before the provision for losses on
loans for the first quarter of 2005 was $6.1 million, a decrease of $1.3 million
from the first quarter of 2004. The Company's net interest margin (which is net
interest income as a percentage of average interest-earning assets) remained
stable at 2.00% for the first quarter of 2005 as compared to the first quarter
of 2004. Both the net interest income and net interest margin were negatively
impacted by the $4.7 million premium amortization previously discussed. The net
interest margin was also negatively affected by the average unamortized deferred
premium which is classified as an offset to the Company's average borrowings
outstanding. The average unamortized portion of the deferred premium totaled
$28.1 million for the first quarter of 2005. The effect of the unamortized
deferred premium and the related quarterly amortization was to reduce the
Company's net interest margin by 156 basis points for the first quarter of 2005.
Partially offsetting the effects of the deferred premium amortization was a 79
basis point increase in the average yield on earning assets combined with a 14
basis point decrease in the average cost of deposits during the first three
months of 2005 compared to the first three months of 2004.

Interest Income. Total interest income was $16.7 million for the three
months ended March 31, 2005, a decrease of 4.6% from $17.5 million for the
comparable 2004 period. The decrease in interest income was primarily the result
of a decrease of $126.1 million in the average balance of its securities and a
$133.4 million decrease in the average balance of its other interest-earning
assets from the three months ended March 31, 2004 due to the Company utilizing
its low yielding interest-earning assets to reduce the total amount of its
borrowings, pay the prepayment penalties associated with the FHLB debt
restructuring, and to allow runoff of high cost certificates of deposit. The
effects of this decrease in the average balances was partially offset by a 79
basis point increase in the yields on interest-earning assets to 5.51% during
the first quarter of 2005 from the first quarter of 2004 as the Company's
adjustable-rate assets reflected higher market interest rates.

Interest Expense. Total interest expense was $10.6 million for the
three months ended March 31, 2005, a 5.1% increase from the comparable 2004
period. The increase in the Company's interest expense for the first quarter of
2005 from the comparable 2004 period was primarily a result of the $4.7 million
premium amortization expense related to the early extinguishment of debt which
is recorded as a charge to interest expense. The non-cash amortization was
partially offset by a $3.4 million decrease in interest expense related to the
Company's lower contractual interest rates on its restructured FHLB borrowings
coupled with an $831,000 decrease in interest expense on deposits.

The weighted average cost of deposits decreased to 1.53% for the first
quarter of 2005 as compared to 1.67% for the first quarter of 2004. The average
balance of interest-bearing liabilities decreased 19.1% as a result of the lower
average balances on certificates of deposit combined with the reduction in the
average balance of borrowings resulting from the repayment in 2004 of $75.0
million of FHLB borrowings together with the average balance of the

15

unamortized deferred premium. The average cost of interest-bearing liabilities
increased 94 basis points for the quarter ended March 31, 2005 when compared to
the first quarter of 2004. The increase in the weighted average cost of
interest-bearing liabilities was primarily a result of the premium amortization
expense recognized during the first quarter of 2005. The interest expense
related to the deferred premium amortization is expected to be $4.0 million,
$2.9 million and $2.8 million before taxes in the quarters ended June 30, 2005,
September 30, 2005 and December 31, 2005, respectively.

Provision for losses on loans. The Company's provision for losses on
loans was $255,000 for the first quarter of 2005, a decrease of $484,000 from
the comparable 2004 period. During the first quarter of 2004, the Company
increased its provision due to a non-performing commercial real estate loan
secured by a motel. During the second quarter of 2004, this loan was transferred
to other real estate owned and sold.

Non-interest income. The Company's first quarter of 2005 non-interest
income was $2.5 million, a decrease of $651,000 from the first quarter of 2004.
The decrease was primarily related to net realized losses on securities
available-for-sale of $65,000 coupled with an "other-than-temporary" impairment
of $240,000 realized on the Company's $1.5 million investment in Freddie Mac
fixed-rate preferred stock. (For further discussion related to this impaired
security, see the "Securities" section in this Form 10-Q.) These losses were
partially offset by net realized gains of $62,000 on the sale of other real
estate owned during the first quarter of 2005. Net realized gains on the sales
of securities available-for-sale was $321,000 for the first quarter of 2004.

The remaining components of non-interest income remained relatively
stable during the first quarter of 2005 as compared to the first quarter of 2004
with an increase in service charges and other fees of $36,000 partially
offsetting the decrease of $141,000 in other income.

Non-interest expense. Non-interest expense for the first quarter of
2005 was $8.3 million, a decrease of $273,000 from $8.5 million for the
comparable period in 2004. The decrease was primarily a result of decreased
compensation and employee benefit expenses of $314,000 during the first quarter
of 2005 due to reduced expense associated with the vesting of stock issued under
the Company's Recognition and Retention Plan (RRP). The Company's marketing
expense also decreased $98,000 during the first quarter of 2005 as compared to
the comparable 2004 period due to a decrease in the use of newspaper advertising
and direct mail campaigns. The above mentioned decreases were partially offset
by increases in net occupancy expense related to the Company's new offices which
opened during the second and third quarters of 2004 and data processing charges
related to the increased usage of electronic banking services that the Company
offers to its customers.

Management has historically used an efficiency ratio that is a non-GAAP
financial measure of operating expense control and efficiency of operations. The
efficiency ratio is typically defined as the ratio of non-interest expense to
the sum of net interest income before the provision for losses on loans and
non-interest income. Many financial institutions, in calculating the efficiency
ratio, adjust non-interest income (as calculated under generally accepted
accounting principles) to exclude certain component elements, such as gains or
losses on sales of securities and assets. Management follows this practice to
calculate its efficiency ratio and utilizes this non-GAAP measure in its
analysis of the Company's performance. The non-GAAP measure is different from
the GAAP-based efficiency ratio which is also presented in this Form 10-Q. The
GAAP-based measure is calculated using non-

16

interest expense, net interest income before the provision for losses on loans
and non-interest income as presented on the Consolidated Statements of Income.

Management computes a core efficiency ratio which is calculated as
non-interest expense, excluding any prepayment penalties on early extinguishment
of debt, divided by the sum of net interest income before the provision for
losses on loans, excluding the deferred premium amortization, and non-interest
income, adjusted for gains or losses on the sale of securities and other assets
and other-than-temporary impairments. Management believes that the non-GAAP core
efficiency ratio enhances investors' understanding of its business and
performance. The measure is also believed to be useful in understanding the
Company's performance trends and to facilitate comparisons with the performance
of others in the financial services industry. Management further believes the
presentation of the core efficiency ratio provides useful supplemental
information, a clearer understanding of the Company's financial performance and
better reflects the Company's core operating activities.

The limitations associated with utilizing operating measures (such as
the efficiency ratio) are the risk that different persons might disagree as to
the appropriateness of items comprising these measures and that other companies
might calculate these measures differently. Management of the Company
compensates for these limitations by providing detailed reconciliations between
GAAP information and its core efficiency ratio. These disclosures should not be
considered as an alternative to GAAP.

The Company's efficiency ratio for the first quarter of 2005 was 97% as
compared to 81% for the first quarter of 2004. The Company's core efficiency
ratio was 61% for the first quarter of 2005 as compared to 84% for the first
quarter of 2004. The calculations of the efficiency ratio are presented below.

17

Income Tax Expense. The Company's income tax benefit for the first
quarter of 2005 was $246,000 compared to the income tax benefit of $21,000 for
the comparable period in 2004. The increased tax benefit was a result of the
lower pre-tax earnings, the effects of permanent tax differences primarily
related to the Company's investment in Bank-owned life insurance and the
application of available tax credits. The permanent tax differences and
available tax credits are expected to continue to have a favorable impact on
income tax expense throughout 2005.

CHANGES IN FINANCIAL CONDITION

General. At March 31, 2005, the Company's total assets had decreased by
$16.3 million to $1.30 billion from $1.31 billion at December 31, 2004. The
significant changes in the Company's total assets were mainly a result of a
decrease in cash and cash equivalents coupled with a decrease in loans
receivable, net of unearned fees which were partially offset by increases in
securities available-for-sale as the Company utilized its lower yielding cash
and the repayments on loans to purchase securities.

Securities. The amortized cost of the Company's securities and their
fair values were as follows at March 31, 2005 and December 31, 2004:

During the first quarter of 2005, approximately $16.8 million of
available-for-sale securities were sold realizing a net loss on the sales of
$65,000. The Company also identified a $240,000 impairment in a Freddie Mac
fixed-rate perpetual preferred stock that had an original cost basis of $1.5
million. The impairment was identified based on the facts and circumstances
surrounding the security and its issuer at the time of the impairment, including
the duration and severity of the unrealized loss in the security and the
uncertainty as to the timing of a full recovery.

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Management does not believe that any other unrealized loss on the
Company's securities as of March 31, 2005 represents an other-than-temporary
impairment. The unrealized losses reported for the remainder of the portfolio
were attributable to changes in interest rates.

Loans. Loans receivable, net of unearned fees, and the percentage of
loans by category are presented below as of March 31, 2005 and December 31,
2004:

Total loans decreased 1% as of March 31, 2005 from December 31, 2004.
The decrease was mainly a result of loan repayments in construction and land
development loans and in single-family residential mortgage loans. Total loan
repayments were partially offset by increased fundings of commercial real estate
loans totaling $5.9 million and increased usage of home equity lines of credit
totaling $2.3 million.

Allowance for Losses on Loans. At March 31, 2005, the Bank's allowance
for losses on loans amounted to $13.4 million and remained relatively stable
compared to December 31, 2004. The allowance for losses on loans represented
51.2% and 48.3%, respectively, of the Bank's non-performing loans and 1.37% and
1.35%, respectively, of its total loans receivable as of March 31, 2005 and
December 31, 2004. Management of the Bank believes that, as of March 31, 2005,
the allowance for losses on loans was adequate.

As of March 31, 2005, the Company had nine impaired loans with
aggregate outstanding balances totaling $25.3 million with impairment
allocations related to these loans totaling $6.2 million. Seven of the impaired
loans are commercial real estate loans, of which four are secured by hotels and
as of March 31, 2005, had an aggregate carrying value of $20.8 million with
aggregate impairment allocations of $4.1 million. The other three impaired
commercial real estate loans are secured by a golf course and as of March 31,
2005, total $3.4 million with an impairment allocation of $1.4 million. The two
remaining impaired loans are commercial loans, one of which is secured by
business assets and the other by improved land. As of March 31, 2005, these two
loans total $1.1 million with an aggregate impairment allocation of $694,000.

The following is a summary of changes in the allowance for losses on
loans for the periods presented:

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See additional discussion for the decreased provision for losses on
loans under the sub-heading "Provision for Losses on Loans" above.

Non-performing Assets. The following table provides information
relating to the Company's non-performing assets as of the dates indicated. The
Company has no loans past due greater than 90 days still on accrual at either
date presented below.

Total non-performing loans decreased $1.4 million or 5.1% as of March
31, 2005 as compared to December 31, 2004. The primary reason for the decrease
was the transfer of seven single-family residential mortgage loans totaling
$443,000 to other real estate owned during the first quarter of 2005, of which
three of these properties were also sold during the quarter for a total gain on
sale of $63,000. The remaining decrease in non-performing loans was a result of
loan repayments offset by loans transferred to non-performing loans. With the
exception of the addition of one $400,000 commercial real estate loan secured by
a hotel in Michigan (see further

20

discussion below), there were no significant transfers to non-performing loans
during the first quarter of 2005.

As of March 31, 2005, the Company's non-performing commercial real
estate loans included:

o Two loans totaling $9.2 million which are secured by a hotel in
Michigan. As of March 31, 2005, these loans were considered
impaired loans with an estimated impairment allocation of
$811,000. In conjunction with a forbearance agreement negotiated
during the fourth quarter of 2004, the Company loaned an
additional $400,000 to the borrower to pay for delinquent real
estate taxes on the properties securing the loans. During the
first quarter of 2005, the borrower made interest payments which
totaled $71,000 in the aggregate as agreed.

o One loan totaling $7.0 million secured by a hotel in the Chicago
metropolitan area which is considered impaired and had an
estimated impairment allocation of $1.8 million as of March 31,
2005. 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. Although the borrowers filed for
reorganization under Chapter 11 of the Bankruptcy Code during the
first quarter of 2005, the Company does not believe the
bankruptcy will affect the terms of the forbearance agreement.

o Two loans totaling $2.2 million which 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
March 31, 2005.

21

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

The Company's total deposits amounted to $843.1 million at March 31,
2005 compared to $863.2 million at December 31, 2004. The decrease of $20.1
million was primarily the result of a reduction of $20.4 million in certificates
of deposit, partially offset by an increase in core deposits of $313,000. The
Company continues to strategically focus on increasing lower cost core deposits.

The Company's borrowed money consisted of the following at the dates
indicated:

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

22

As of March 31, 2005, the Company had two lines of credit with a
maximum of $25.0 million and $15.0 million, respectively, in unsecured overnight
federal funds at the market rate for the purchase of federal funds at the time
of a request. During the first quarter, these lines were used for liquidity
purposes. As of March 31, 2005, these lines had a zero balance. The maximum
amount borrowed during the first quarter of 2005 was $5.0 million and the
weighted-average rate paid was 2.61%.

On March 21, 2005, the Company obtained a $10.0 million revolving line
of credit with a maturity date of March 31, 2006 and with each borrowing
carrying an interest rate of either the Prime Rate minus 75 basis points or the
LIBOR rate at the Company's option. The line of credit was obtained by the
Holding Company and is secured by the stock of Citizens Financial Services, FSB.
The Company did not borrow any funds under this line of credit during the first
quarter of 2005.

Capital Resources. The Company's stockholders' equity at March 31, 2005
was $146.1 million as compared to $147.9 million at December 31, 2004. The
decrease was primarily due to:

o a $904,000 increase in unrealized losses on available-for-sale
securities, net of tax;

o cash dividends declared during 2005 totaling $1.4 million; and

o repurchases of the Company's common stock during 2005 totaling
$283,000.

Partially offsetting the above decreases in stockholders' equity, the Company
also realized during 2005:

o net income of $266,000;

o $422,000 related to shares committed to be released under the
Company's Employee Stock Ownership Plan; and

o proceeds from stock option exercises totaling $52,000.

During the first quarter of 2005, the Company repurchased 20,000 shares
of its common stock with an average price of $14.17 per share pursuant to the
share repurchase program announced in March 2003. Since its initial public
offering, the Company has repurchased an aggregate of 11,612,616 shares of its
common stock at an average price of $11.75 per share. As of March 31, 2005, the
Company has 1,160,156 of shares remaining to be repurchased under its current
share repurchase program.

23

At March 31, 2005, the Bank's regulatory capital was in excess of
regulatory limits set by the Office of Thrift Supervision (OTS). The current
requirements and the Bank's actual levels at March 31, 2005 and at December 31,
2004 are provided below:

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:

o deposits,

o scheduled payments of amortizing loans and mortgage-related
securities,

o prepayments and maturities of outstanding loans and
mortgage-related securities,

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

o funds provided from operations, and

o 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 requirements.

At March 31, 2005, the Company had cash and cash equivalents of $17.9
million which was a decrease of $20.1 million from December 31, 2004. The
decrease was mainly caused by purchases of securities available-for-sale
totaling $43.1 million and decreased deposits of $20.1 million. Cash outflows
were partially offset by proceeds from sales, maturities and paydowns on
securities available-for-sale of $28.6 million, net loan repayments of $8.6
million and cash flows from operating activities of $6.2 million.

24

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,
securities available-for-sale and dividends from the Bank. CFS Bancorp, Inc.
also has $10.0 million of available liquidity under its line of credit obtained
during March 2005. Under regulations of the OTS, without prior approval, the
dividends from 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, at March 31, 2005,
the Company had $11.7 million in cash and cash equivalents along with $270,000
million in securities available-for-sale.

CONTRACTUAL OBLIGATIONS. The following table presents significant fixed
and determinable contractual obligations to third parties by payment date as of
March 31, 2005.

(1) Does not include interest expense at the weighted-average contractual rate
of 3.65% for the periods presented.

See the "Deposits and Borrowed Money" 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.

The Company also has commitments to fund certificates of deposit which
are scheduled to mature within one year or less. These deposits totaled $258.8
million at March 31, 2005. 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

25

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 for commitments to extend credit and letters of credit is represented by
the contractual notional amount of these instruments. The Company uses the same
credit policies in making commitments and conditional obligations as it does for
on-balance sheet instruments.

The following table details the amounts and expected maturities of
significant commitments as of March 31, 2005.

The above listed commitments do not necessarily represent future cash
requirements in that these commitments often expire without being drawn upon.

Letters of credit include credit enhancements which are related to the
issuance by municipalities of taxable and nontaxable revenue bonds. The proceeds
from the sale of such bonds are loaned to for-profit and not-for-profit
companies for economic development projects. In order for the bonds to receive a
triple-A rating 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 traded in and has no intention of trading
in derivatives or commodity contracts.

26

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE 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 March 31, 2005, the Bank had approximately $718.2 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 March 31, 2005, 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 March 31, 2005, the Bank had $490.5 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.

The table below presents, as of March 31, 2005 and December 31, 2004,
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 200 basis points in 2005 and 2004 in
accordance with OTS regulations. At March 31, 2005 and December 31, 2004, the
Bank was within the Board-approved tolerance limits in each rate scenario.

27

(1) Information as of December 31, 2004 was not available from the OTS.

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.

ITEM 4. CONTROLS AND PROCEDURES

No change in the Company's internal control over financial reporting
(as defined in Rule 13a - 15(f) or 15(d) - 15(f) under the Securities Exchange
Act of 1934, as amended) occurred during the last fiscal quarter that has
materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.

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 upon that 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.

Disclosure controls and procedures are the Company's controls and other
procedures that are designed to ensure that information required to be disclosed
by the Company in the reports that it files or submits under the Exchange Act is
recorded, processed, summarized and reported

28

within the time periods specified in the SEC's rules and forms. Disclosure
controls and procedures include, without limitation, controls and procedures
designed to ensure that information required to be disclosed by the Company in
the reports that it files or submits under the Exchange Act is accumulated and
communicated to the Company's management, including its Chief Executive Officer
and Chief Financial Officer, as appropriate, to allow timely decisions regarding
required disclosure.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The Bank's suit that was filed against the U.S. government during 1993,
Citizens Financial Services, FSB v. United States, went to trial in June 2004 in
the U.S. Court of Claims. The Bank previously had been granted summary judgment
on its breach of contract claim, leaving for trial the issue of damages. The
trial concluded in early July 2004. On March 7, 2005, the Court of Claims
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. The
Government has indicated that these costs are less than $5,000. Management of
the Company is currently reviewing its options and whether or not to pursue an
appeal of the matter.

On February 13, 2005, the Bank filed suit in the Lake County Superior
Court sitting in Hammond, Indiana, to foreclose on its loans made to a golf
course in the case titled Citizens Financial Services, FSB v. Innsbrook Country
Club, Inc. and the New Innsbrook Country Club, LLC and identified Case No.
45D05-0402-PL-30. The loans in question have a balance of over $2.2 million.
Subsequent to the Bank's initiation of foreclosure proceedings, the current
owners of the property counterclaimed in the same action for damages, due to the
Bank's alleged bad faith and breach of an alleged oral agreement with current
ownership. At this stage, the opposing party has not made a formal demand for a
specific amount of damages; thus, the Bank cannot, with any degree of certainty,
determine the amount of any potential loss.

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 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

(a) - (b) Not applicable.

(c) The following table presents information related to purchases made
by or on behalf of the Company of shares of the Company's common stock during
the indicated periods.

29

(1) The Company publicly announced on March 17, 2003 a repurchase program for
1,200,000 shares. Prior to January 1, 2005, a total of 19,844 shares had been
repurchased under that program. A total of 15,361 shares were purchased in April
2005 under this program.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

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

(a) An annual meeting of stockholders of the Company was held on April
26, 2005 (Annual Meeting).

(b) None.

(c) There were 12,385,087 shares of Common Stock of the Company
eligible to be voted at the Annual Meeting, and 10,663,711 shares were
represented at the meeting by the holders thereof, which constituted a quorum.
The items voted upon at the Annual Meeting and the vote for each proposal were
as follows:

(1) Election of directors for a three-year term.

Gregory W. Blaine 9,534,361 FOR 1,129,350 WITHHELD
Robert R. Ross 9,673,972 FOR 989,739 WITHHELD
Joyce M. Simon 9,909,897 FOR 753,814 WITHHELD

(2) Approval to reincorporate the Company in the State of Indiana.

6,758,911 FOR 655,984 AGAINST 100,592 ABSTAIN
3,148,222 BROKER NON-VOTES

(d) None.

ITEM 5. OTHER INFORMATION

Not applicable.

30

ITEM 6. EXHIBITS

(a) List of exhibits (filed herewith unless otherwise noted).

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 (7)

10.14 Employment Agreement entered into between CFS Bancorp, Inc.
and Zoran Koricanac (7)

10.15 Amended and Restated Supplemental ESOP Benefit Plan of CFS
Bancorp, Inc. and Citizens Financial Services, FSB (7)

10.16 CFS Bancorp, Inc. Directors' Deferred Compensation Plan (7)

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 quarterly report on Form
10-Q for the quarterly period ended September 30, 2003.

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

31

(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 quarterly report on Form
10-Q for the quarterly period ended September 30, 2004.

(7) Incorporated by Reference from the Company's annual report on Form 10-K
for the year ended December 31, 2004.

32

SIGNATURES

In accordance with the requirements of the Securities Exchange Act of 1934, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.

CFS BANCORP, INC.

Date: May 10, 2005 By: /s/ Thomas F. Prisby
---------------------------------------------
Thomas F. Prisby, Chairman and
Chief Executive Officer

Date: May 10, 2005 By: /s/ Charles V. Cole
---------------------------------------------
Charles V. Cole, Executive Vice President and
Chief Financial Officer

33