Dear Loyal Customers,

Last year, I acknowledged that we had no clear idea how much the national recession would affect the local economy. We know now that it negatively affected our market more than we hoped but much less than it did other markets throughout the country. I promised that in 2009 we would focus our attention on preserving capital, controlling expenses, and expanding the net interest margin, and that our goal would be to continue generating positive earnings. Although we are not satisfied with our earnings, we are encouraged with the progress made on the other three objectives.

First, we ended the year with a ratio of “Tier 1 capital” to assets of 9.13%, which compares favorably with the regulatory minimum level of 5.00%. This level, virtually the same as at year-end 2008, is what we hoped to accomplish when we rejected the government’s bailout in February 2009. At that time, we felt that our conservative investment strategies and philosophy of lending close to home would serve us well as we weathered the recession. It has.

In July, to help meet our second objective, we launched the “Incredible Cost Saves” program. We asked all our employees to help us come up with cost-saving ideas. Our goal was $139,000 in savings for the last half of the year. Well, when you ask the right people, the results can be amazing! Identified savings topped $150,000, with several “saves” still being implemented.

The majority of our non-interest expense increase this year relates to the $68 million in residential loans that we generated and sold on the secondary market and the additional assessments we paid to replenish the FDIC insurance fund.

Our third objective was to improve the net interest margin. Unlike Wall Street banks, we generate nearly 80% of our revenue from our net interest income—that is, the difference between what we earn on loans and investments and what we pay out to depositors. In 2008, our net interest margin dropped 45 basis points; in 2009, however, we were able to hold the decrease to just 3 basis points, a decided improvement! The margin bottomed out in the first quarter of 2009. Each quarter during the rest of the year, the net interest margin got a little better, hitting 3.27% for the fourth quarter. One of the main contributing factors to this improvement was the yearlong effort by our branch staff to become the only bank our customers need. This emphasis resulted in a $26.6 million increase in core deposits that allowed us to pay down or run off higher-priced deposits and Federal Home Loan Bank advances.

Finally, generating profits was an industry wide struggle in 2009. The FDIC reported that one out of every four FDIC-insured institutions in Indiana lost money last year. Our net income for 2009 was $460,000, or $0.30 per share, compared to $1,740,000, or $1.12 per share, in 2008. Our results equate to a return on average equity of 1.34% and a return on assets of 0.12%, slightly better than the Indiana peer average of 0.07% and 0.01%, respectively.

That our market did not avoid the effects of the national recession showed most in our non-performing assets, which increased to $14.5 million, representing 3.91% of our total assets. This level is higher than in 2008, and is the primary reason we increased our loan loss provision to $3.2 million for the year. To put this in perspective, $7.5 million of the non-performing loans can be attributed to six borrowers. Some 95% of our non-performing loans are collateralized by real estate with an average loan-to-value of 65%.

Although working through these situations will take time, we believe they are all manageable. In the last five years, we have had to reserve over $8 million for potential loan losses; $4 million of that provision sits in our loan loss reserve, which now represents 1.16% of total loans.

Despite numerous efforts by the federal government to ignite business lending, we continue to see fewer loan opportunities and more competition than we did last year at this time. Total loans ended the year at $321 million, down 1.7%. A substantial number of borrowers did take advantage of the first-time homebuyer tax credit and low rates to purchase or refinance their homes. In total, we generated and sold $68.7 million in residential loans, most during the first half of 2009.

Now for the positives … and we do see some in the local economy. (1) Several of the larger employers have announced callbacks. (2) Our area’s year-end 8.5% unemployment rate is better than that of either the state of Indiana or the United States. (3) Federal Housing Finance Agency data show our metropolitan statistical area (MSA) in the top 10% in appreciation four of the last five quarters. Obviously, we do not expect overnight improvement in the local economy, but we do see encouraging signs.

Lafayette Savings Bank has always operated under the principle of being a community bank. Despite the difficult economic environment, we have held fast to that belief. In 2009, we financially supported 58 local not-for-profits, and one-third of our employees took active roles as volunteer leaders in these organizations. Our community involvement was recognized during the year. We received the Marquis de Lafayette award from the Lafayette Chamber of Commerce for our community involvement. We are only the third company to receive this prestigious award, after Kirby Risk and Eli Lilly. In addition, we received the Governor’s Century Award, which recognizes businesses that have been in existence for over 100 years and have demonstrated a history of community involvement.

Finally, in 2009 we celebrated our 140th anniversary as Lafayette Savings Bank. In 140 years of operation, this may well have been the second most difficult economy for the bank. However, we started as Lafayette Savings Bank, and we remain Lafayette Savings Bank— dedicated to improving our position and shareholder value by building an ever stronger franchise in Tippecanoe County.

Thank you for your continued support during this difficult economic period, and we welcome any comments or questions.

Randolph F. Williams

President/CEO

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