Annual Report (10-k)

ITEM 1        BUSINESS.

Company Overview

Tower Financial Corporation, collectively with its subsidiaries, the “Company,” was incorporated as an Indiana corporation on July 8, 1998. We are a bank holding company with one bank subsidiary, Tower Bank & Trust (the “Bank” or “Tower Bank”) and two unconsolidated subsidiary guarantor trusts, Tower Capital Trust 2, and Tower Capital Trust 3.

The Bank is an Indiana chartered bank with depository accounts insured by the Federal Deposit Insurance Corporation (“FDIC”) and is a member of the Federal Reserve System. Tower Capital Trust 2 and Tower Capital Trust 3 are unconsolidated, wholly-owned Delaware statutory business trusts formed in December 2005 and December 2006, respectively, for the exclusive purpose of raising Federal Reserve approved capital through the issuance and sale of securities known as trust preferred securities. The Bank has a direct wholly-owned trust company subsidiary, Tower Trust Company (the “Trust Company”), an Indiana Corporation formed on January 1, 2006 which was previously owned by the bank holding company until December 1, 2009.

Our Bank opened on February 19, 1999 and provides a range of commercial and consumer banking services from six locations in the metropolitan area of Fort Wayne, Allen County, Indiana, and one location in Warsaw, Indiana. The Bank’s lending strategy is focused on commercial and commercial mortgage loans and, to a lesser extent, on consumer and residential mortgage loans. The Bank offers a broad array of deposit products, including checking, savings, money market accounts, certificates of deposit and direct deposit services. Trust investment and management services are offered by the Trust Company.

Our main office and corporate headquarters are located at 116 East Berry Street in downtown Fort Wayne, Indiana.

On September 10, 2013, we filed a Current Report on Form 8-K with the Securities and Exchange Commission in which we and Old National Bancorp (“Old National”) jointly announced the signing of a definitive agreement (the “Agreement”) pursuant to which we will be merged with and into Old National (the “Merger”). Simultaneously with the Merger, our wholly-owned subsidiary Tower Bank & Trust Company, will be merged with an into Old National Bank, a national banking association and wholly-owned subsidiary of Old National, with Old National Bank as the surviving bank. The closing is anticipated to take place in second quarter of 2014.

Cautionary Note Regarding Forward-Looking Statements

Throughout this Annual Report on Form 10-K, or in other reports or registration statements filed from time to time with the Securities and Exchange Commission under the Securities Exchange Act of 1934, or under the Securities Act of 1933, as well as in documents we incorporate by reference or in press releases or oral statements made by our officers or representatives, we may make statements that express our opinions, expectations, or projections regarding future events or future results, in contrast with statements that reflect historical facts. These predictive statements, which we generally precede or accompany by such typical conditional words such as "anticipate," "intend," "believe," "estimate," "plan," "seek," "project," "potential," or "expect," or by the words "may," "will," "could," or "should," and similar expressions or terminology are intended to operate as "forward-looking statements" of the kind permitted by the Private Securities Litigation Reform Act of 1995. That legislation protects such predictive statements by creating a "safe harbor" from liability in the event that a particular prediction does not turn out as anticipated.

Forward-looking statements convey our current expectations or forecast future events. While we always intend to express our best judgment when we make statements about what we believe will occur in the future, and although we base these statements on assumptions that we believe to be reasonable when made, these forward-looking statements are not a guarantee of performance, and you should not place undue reliance on such statements. Forward-looking statements are subject to many uncertainties and other variable circumstances, many of which are outside of our control, that could cause our actual results and experience to differ materially from those we thought would occur.

Important factors that could cause actual results to differ materially from our expectations include, without limitation, the following:

Please also refer to the “Risk Factors” section of this report for a discussion of some of the principal risks and uncertainties inherent in our businesses.

Any forward-looking statements which we make in this report or in any of the documents that are incorporated by reference herein speak only as of the date of such statement, and we undertake no ongoing obligation to update such statements. Comparisons of results between current and any prior periods are not intended to express any future trends or indications of future performance, unless expressed as such, and should only be viewed as historical data.

Tower Bank

Lending

We generally make loans to individuals and businesses located in Allen, Kosciusko and the surrounding counties in Northeast Indiana. Our loan portfolio at December 31, 2013 consisted of commercial and commercial real estate loans (74.6%), residential mortgage loans (16.9%) and personal loans (8.5%). The Bank’s legal lending limit under applicable federal banking regulations is approximately $12.6 million, based on the legal lending limit of 15% of the Bank’s total risk-based capital. We continue to pursue opportunities with both new and existing customers to originate new loans in order to increase our earning assets.

Our Loan Segments:

Commercial Loan: Our lending activities focus primarily on providing small- and medium-sized businesses in our market area with commercial loans. These loans can be both secured and unsecured and are made available for general operating purposes, including acquisition of fixed assets such as real estate, equipment and machinery, and lines of credit collateralized by inventory and accounts receivable.

Our customers typically have financing needs between $250,000 and $5.0 million. Commercial loans comprised 52% of our total loans at December 31, 2013 and the majority of these loans are secured liens on equipment, inventory and other assets. These loans are also sometimes secured by owner-occupied or investment real estate, and typically have maturities of one to five years.

Commercial and industrial loans also include revolving notes for working capital that range in maturity from on demand to no longer than two years, with the majority of these having a one year maturity. Commercial real estate loans comprised 22.6% of our total loans at December 31, 2013. Commercial and commercial real estate loans can have either fixed or floating interest rates.

Commercial real estate lending involves more risk than residential lending because loan balances are typically greater and repayment is dependent not only upon general economic conditions and the continuing merits of the particular real estate project securing the loan, but also upon the underlying value of the collateral and the borrower’s financial health and liquidity. Accordingly, we believe we have reduced the risk associated with these transactions by establishing limits for concentration in certain types of loans, projects, and borrowers, developed additional checks and balances in the approval process, increased underwriting standards and employed a higher degree of oversight.

In 2013, we remained focused on improving our asset quality and growing our loan portfolio. As a result of our efforts over the past several years, we have been able to reduce the loans categorized as special mention, substandard, or doubtful. The decreases in these categories have resulted from the liquidation of collateral, encouraging and assisting with the refinancing of these loans through other financial institutions, or taking additional charge-offs against certain loans. We have also continued to place a greater emphasis on credit quality by focusing on the timely collection of required financial statements, centralization of consumer and retail small business (commercial loans under $250,000) loan underwriting, adherence to our internal policy and guidelines, and allocation of additional resources to improve the efficiency, quality and consistency of all loans underwritten.

The following table illustrates the recorded investment ⁽¹⁾ of loans by risk category for the years ending December 31, 2013, 2012, and 2011.

⁽¹⁾ The recorded investment in loans includes accrued interest and deferred fees, less nonaccrual interest paid, and deferred costs.

Mortgage Banking : We provide fixed rate, long-term residential mortgage loans and floating, short-term construction loans to our customers. Our general policy, which is subject to periodic review by management, is to sell the majority of the mortgage loans we originate on the secondary market. We generally retain only those loans where we have ongoing, multi-faceted customer relationships or those that allow us to keep our portfolio at benchmark levels and support our commitment to our customers and community. All other loans are sold, or are originated on a brokered basis for another investor.

We utilize both correspondent and wholesale delivery methods for sold loans where we may also have delegated underwriting and closing responsibility. In 2013, we received an average of 1.68% of the loan amount between the service release premium and fees on sold and brokered loans. We do not retain servicing rights with respect to residential mortgage loans that we broker or sell.

During 2013, we originated $6.2 million in construction loans and $71.8 million of residential mortgage loans. We retain all construction loans in our loan portfolio. Of the $71.8 million of residential mortgage loans originated, we retained $15.7 million, sold $49.9 million in the secondary market, and brokered $6.2 million. These loans were a combination of traditional conventional loan products, jumbo whole loans, and government loan programs (FHA/VA). We neither originated nor purchased any subprime loans in 2013, nor have we done so historically.    

Personal Loans and Lines of Credit : We make personal loans and lines of credit available to consumers for various purposes, such as the purchase of automobiles, boats and other recreational vehicles, as well as to make home improvements and personal investments. The majority of our personal loans are home equity loans secured by a second lien on real estate. We retain these loans in our portfolio.

Consumer loans generally have shorter terms and higher interest rates than residential mortgage loans and usually involve more credit risk than mortgage loans because of the type and nature of the collateral. Consumer lending collections are dependent on a borrower’s continuing financial stability and are thus likely to be adversely affected by job loss, illness and personal bankruptcy. In many cases, repossessed collateral for a defaulted consumer loan will not provide an adequate source of repayment of the outstanding loan balance because of depreciation of the underlying collateral.

In order to maximize our consumer loan approval efficiencies and ensure we met our customer’s service expectations, we utilize centralized underwriting. We continue to pursue a policy of prudent loan underwriting, with an emphasis on our borrower’s credit history, collateral value, employment stability, and monthly income. Consumer loans are generally repaid on a monthly repayment schedule with the payment amount tied to the borrower’s periodic income. We believe that the generally higher yields earned on consumer loans help to compensate for the increased credit risk associated with such loans, and we believe that consumer loans are important to our efforts to serve the credit needs of our customer base. Historically, our delinquency rates and losses on consumer loans have been lower than that of the national average, which held true in 2013.

Our Lending Policies:

Loan Policies : Although we maintain a competitive approach to lending, we strive to underwrite high quality loans. We employ written loan policies that contain general lending guidelines and are subject to periodic review and revision by our Bank Board’s Loan and Investment Committee and our Board of Directors. These policies relate to loan administration, documentation, and approval and reporting requirements for various types of loans.

Our loan policies include procedures for oversight and monitoring of our lending practices and loan portfolio. We seek to make sound loans, while recognizing that lending money involves a degree of business risk. Our loan policies are designed to assist in managing the business risk involved in making loans. These policies provide a general framework for our lending operations, while recognizing that not all loan outcomes and results can be anticipated. Our loan policies instruct lending personnel to use care and prudent decision-making and to seek the guidance of our Chief Executive Officer, Chief Lending Officer, Director of Lending, and the Executive Vice President of Risk Management where appropriate.

We maintain a separate credit department that is responsible for the integrity of data used by lending personnel for underwriting decisions. Additionally, our credit department is responsible for providing independent financial analysis and credit assessments for loan aggregations above $250,000. Our credit department also assists in the application of loan policy and the identification of unresolved or potential credit issues. We have also engage an independent accounting firm to perform a review of our loan accounting and credit risk ratings.

Our loan policies provide limits for loan-to-value ratios that limit the size of certain types of loans to a maximum percentage of the value of the real estate collateral securing the loans. The loan-to-value percentage varies by the type of collateral. The Federal Deposit Insurance Corporation Improvement Act of 1991 established regulatory and supervisory loan-to-value limits. Our internal loan-to-value limitations follow those limits and, in certain cases, are more restrictive than those required by regulators. However, exceptions may be made to these limits and are allowable under the regulatory rules as long as the aggregate balance of these exceptions does not exceed certain capital thresholds. Exception balances are below the capital thresholds established by regulatory rules.

Our loan policies include an “in-house” guideline limit of $5 million on the aggregate amount of loans to any one borrower. Our loan committee approves all loan relationships above $1 million. Additionally, the Bank Board’s Loan and Investment Committee reviews all lending relationships over $5.0 million on a quarterly basis. This internal limit is subject to review and revision by our Board of Directors from time to time. In addition, our loan policies provide guidelines for (i) personal guarantees, (ii) loans to employees, executive officers and directors, (iii) problem loan identification, (iv) maintenance of an allowance for loan losses (v) interest reserves, and (vi) other matters relating to our lending practices.

Our Underwriting Policies:

Commercial Loans : Commercial loans are underwritten using an analysis of the customer’s current and historical financial statements. The type of financial statement that we require (audited, reviewed, compiled, tax return, or internally prepared) varies depending on the credit size, complexity, and risk. In addition to historical financial statements, projections may be required for loans with a term greater than one year. For all aggregated borrowing relationships in excess of $250,000, a cash flow analysis is completed for each corporate borrower, and a debt-to-income ratio is calculated for each personal guarantor. For those relationships where reliance is placed on a borrower or guarantor that is involved in multiple loans, business ventures or real estate projects, both a separate cash flow analysis and a consolidated global cash flow analysis is performed. In addition, we review the quality and value of collateral provided to determine the appropriate advance rates and analyze the risks inherent in the business enterprise to determine the appropriate financial covenant package.

Commercial Real Estate Loans: We will consider commercial real estate financing for any feasible project including land loans, acquisition and development loans, construction loans and long-term mortgages for income producing and investment properties. We will not extend loans to developers or builders who have been subject to a foreclosure action or have given a creditor a deed in-lieu of foreclosure. Commercial Real Estate loans are generally structured to provide full recourse or limited recourse to all principals and owners.

All real estate credit extensions are to meet high standards of quality and are to be in compliance with the Bank’s policies. Our relationship managers are required to document and provide explanations for any exceptions to our underwriting policies.

Residential Mortgage Loans: Residential mortgage loans are defined as loans for primary or secondary residences. Loans for rental properties will not be considered under the guidelines for residential mortgage underwriting, but instead are to be considered as business loan requests subject to our Commercial Real Estate guidelines.

Loans sold into the secondary market are not subject to these guidelines. Portfolio loans must adhere to all requirements established in our lending guidelines regarding the borrower and property characteristics, including net worth, debt-to-income ratios, credit reporting, and collateral requirements.

Our goal is to offer mortgage loans on owner-occupied real estate at competitive rates and terms to customers in our defined lending areas. Mortgage loan terms should be related to the nature and market value of the security property, as well as income, future earning ability and credit history of the borrower. Mortgages should be made in anticipation of regular amortization, not foreclosure.

Rates for residential mortgage loans are fixed or variable for the term of the loan. The Company does not underwrite any hybrid loans, or sub-prime loans within its residential portfolio. Adjustable rate loans are primarily tied to the Prime Rate index and LIBOR Rate index as stated in the Wall Street Journal .

Home Equity Loans: Home equity loans and home equity lines of credit are underwritten using the same guidelines and procedures outlined above for residential mortgage loans. We cap the loan to value maximum for home equity loans or lines of credit at 90% of the appraised value.

Consumer Loans: All consumer loans are to be supported by a signed, completed credit application disclosing loan purpose, applicant’s income and obligations, and repayment terms. Related documents should include a current or recent credit bureau report, proof of income (level of documentation dependent upon the loan type and amount), valuation of collateral (dependent on type of collateral), and other required documentation as outlined in the bank’s Loan Policy and Guidelines. Unsecured consumer loans of $5,000 and larger must also have a current financial statement on file on a form acceptable to the Company.

Typically, the rates for variable rate loans in all categories are underwritten using the Prime Rate index or LIBOR index as stated in the Wall Street Journal . Typical loan terms on these types of products range from one to five years with interest rates between 0.00% to 3.00% over the Prime Rate or LIBOR.

Sources of Our Funds

In 2013, the Bank paid dividends to the Company in the amount of $3.4 million. Those funds were used to pay stockholders dividends in the amount of $2.6 million and to repurchase shares of our common stock in the amount of $863,000. In 2012, the Bank paid a dividend to the Company in the amount of $5.7 million and those funds were used to pay stockholders a $2.9 million dividend; to repurchase shares of our common stock in the amount of $1.7 million; and to fund the purchase of a $1.0 million par value equity security held at the Holding Company for $902,900. In 2011, no inter-company contributions were made; nor did we pursue any capital sources other than through our net income.

On an ongoing basis, the Bank funds its operations and loan growth primarily through local deposits. Secondarily, the Bank uses alternative funding sources as needed, including advances from the Federal Home Loan Bank, out-of-market deposits (including national market certificates of deposit and brokered certificates of deposit) and other forms of wholesale financing. At the end of 2013, core deposits comprised 81.9% of total deposits compared to 80.8% and 78.7% at December 31, 2012 and December 31, 2011, respectively.

Deposit Generation: We generate deposits primarily through offering a broad array of products to individuals, businesses, associations, financial institutions, and government entities in our primary market areas. We generally seek a comprehensive banking relationship from our lending customers, which has contributed to our internal deposit growth. This often includes encouraging new customers to consider both business and personal checking accounts and other deposit services. Our deposit services include checking, savings, health savings accounts, money market accounts, certificates of deposit, direct deposit services, and telephone and Internet banking. Our deposit portfolio increased by approximately $37.4 million during 2013. Interest-bearing checking accounts increased by $23.2 million, primarily the result of an increase of $15.6 million in our Health Savings Accounts. During 2013, money-market accounts, savings accounts and non-interest bearing checking accounts increased by $10.1 million, $3.9 million and $2.6 million respectively, while certificates of deposits, both in-market and brokered, decreased by $2.4 million.

In 2013, the average cost of funds on out-of-market deposits was 1.94%, while the average cost of funds on in-market deposits was 0.10%. At December 31, 2013, approximately 84.2% of our deposits were generated in-market, while 15.8% were out-of-market deposits, compared to 83.9% of in-market deposits and 16.1% out-of-market deposits at December 31, 2012.

Deposits at December 31, 2013, 2012, and 2011 are summarized as follows:

Investments

We invest funds from time to time in various debt instruments, including but not limited to obligations guaranteed by the United States, general obligations of a state or political subdivision thereof, bankers’ acceptance of deposit of U.S. commercial banks, commercial paper of U.S. issuers rated in the highest category by a nationally recognized statistical rating organization, or trust preferred securities.

We are permitted to make limited portfolio investments in equity securities and we currently have two of these investments. The first is an investment of $2.0 million in Senior Housing Crime Prevention fund that is specifically allocated to a facility in Warsaw, Indiana. The second is an equity investment with an initial investment of $1 million in a limited partnership focused primarily on bank holding companies. Due to the volatility of the equity investment in the limited partnership as well as the accounting treatment for the investment, the Board of Directors approved the gradual liquidation of this investment. In 2009, requests were made to liquidate the investment. Disbursements received in 2013, 2012, 2011, 2010, and 2009 were $18,499, $0, $9,390, $23,022, and $740,437, respectively, leaving a value of $41,890 as of December 31, 2013. The remaining balance is invested in side-pocket investments, which are primarily made up of small equity investments in local start-up businesses, and is projected to be fully liquidated in the next couple of years.

Additionally, the bank subsidiary has made investments in two Section 42 Housing Credit funds totaling $2.4 million. These funds own Section 42 accredited housing projects that provide federal tax credits to their investors over a 10 to 15 year period. The tax credits expected are equal to our investment of $2.4 million.

We may invest our funds in a wide variety of debt instruments and may participate in the federal funds market with other depository institutions. Real estate, which we may acquire in satisfaction of or as a result of foreclosure upon loans and which at December 31, 2013 amounted to $2.2 million, may be held for no longer than ten years after the date of acquisition without the written consent of the Indiana Department of Financial Institutions (“IDFI”). We are also permitted to invest an aggregate amount not to exceed 50% of our “sound capital” in various other real estate and buildings as are necessary for the convenient transaction of our business, such as but not limited the ownership of branch banking facilities.

Tower Trust Company

Investment Management and Trust Services

Our investment management and trust services provide a wide range of traditional personal trust services to customers in our market area. Our trust services include estate planning and money management, as well as traditional revocable trusts, irrevocable trusts, charitable trusts, estate administration, guardianship administration, individual retirement account administration, personal and institutional investment management, and custodial services. We believe that by offering trust services through personalized client service, an experienced professional staff, and a tailored approach to investments that we can enhance and leverage client relationships.

The following table reflects assets under management and revenue derived from trust services for the periods indicated.

Tower Investment Services

In July of 2004, we began offering securities and insurance brokerage services under the private label name of Tower Investment Services. Until December of 2012, the services were provided through PrimeVest Financial Services, Inc. Beginning in December of 2012, we changed our provider of brokerage services to LPL Financial, a self-clearing broker dealer. Tower Investment Services had $204.5 million in assets under management at December 31, 2013, compared to $192.6 million at December 31, 2012.

The following table reflects assets under management and revenues of our investment services department for the periods indicated.

Effect of Government Monetary Policies

Our performance and our results are affected by domestic economic conditions and the monetary and fiscal policies of the United States government, its agencies and the Federal Reserve Board (“Federal Reserve”). The Federal Reserve’s monetary policies have had, and will continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order, among other things to, curb inflation or, conversely, to stimulate the economy. The instruments of monetary policy employed by the Federal Reserve include open market operations in U.S. government securities, changes in the discount rate on member bank borrowing and changes in reserve requirements against deposits held by all federally insured banks. During 2008, the Federal Reserve lowered the federal funds discount rate to 0.25% where it remains at December 31, 2013. The drop in interest rates in 2008 continues to have an impact on the Company over the past three years by forcing the Company to reduce both loan and deposit rates to remain competitive in the local market. While interest rates have remained low the last several years, we do not expect much change in the near future based on statements from the Federal Reserve. Federal officials have stated that prolonged economic conditions would warrant exceptionally low levels for the federal funds rate at least through 2015.

Regulation and Supervision

General

Financial institutions and their holding companies are extensively regulated by federal and state law. Consequently, our growth and earnings performance can be affected not only by management decisions and general economic conditions, but also by the regulations and policies of, various governmental regulatory authorities. Those authorities include but are not limited to the Federal Reserve, the FDIC, the IDFI, the Internal Revenue Service and the state taxing authorities. The effect of such regulations and policies can be significant and cannot be predicted with any high degree of certainty.

Federal and state laws and regulations generally applicable to our business regulate among other things:

The foregoing system of supervision and regulation establishes a comprehensive framework, and is intended primarily for the protection of the FDIC’s deposit insurance funds, the depositors of the Bank and the public, rather than our stockholders, and any change in government regulation may have a material adverse effect on our business.

Bank Holding Company Regulation

As a bank holding company, we are subject to regulation by the Federal Reserve under the Federal Bank Holding Company Act of 1956, as amended (the “FBHC Act”). Under the FBHC Act, we are subject to examination by the Federal Reserve and are required to file reports of the Company’s operations and such additional information as the Federal Reserve may require. Under Federal Reserve policy, we are expected to act as a source of financial strength to the Bank and to commit resources to support the Bank in circumstances where we might not do so absent such policy.

Any loans by a bank holding company to a subsidiary bank are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary bank. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority of payment.

With certain limited exceptions, the FBHC Act prohibits bank holding companies from acquiring direct or indirect ownership or control of voting shares or assets of any company other than a bank, unless the company involved is engaged in one or more activities which the Federal Reserve has determined to be so closely related to banking or managing or controlling banks as to be incidental to these operations. Under current Federal Reserve regulations, including rules under which we qualify as a bank holding company as described in the following paragraph, such permissible non-bank activities include such things as mortgage banking, equipment leasing, securities brokerage, and consumer and commercial finance company operations. As a result of recent amendments to the FBHC Act, many of these acquisitions may be affected by bank holding companies that satisfy certain statutory criteria concerning management, capitalization, and regulatory compliance, if written notice is given to the Federal Reserve within ten business days after the transaction. In certain cases, prior written notice to the Federal Reserve will be required. Notwithstanding the scope of these permissible activities, we have not organized nor have we sought to establish any of these types of businesses.

The Federal Reserve uses capital adequacy guidelines in its examination and regulation of bank holding companies. If capital falls below minimum guidelines, a bank holding company may, among other things, be denied approval to acquire or establish banks or non-bank businesses. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Capital Sources."

Bank Regulation

Our Bank is an Indiana banking corporation and a member of the Federal Reserve System. As a state-chartered member bank, we are subject to the examination, supervision, reporting and enforcement jurisdiction of the IDFI, as the chartering authority for Indiana banks, and the Federal Reserve as the primary federal bank regulatory agency for state-chartered member banks. Our deposit accounts are insured by the Bank Insurance Fund of the FDIC.

These agencies, and federal and state law, extensively regulate various aspects of the banking business including, among other things:

Federal law and regulations, including provisions added by the Federal Deposit Insurance Corporation Improvement Act of 1991 and regulations promulgated thereunder, establish supervisory standards applicable to the lending activities of the Bank, including internal controls, credit underwriting, loan documentation, and loan-to-value ratios for loans secured by real property.

The Bank is subject to certain federal and state statutory and regulatory restrictions on any extension of credit to Tower Financial Corporation or any of our subsidiaries, on investments in our stock or other securities of our subsidiaries, and on the acceptance of our stock or other securities of our subsidiaries as collateral for loans to any person. Limitations and reporting requirements are also placed on extensions of credit by the Bank to its directors and officers, to our directors and officers and to the directors and officers of our subsidiaries, to our principal stockholders, and to “related interests” of such persons. In addition, such legislation and regulations may affect the terms upon which any person becoming a director or officer of Tower Financial Corporation or one of our subsidiaries or a principal stockholder of Tower Financial Corporation may obtain credit from banks with which we maintains a correspondent relationship. Also, in certain circumstances, an Indiana banking corporation may be required by order of the Department to increase our capital or reduce the amount of our deposits.

The federal banking agencies have published guidelines implementing the FDIC’s requirement that the federal banking agencies establish operational and managerial standards to promote the safety and soundness of federally insured depository institutions. The guidelines establish standards for internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, and compensation, fees and benefits. In general, the guidelines prescribe the goals to be achieved in each area, and each institution is responsible for establishing its own procedures to achieve those goals. If an institution fails to comply with any of the standards set forth in the guidelines, the institution’s primary federal bank regulator may require the institution to submit a plan for achieving and maintaining compliance. The preamble to the guidelines states that the agencies expect to require a compliance plan from an institution whose failure to meet one or more of the standards is of such severity that it could threaten the safe and sound operation of the institution. Failure to submit an acceptable compliance plan, or failure to adhere to a compliance plan that has been accepted by the appropriate regulator, would constitute grounds for further enforcement action.

Insurance of Deposit Accounts

As an FDIC-insured institution, the Bank is required to pay deposit insurance premiums based on the risk it poses to the Bank Insurance Fund. The FDIC also has authority to raise or lower assessment rates on insured deposits to achieve the statutorily required reserve ratios in insurance funds and to impose special additional assessments. The FDIC has utilized a risk based assessment system since 2008. Under this system, the banks are evaluated based on three primary sources of information: supervisory ratings, financial ratios, and long-term debt issuer ratings (for large institutions only). Due to a large number of bank failures throughout the United States in 2008 and 2009, the FDIC deposit insurance fund was depleted and required additional assessments to replenish the fund to an acceptable level. Premiums were not only increased to replenish the fund, but because of additional operating expenses the FDIC would incur due to increased resolution activities expected in the future.

Also, in 2008, the FDIC increased the limit of insured funds to $250,000 on interest-bearing deposits and an unlimited amount on noninterest-bearing deposits compared to the previous limit of $100,000 on all deposits. These temporary limits for unlimited insurance on noninterest-bearing accounts ended on December 31, 2012, but the increased limit on all deposit accounts up to $250,000 was permanently implemented to ease the fears of banking customers after the bank failures over the recent years. Based on these additional costs, the FDIC raised the assessment rates in 2009, assessed a one-time special assessment due September 30, 2009 equal to five basis points of total assets less Tier 1 Capital, and issued an assessment to prepay the quarterly assessments for the fourth quarter 2009, and for all 2010, 2011 and 2012 along with the quarterly risk-based assessment for the third quarter of 2009 on December 30, 2009.

The FDIC began drawing down prepaid assessments on March 30, 2010, representing payment for the regular quarterly risk-based assessment for the fourth quarter of 2009. Each institution continues to receive quarterly assessment statements from the FDIC and expenses the amount due, but the institution’s quarterly risk-based deposit insurance assessments are paid through a reduction in the amount prepaid in March of 2010 until that amount is exhausted or until December 31, 2014, when any amount remaining will be returned to the institution. The remaining balance in our prepaid FDIC assessment account was paid off as of December 31, 2013.

Consumer and Other Laws

The Bank’s business also includes making a wide variety of consumer loans. When making consumer loans, the Bank is subject to state usury and regulatory laws and to various federal statutes, such as the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Truth in Lending Act, the Real Estate Settlement Procedures Act, the Secure and Fair Enforcement for Mortgage Licensing Act and the Home Mortgage Disclosure Act, as well as the regulations promulgated thereunder, which prohibit discrimination, specify disclosures to be made to borrowers regarding credit and settlement costs and regulate the mortgage loan servicing activities of the Bank, including the maintenance and operation of escrow accounts and the transfer of mortgage loan servicing.

The Riegle Act imposed new escrow requirements on depository and non-depository mortgage lenders and services under the National Flood Insurance Program. In receiving deposits, the Bank is subject to extensive regulation under state and federal law and regulations, including the Truth in Savings Act, the Expedited Funds Availability Act, the Bank Secrecy Act, the Electronic Funds Transfer Act, and the Federal Deposit Insurance Act. Violation of these laws could result in the imposition of significant damages and fines upon the Bank, its directors and officers.

The Gramm-Leach-Bliley Act (or "Gramm-Leach") which was signed into law on November 12, 1999 and contains provisions intended to safeguard consumer financial information in the hands of financial service providers by, among other things, requiring these entities to disclose their privacy policies to their customers and allowing customers to "opt out" of having their financial service providers disclose their confidential financial information to non-affiliated third parties, subject to certain exceptions. Final regulations implementing the new financial privacy regulations became effective during 2001. Similar to most other consumer-oriented laws, the regulations contain some specific prohibitions and require timely disclosure of certain information.

Under the Community Reinvestment Act (or “CRA”) and the implementing regulations, the Bank has a continuing and affirmative obligation to help meet the credit needs of its local community, including low- and moderate-income neighborhoods, consistent with the safe and sound operation of the institution. The CRA requires the Board of Directors of financial institutions, such as the Bank, to adopt a CRA statement for each assessment area that, among other things, describes its efforts to help meet community credit needs and the specific types of credit that the institution is willing to extend. The Bank’s service area is designated as all of Allen County and Warsaw, Indiana. The Bank’s Board of Directors is required to review the appropriateness of this area designation at least annually. The CRA also requires that all financial institutions publicly disclose their CRA ratings. The Bank received a "satisfactory" rating on its most recent CRA performance evaluation.

The Dodd-Frank Wall Street Reform and Consumer Protection Act was signed on July 21, 2010 (“Dodd-Frank”) and was enacted to create a sound economic foundation to grow jobs, protect consumer, rein in Wall Street and big bonuses, end bailouts and the “Too Big to Fail”, and prevent another financial crisis. Highlights of Dodd-Frank include the following:

USA Patriot Act of 2001

On October 6, 2001, the "Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (“USA Patriot Act”) was enacted. The statute increased the power of the U.S. Government to obtain access to information and to investigate a full array of criminal activities. In the area of money laundering activities, the statute added terrorism, terrorism support, and foreign corruption to the definition of money laundering offenses and increased the civil and criminal penalties for money laundering; applied certain anti-money laundering measures to U.S. bank accounts used by foreign persons; prohibited financial institutions from establishing, maintaining, administering or managing a correspondent account with a foreign shell bank; provided for certain forfeitures of funds deposited in U.S. interbank accounts by foreign banks; provided the Secretary of the Treasury with regulatory authority to ensure that certain types of bank accounts are not used to hide the identity of customers transferring funds and to impose additional reporting requirements with respect to money laundering activities; and included other measures.

On October 28, 2002, the Department of Treasury issued a final rule concerning compliance by covered U.S. financial institutions with the new statutory anti-money laundering requirement regarding correspondent accounts established or maintained for foreign banking institutions, including the requirement that financial institutions take reasonable steps to ensure that correspondent accounts provided to foreign banks are not being used to indirectly provide banking services to foreign shell banks. We believe that compliance with the new requirements has not had a material adverse impact on its operations or financial condition.

Written Agreement with the Federal Reserve

Effective July 10, 2012, our written agreement which had been in effect since April 23, 2010 with the Federal Reserve and IDFI (the “Written Agreement”) was terminated.

Competition

All phases of our banking business are highly competitive. We compete with numerous financial institutions, including other commercial banks in the greater Fort Wayne, Warsaw, Allen County and Kosciusko County market areas in Northeast Indiana. As of June 30, 2013, there were 21 banking institutions, excluding credits unions, with 106 total locations throughout Allen County. This is unchanged from June 30, 2012. The four largest banks in Allen County are Wells Fargo, JP Morgan Chase, Lake City Bank, and PNC, and they comprise approximately 66% of the deposit market share as of June 30, 2013. As of June 30,2013, we were ranked fifth in Allen County with 9% of the deposit market share.

We also face competition from thrift institutions, credit unions and other banks as well as finance companies, insurance companies, mortgage companies, securities brokerage firms, money market funds, trust companies and other providers of financial services. Many of our competitors have been in business for many years longer than us, so they have established customer bases, and are larger and have larger lending limits than we do. We compete for loans principally through our ability to communicate effectively with our customers and understand and meet their needs. We offer personal attention, professional service, off-site ATM capability and competitive interest rates. We believe that our personal service philosophy enhances our ability to compete favorably in attracting individuals and small- to medium-sized businesses. Additionally, we were one of the first to bring HSAs to the market after they were established in 2004 and we provide HSAs to clients in all fifty states. In 2013 and 2012, we were ranked as one of the top 20 HSA providers in the nation.

Employees

As of March 11, 2014, we had 127 employees, including approximately 122.75 full-time equivalents. None of our employees are covered by a collective bargaining agreement. Management believes that its relationship with our employees is good. This is down significantly from prior years due to planned staff reduction upon the merger with ONB and the conversion of operating platforms planned for the second quarter of 2014.

Statistical Disclosure

The statistical disclosure concerning the Company and the Bank, on a consolidated basis, is included in Item 7 of this report.

Available Information

Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are available or may be accessed free of charge on the Securities and Exchange Commission’s website under the symbol “TOFC,” at www.sec.gov , as well as through the Tower Financial Corporation Investor Relations section of the Company's Internet website at www.tofc.net .

The following corporate governance documents are also available through the TOFC Investor Relations section of our Internet website, or may be obtained in print form by written request addressed to Secretary, Tower Financial Corporation, 116 East Berry Street, Fort Wayne, Indiana 46802: Code of Business Conduct and Ethics, Audit Committee Charter, Compensation Committee Charter, and Nominating and Corporate Governance Committee Charter. The Company intends to post any amendments to the foregoing documents on its website and will report any waivers of the Code for directors and executive officers on a Current Report on Form 8-K.