UNITED STATES


SECURITY AND EXCHANGE COMMISSION


WASHINGTON, D.C. 20849





FORM 10-Q





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


FOR THE QUARTER ENDEDMARCH 31, 2011





o
TRANSITION REPORT PURSUANT TO SECTION 13 OF THE EXCHANGE ACT FOR THE TRANSITION PERIOD





COMMISSION FILE NUMBER 0-50237





VSB Bancorp, Inc.(Exact name of registrant as specified in its charter)New York(State or other jurisdiction of incorporation or organization)11 - 3680128(I. R. S. Employer Identification No.)4142 Hylan Boulevard, Staten Island, New York 10308(Address of principal executive offices)(718) 979-1100Registrant’s telephone numberCommon Stock(Title of Class)





Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 o





Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).


Yes o No o





Indicate by check mark whether the registrant is a large accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.





Large Accelerated Filer o
Accelerated Filer o
Non-Accelerated Filer o
Smaller Reporting Company x





Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):


Yes o No x





Par Value: $0.0001 Class of Common Stock





The Registrant had 1,825,009 common shares outstanding as of May 4, 2011.











CROSS REFERENCE INDEX




PagePART IItem 1
Consolidated Statements of Financial Condition as of March 31, 2011 and December 31, 2010 (unaudited)

4Consolidated Statements of Operations for the Three Months Ended March 31, 2011 and 2010 (unaudited)

5Consolidated Statements of Changes in Stockholders’ Equity for the Three Months Ended March 31, 2011 and the Year Ended December 31, 2010 (unaudited)

6Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2011 and 2010 (unaudited)

7Notes to Consolidated Financial Statements for the Three Months Ended March 31, 2011 and 2010 (unaudited)

8 to 23Item 2
Management’s Discussion and Analysis of Financial Condition and Results of Operations

23 to 33Item 3
Control and Procedures

33PART IIItem 1
Legal Proceedings

34Signature Page

35Exhibit 31.1, 31.2, 32.1, 32.2

36 to 39





2





Forward-Looking Statements





When used in this periodic report , or in any written or oral statement made by us or our officers, directors or employees, the words and phrases “will result,” “expect,” “will continue,” “anticipate,” “estimate,” “project,” or similar terms are intended to identify “forward-looking statements.” A variety of factors could cause our actual results and experiences to differ materially from the anticipated results or other expectations expressed in any forward-looking statements. Some of the risks and uncertainties that may affect our operations, performance, development and results, the interest rate sensitivity of our assets and liabilities, and the adequacy of our loan loss allowance, include, but are not limited to:





●
deterioration in local, regional, national or global economic conditions which could result in, among other things, an increase in loan delinquencies, a decrease in property values, or a change in the real estate turnover rate;●
changes in market interest rates or changes in the speed at which market interest rates change;●
changes in laws and regulations affecting the financial service industry;●
changes in the public’s perception of financial institutions in general and banks in particular;●
changes in competition; and●
changes in consumer preferences by our customers or the customers of our business borrowers.





Please do not place undue reliance on any forward-looking statement, which speaks only as of the date made. There are many factors, including those described above, that could affect our future business activities or financial performance and could cause our actual future results or circumstances to differ materially from those we anticipate or project. We do not undertake any obligation to update any forward-looking statement after it is made.





3





VSB Bancorp, Inc.


Consolidated Statements of Financial Condition


(unaudited)





March 31,


December 31,2011


2010Assets:Cash and due from banks

$
37,660,747


$
28,764,987Investment securities, available for sale


117,364,785



121,307,907Loans receivable


79,898,528



81,538,224Allowance for loan loss


(1,301,598
)


(1,277,220
)Loans receivable, net


78,596,930



80,261,004Bank premises and equipment, net


2,604,130



2,732,229Accrued interest receivable


624,239



673,967Other assets


1,340,078



1,513,605Total assets

$
238,190,909


$
235,253,699Liabilities and stockholders’ equity:Liabilities:Deposits:Demand and checking

$
70,621,956


$
66,407,225NOW


31,369,855



35,138,867Money market


27,737,090



27,057,632Savings


15,952,574



14,938,440Time


64,503,282



63,644,963Total deposits


210,184,757



207,187,127Escrow deposits


320,904



219,530Accounts payable and accrued expenses


1,550,376



1,802,186Total liabilities


212,056,037



209,208,843Stockholders’ equity:Common stock ($.0001 par value, 3,000,000 shares authorized, 1,989,509 issued, 1,825,009 outstanding at March 31, 2011 and at December 31, 2010)


199



199Additional paid in capital


9,256,237



9,249,600Retained earnings


17,886,510



17,563,435Treasury stock, at cost (164,500 shares at March 31, 2011and at December 31, 2010)


(1,643,797
)


(1,643,797
)Unearned Employee Stock Ownership Plan shares


(521,324
)


(563,594
)Accumulated other comprehensive income, net of taxes of $975,759 and $1,213,545, respectively


1,157,047



1,439,013Total stockholders’ equity


26,134,872



26,044,856Total liabilities and stockholders’ equity

$
238,190,909


$
235,253,699





See notes to consolidated financial statements.





4





VSB Bancorp, Inc.


Consolidated Statements of Operations


(unaudited)





Three months


Three monthsended


endedMarch 31, 2011


March 31, 2010Interest and dividend income:Loans receivable

$
1,454,292


$
1,390,296Investment securities


1,012,552



1,162,222Other interest earning assets


11,138



9,207Total interest income


2,477,982



2,561,725Interest expense:NOW


33,089



39,252Money market


59,379



62,486Savings


12,696



11,460Time


121,506



160,117Total interest expense


226,670



273,315Net interest income


2,251,312



2,288,410Provision for loan loss


30,000



90,000Net interest income after provision for loan loss


2,221,312



2,198,410Non-interest income:Loan fees


27,570



2,304Service charges on deposits


522,237



540,701Net rental income


11,613



11,983Other income


46,283



46,686Total non-interest income


607,703



601,674Non-interest expenses:Salaries and benefits


980,003



963,616Occupancy expenses


376,563



363,790Legal expense


64,986



89,521Professional fees


80,451



66,200Computer expense


65,322



66,955Directors’ fees


62,450



58,950FDIC and NYSBD assessments


94,000



94,000Other expenses


309,275



300,344Total non-interest expenses


2,033,050



2,003,376Income before income taxes


795,965



796,708Provision/(benefit) for income taxes:Current


414,690



442,310Deferred


(50,516
)


(77,824
)Total provision for income taxes


364,174



364,486Net income

$
431,791


$
432,222Earnings per share:Basic

$
0.24


$
0.25Diluted

$
0.24


$
0.25Comprehensive income

$
149,825


$
654,963Book value per common share

$
14.32


$
14.22




See notes to consolidated financial statements.





5





VSB Bancorp, Inc.


Consolidated Statements of Changes in Stockholders’ Equity


Year Ended December 31, 2010 and Three Months Ended March 31, 2011


(unaudited)





Number of
















AccumulatedCommon




Additional





Treasury


Unearned


Other


TotalShares


Common

Paid-In


Retained


Stock,


ESOP


Comprehensive


Stockholders’Outstanding


Stock

Capital


Earnings


at cost


Shares


Gain


EquityBalance at January 1, 2010


1,762,191


$
195

$
9,317,719


$
16,112,741


$
(1,840,249
)

$
(732,672
)

$
1,626,215


$
24,483,949Exercise of stock option, including tax benefit


44,375



4


292,207



















292,211Stock-based compensation









70,811



















70,811Amortization of earned portion of ESOP common stock





















169,078







169,078Amortization of cost over fair value - ESOP









(35,551
)


















(35,551
)Cash dividends declared($0.24 per share)













(429,935
)














(429,935
)Purchase of treasury stock, at cost


(17,057
)













(199,134
)










(199,134
)Contribution to RRP Trust from treasury shares


35,500






(395,586
)






395,586











—Comprehensive income:Net income













1,880,629















1,880,629Other comprehensive income, net:Change in unrealized gain on securities available for sale, net of tax effects


—



—


—



—



—



—



(187,202
)


(187,202
)Total comprehensive income





























1,693,427Balance at December 31, 2010


1,825,009


$
199

$
9,249,600


$
17,563,435


$
(1,643,797
)

$
(563,594
)

$
1,439,013


$
26,044,856Stock-based compensation









23,390



















23,390Amortization of earned portion of ESOP common stock





















42,270







42,270Amortization of cost over fair value - ESOP









(16,753
)


















(16,753
)Cash dividends declared ($0.06 per share)













(108,716
)














(108,716
)Purchase of treasury stock, at cost





























—Comprehensive income:Net income













431,791















431,791Other comprehensive income, net:Change in unrealized gain on securities available for sale, net of tax effects


—



—


—



—



—



—



(281,966
)


(281,966
)Total comprehensive income





























149,825Balance at March 31, 2011


1,825,009


$
199

$
9,256,237


$
17,886,510


$
(1,643,797
)

$
(521,324
)

$
1,157,047


$
26,134,872




See notes to consolidated financial statements.





6





VSB Bancorp, Inc.


Consolidated Statements of Cash Flows


(unaudited)





Three months


Three monthsended


endedMarch 31, 2011


March 31, 2010CASH FLOWS FROM OPERATING ACTIVITIES:Net income

$
431,791


$
432,222Adjustments to reconcile net income to net cash provided by operating activitiesDepreciation and amortization


148,541



152,206Accretion of income, net of amortization of premium


33,344



8,770ESOP compensation expense


25,517



25,688Stock-based compensation expense


23,390



1,944Provision for loan losses


30,000



90,000Decrease in prepaid and other assets


173,527



105,153Decrease in accrued interest receivable


49,728



63,464Increase in deferred income taxes


(50,516
)


(77,824
)Increase in accrued expenses and other liabilities


36,492



412,267Net cash provided by operating activities


901,814



1,213,890CASH FLOWS FROM INVESTING ACTIVITIES:Net change in loan receivable


1,667,929



868,869Proceeds from repayment and calls of investment securities, available for sale


9,431,300



10,242,054Purchases of investment securities, available for sale


(6,075,129
)


(8,941,161
)Purchases of premises and equipment, net


(20,442
)


(21,594
)Net cash provided by investing activities


5,003,658



2,148,168CASH FLOWS FROM FINANCING ACTIVITIES:Net increase in deposits


3,099,004



1,664,732Cash dividends paid


(108,716
)


(103,542
)Net cash provided by financing activities


2,990,288



1,561,190NET INCREASE IN CASH AND CASH EQUIVALENTS


8,895,760



4,923,248CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD


28,764,987



39,716,919CASH AND CASH EQUIVALENTS, END OF PERIOD

$
37,660,747


$
44,640,167SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:Cash paid during the period for:Interest

$
231,064


$
302,984Taxes

$
186,900


$
86,725





See notes to consolidated financial statements.





7




VSB BANCORP, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE MONTHS ENDEDMARCH 31, 2011 AND 2010 (UNAUDITED)








1.
GENERAL





VSB Bancorp, Inc. (referred to using terms such as “we,” “us,” or the “Company”) is the holding company for Victory State Bank (the “Bank”), a New York chartered commercial bank. Our primary business is owning all of the issued and outstanding stock of the Bank. Our common stock is listed on the NASDAQ Global Market. We trade under the symbol “VSBN”.





Through the Bank, the Company is primarily engaged in the business of commercial banking, and to a lesser extent retail banking. The Bank gathers deposits from individuals and businesses primarily in Staten Island, New York and makes loans throughout that community. Therefore, the Company’s exposure to credit risk is significantly affected by changes in the local Staten Island economic and real estate markets. The Bank invests funds that are not used for lending primarily in government securities, mortgage backed securities and collateralized mortgage obligations. Customer deposits are insured, up to the applicable limit, by the Federal Deposit Insurance Corporation (“FDIC”). The Bank is supervised by the New York State Banking Department and the FDIC.





2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





The following is a description of the significant accounting and reporting policies followed in preparing and presenting the accompanying consolidated financial statements. These policies conform with accounting principles generally accepted in the United States of America (“GAAP”).





Principles of Consolidation - The consolidated financial statements of the Company include the accounts of the Company, including its subsidiary Victory State Bank. All significant inter-company accounts and transactions between the Company and Bank have been eliminated in consolidation.





Use of Estimates - The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the amounts of revenues and expenses during the reporting period. Actual results can differ from those estimates. The allowance for loan losses, prepayment estimates on the mortgage-backed securities and collateralized mortgage obligation portfolios, contingencies and fair values of financial instruments are particularly subject to change.





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





Cash and Cash Equivalents – Cash and cash equivalents consists of cash on hand, due from banks and interest-bearing deposits. Interest-bearing deposits with original maturities of 90 days or less are included in this category. Customer loan and deposit transactions are reported on a net cash basis. Regulation D of the Board of Governors of the Federal Reserve System requires that Victory State Bank maintain interest-bearing deposits or cash on hand as reserves against its demand deposits. The amount of reserves which Victory State Bank is required to maintain depends upon its level of transaction accounts. During the fourteen day period from March 24, 2011 through April 6, 2011, Victory State Bank was required to maintain reserves, after deducting vault cash, of $3,734,000. Reserves are required to be maintained on a fourteen day basis, so, from time to time, Victory State Bank may use available cash reserves on a day to day basis, so long as the fourteen day average reserves satisfy Regulation D requirements. Victory State Bank is required to report transaction account levels to the Federal Reserve on a weekly basis.




8




Interest-bearing bank balances– Interest-bearing bank balances mature overnight and are carried at cost.





Investment Securities, Available for Sale - Investment securities, available for sale, are to be held for an unspecified period of time and include securities that management intends to use as part of its asset/liability strategy. These securities may be sold in response to changes in interest rates, prepayments or other factors and are carried at estimated fair value. Gains or losses on the sale of such securities are determined by the specific identification method. Interest income includes amortization of purchase premium and accretion of purchase discount. Premiums and discounts are recognized in interest income using a method that approximates the level yield method without anticipating prepayments, except for mortgage-backed securities where prepayments are estimated. Unrealized holding gains or losses, net of deferred income taxes, are excluded from earnings and reported as other comprehensive income in a separate component of stockholders’ equity until realized. For debt securities with other than temporary impairment (OTTI) that management does not intend to sell or expect to be required to sell, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the income statement and 2) OTTI related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis.





The Company invests primarily in agency collateralized mortgage-Backed obligations (“CMOs”) with estimated average lives primarily under 5 years and mortgage-backed securities. These securities are primarily issued by the Federal National Mortgage Association (“FNMA”), the Government National Mortgage Association (“GNMA”) or the Federal Home Loan Mortgage Corporation (“FHLMC”) and are primarily comprised of mortgage pools guaranteed by FNMA, GNMA or FHLMC. The Company also invests in whole loan CMOs, all of which are AAA rated. These securities expose the Company to risks such as interest rate, prepayment and credit risk and thus pay a higher rate of return than comparable treasury issues.





Loans Receivable - Loans receivable, that management has the intent and ability to hold for the foreseeable future or until maturity or payoff, are stated at unpaid principal balances, adjusted for deferred net origination and commitment fees and the allowance for loan losses. Interest income on loans is credited as earned.





It is the policy of the Company to provide a valuation allowance for probable incurred losses on loans based on the Company’s past loan loss experience, known and inherent risks in the portfolio, adverse situations which may affect the borrower’s ability to repay, estimated value of underlying collateral and current economic conditions in the Company’s lending area. The allowance is increased by provisions for loan losses charged to earnings and is reduced by charge-offs, net of recoveries. While management uses available information to estimate losses on loans, future additions to the allowance may be necessary based upon the expected growth of the loan portfolio and any changes in economic conditions beyond management’s control. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses. Such agencies may require the Bank to recognize additions to the allowance based on judgments different from those of management. Management believes, based upon all relevant and available information, that the allowance for loan losses is appropriate.





The Company has a policy that all loans 90 days past due are placed on non-accrual status. It is the Company’s policy to cease the accrual of interest on loans to borrowers past due less than 90 days where a probable loss is estimated and to reverse out of income all interest that is due but has not been paid. The Company applies payments received on non-accrual loans to the outstanding principal balance due before applying any amount to interest, until the loan is restored to an accruing status. On a limited basis, the Company may apply a payment to interest on a non-accrual loan if there is no impairment or no estimated loss on this asset. The Company continues to accrue interest on construction loans that are 90 days past contractual maturity date if the loan is expected to be paid in full in the next 60 days and all interest is paid up to date.





Loan origination fees and certain direct loan origination costs are deferred and the net amount recognized over the contractual loan terms using the level-yield method, adjusted for periodic prepayments in certain circumstances.




9




The Company considers a loan to be impaired when, based on current information, it is probable that the Company will be unable to collect all principal and interest payments due according to the contractual terms of the loan agreement. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Impairment is measured on a loan by loan basis for commercial and construction loans. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, as a practical expedient, at the loan’s observable market price or the fair value of the collateral. The fair value of the collateral, as reduced by costs to sell, is utilized if a loan is collateral dependent. Loans with modified terms that the Company would not normally consider, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired. Large groups of smaller balance homogeneous loans, such as consumer loans and residential loans, are collectively evaluated for impairment.





Long-Lived Assets - The Company periodically evaluates the recoverability of long-lived assets, such as premises and equipment, to ensure the carrying value has not been impaired. In performing the review for recoverability, the Company would estimate the future cash flows expected to result from the use of the asset. If the sum of the expected future cash flows is less than the carrying amount an impairment will be recognized. The Company reports these assets at the lower of the carrying value or fair value.





Premises and Equipment - Premises, leasehold improvements, and furniture and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are accumulated by the straight-line method over the estimated useful lives of the respective assets, which range from three to fifteen years. Leasehold improvements are amortized at the lesser of their useful life or the term of the lease.





Federal Home Loan Bank (FHLB) Stock - The Bank is a member of the FHLB system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. FHLB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment. Because this stock is viewed as a long term investment, impairment is based on ultimate recovery of par value, which is the price the Bank pays for the FHLB Stock. Both cash and stock dividends are reported as income.





Income Taxes - The Company utilizes the liability method to account for income taxes. Under this method, deferred tax assets and liabilities are determined on differences between financial reporting and the tax bases of assets and liabilities and are measured using the enacted tax rates and laws expected to be in effect when the differences are expected to reverse. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. As such, a tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.





The Company recognizes interest and/or penalties related to income tax matters in income tax expense.





Financial Instruments - In the ordinary course of business, the Company has entered into off-balance sheet financial instruments, primarily consisting of commitments to extend credit.





Basic and Diluted Net Income Per Common Share - The Company has stock compensation awards with non-forfeitable dividend rights which are considered participating securities. As such, earnings per share is computed using the two-class method. Basic earnings per common share is computed by dividing net income allocated to common stock by the weighted average number of common shares outstanding during the period which excludes the participating securities. Diluted earnings per common share includes the dilutive effect of additional potential common shares from stock-based compensation plans, but excludes awards considered participating securities. Earnings and dividends per share are restated for all stock splits and stock dividends through the date of issuance of the financial statements.




10




Basic net income per share of common stock is based on 1,761,754 shares and 1,725,522 shares, the weighted average number of common shares outstanding for the three months ended March 31, 2011 and 2010, respectively. Diluted net income per share of common stock is based on 1,766,550 and 1,744,620, the weighted average number of common shares outstanding plus potentially dilutive common shares for the three months ended March 31, 2011 and 2010, respectively. The weighted average number of potentially dilutive common shares excluded in calculating diluted net income per common share due to the anti-dilutive effect is 23,171 and 34,120 shares for the three months ended March 31, 2011 and 2010, respectively. Common stock equivalents were calculated using the treasury stock method.




The reconciliation of the numerators and the denominators of the basic and diluted per share computations for the three months ended March 31, are as follows:




Reconciliation of EPSThree months ended


Three months endedMarch 31, 2011


March 31, 2010BasicDistributed earnings allocated to common stock

$
105,705


$
103,531Undistributed earnings allocated to common sock


317,557



328,691Net earnings allocated to common stock

$
423,262


$
432,222Weighted common shares outstanding including participating securities


1,797,254



1,725,522Less: Participating securities


(35,500
)


—Weighted average shares


1,761,754



1,725,522Basic EPS

$
0.24


$
0.25DilutedNet earnings allocated to common stock

$
423,262


$
432,222Weighted average shares for basic


1,761,754



1,725,522Dilutive effects of:Stock Options


4,796



19,098Unvested shares not considered particpating securtities


—



—1,766,550



1,744,620Diluted EPS

$
0.24


$
0.25




Net earnings allocated to common stock for the period is distributed earnings during the period, such as dividends on common shares outstanding, plus a proportional amount of retained income for the period based on restricted shares granted but unvested compared to the total common shares outstanding.





Stock Based Compensation - The Company records compensation expense for stock options provided to employees in return for employment service. The cost is measured at the fair value of the options when granted, and this cost is expensed over the employment service period, which is normally the vesting period of the options.





Employee Stock Ownership Plan (“ESOP”)- The cost of shares issued to the ESOP, but not yet allocated to participants, is shown as a reduction of stockholders’ equity. Compensation expense is based on the market price of shares as they are committed to be released to participant accounts. Cash dividends on allocated ESOP shares reduce retained earnings; cash dividends on unearned ESOP shares reduce debt and accrued interest.




11




Stock Repurchase Programs–On September 8, 2008, the Company announced that its Board of Directors had authorized a Rule 10b5-1 stock repurchase program for the repurchase of up to 100,000 shares of the Company’s common stock. On April 21, 2009, the Company announced that its Board of Directors had authorized a second Rule 10b5-1 stock repurchase program for the repurchase of up to an additional 100,000 shares of the Company’s common stock. At March 31, 2011, the Company had repurchased a total of 200,000 shares of its common stock under these stock repurchase programs, which are now completed. Stock repurchases under the program have been accounted for using the cost method, in which the Company will reflect the entire cost of repurchased shares as a separate reduction of stockholders’ equity on its balance sheet.





Retention and Recognition Plan –At the April 27, 2010 Annual Meeting, the stockholders of VSB Bancorp, Inc. approved the adoption of the 2010 Retention and Recognition Plan (the “RRP”). The RRP authorizes the award of up to 50,000 shares of its common stock to directors, officers and employees. In conjunction with the approval the RRP, stockholders approved the award of 4,000 shares of stock to each of its eight directors who had at least five years of service. The director awards will vest over five years, with 20% vesting annually for each of the first five years after the award is made, subject to acceleration and forfeiture. On June 8, 2010, an additional 3,500 shares of stock were awarded to the President and CEO of the Company, which will vest over a 65 month period, with 20% vesting annually for each of the first five years starting in November 2011, subject to acceleration and forfeiture. The recipient of an award will not be required to make any payment to receive the award or the stock covered by the award. As of March 31, 2011, 35,500 shares of the RRP have been awarded. The Company recognizes compensation expense for the shares awarded under the RRP gradually as the shares vest, based upon the market price of the shares on the date of the award. For the three months ended March 31, 2011, the Company recognized $20,186 of compensation expense related to the shares awarded. The income tax benefit resulting from this expense was $9,235. As of March 31, 2011, there was approximately $316,077 of unrecognized compensation costs related to the shares awarded. These costs are expected to be recognized over the next 4.0 years.





A summary of the status of the Company’s nonvested plan shares as of March 31, 2011 is as follows:





For the Three Months Ended March 31, 2011:Shares


Weighted Average

Grant Date Share ValueNon vested at beginning of period

35,500


$
11.46Granted

—Vested

—Non vested at end of period

35,500


$
11.46




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





Recently-Adopted Accounting Standards - In January 2010, the FASB issued guidance to improve disclosure requirements related to fair value measurements and disclosures. The guidance requires that a reporting entity should disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers and that activity in Level 3 should be presented on a gross basis rather than one net number for information about purchases, issuances, and settlements. The guidance also requires that a reporting entity should provide fair value measurement disclosures for each class of assets and liabilities and about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements. This guidance is effective for interim and annual reporting periods beginning after December 31, 2009 except for the roll forward of activity in Level 3 which is effective for interim and annual reporting periods beginning after December 31, 2010. Adopting this pronouncement did not have a material effect on the results of operations or financial condition of the Company.




12




In July 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2010-20, “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses” (“ASU 2010-20”). ASU 2010-20 requires companies to provide a greater level of disaggregated information regarding: (1) the credit quality of their financing receivables; and (2) their allowance for credit losses. ASU 2010-20 further requires companies to disclose credit quality indicators, past due information, and modifications of their financing receivables. For public companies, ASU 2010-20 is effective for interim and annual reporting periods ending on or after December 15, 2010. ASU 2010-20 encourages, but does not require, comparative disclosures for earlier reporting periods that ended before initial adoption. Adoption of ASU 2010-20 did not have a material impact on the Company.





In April 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2011-2, “A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring” (“ASU 2011-2”). ASU 2011-2 clarifies the guidance for determining whether a loan restructuring constitutes a troubled debt restructuring (“TDR”) outlined in Accounting Standards Codification (“ASC”) No. 310-40, “Receivables—Troubled Debt Restructurings by Creditors,” by providing additional guidance to a creditor in making the following required assessments needed to determine whether a restructuring is a TDR: (i) whether or not a concession has been granted in a debt restructuring; (ii) whether a temporary or permanent increase in the contractual interest rate precludes the restructuring from being a TDR; (iii) whether a restructuring results in an insignificant delay in payment; (iv) whether a borrower that is not currently in payment default is experiencing financial difficulties; and (v) whether a creditor can use the effective interest rate test outlined in debtor’s guidance on restructuring of payables (ASC Topic No. 470-60-55-10) when evaluating whether or not a restructuring constitutes a TDR. ASU 2011-2 is effective for interim periods beginning on or after June 15, 2011. Adoption of ASU 2011-2 is not expected to have a material effect.




3.
INVESTMENT SECURITIES, AVAILABLE FOR SALE


The following table summarizes the amortized cost and fair value of the available-for-sale investment securities portfolio at March 31, 2011 and December 31, 2010 and the corresponding amounts of unrealized gains and losses therein:




March 31, 2011Amortized


Unrealized


Unrealized


FairCost


Gains


Losses


ValueFNMA MBS - Residential

$
3,242,248


$
131,083


$
—


$
3,373,331GNMA MBS - Residential


3,956,203



61,431



(114,368
)


3,903,266Whole Loan MBS - Residential


1,087,865



26,462



—



1,114,327Collateralized mortgage obligations


106,945,662



2,350,314



(322,115
)


108,973,861$
115,231,978


$
2,569,290


$
(436,483
)

$
117,364,785




13




December 31, 2010Amortized


Unrealized


Unrealized


FairCost


Gains


Losses


ValueFNMA MBS - Residential

$
3,428,696


$
142,521


$
—


$
3,571,217GNMA MBS - Residential


4,092,912



65,164



(76,964
)


4,081,112Whole Loan MBS - Residential


1,212,246



23,255



—



1,235,501Collateralized mortgage obligations


109,921,495



2,906,359



(407,777
)


112,420,077$
118,655,349


$
3,137,299


$
(484,741
)

$
121,307,907





There were no sales of investment securities for the three months ended March 31, 2011 and the year ended December 31, 2010.





The amortized cost and fair value of the investment securities portfolio are shown by expected maturity. Expected maturities may differ from contractual maturities, especially for collateralized mortgage obligations, if borrowers have the right to call or prepay obligations with or without call or prepayment penalties.





March 31, 2011Amortized


FairCost


ValueLess than one year

$
488,042


$
491,085Due after one year through five years


1,008,856



1,023,374Due after five years through ten years


25,024,490



26,218,396Due after ten years


88,710,590



89,631,930$
115,231,978


$
117,364,785





The following table summarizes the investment securities with unrealized losses at March 31, 2011 and December 31, 2010 by aggregated major security type and length of time in a continuous unrealized loss position:




March 31, 2011

Less than 12 months


More than 12 months


TotalFair


Unrealized


Fair


Unrealized


Fair


UnrealizedValue


Loss


Value


Loss


Value


LossFNMA MBS

$
—


$
—


$
—


$
—


$
—


$
—GNMA MBS


2,871,870



(114,368
)


—



—



2,871,870



(114,368
)Whole Loan MBS


—



—



—



—



—



—Collateralized mortgage obligations


24,585,331



(322,115
)


—



—



24,585,331



(322,115
)$
27,457,201


$
(436,483
)

$
—


$
—


$
27,457,201


$
(436,483
)




14




December 31, 2010

Less than 12 months


More than 12 months


TotalFair


Unrealized


Fair


Unrealized


Fair


UnrealizedValue


Loss


Value


Loss


Value


LossFNMA MBS

$
—


$
—


$
—


$
—


$
—


$
—GNMA MBS


2,991,961



(76,964
)


—



—



2,991,961



(76,964
)Whole Loan MBS


—



—



—



—



—



—Collateralized mortgage obligations


20,223,509



(407,777
)


—



—



20,223,509



(407,777
)$
23,215,470


$
(484,741
)

$
—


$
—


$
23,215,470


$
(484,741
)




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





At March 31, 2011, the unrealized loss on investment securities was caused by interest rate increases. We expect that these securities, at maturity, will not be settled for less than the amortized cost of the investment. Because the decline in fair value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the securities and it is not more likely than not the Company will be required to sell the securities before recovery of the amortized cost basis less any current-period loss, these investments are not considered other-than-temporarily impaired. At March 31, 2011, there were no debt securities with unrealized losses with aggregate depreciation of 5% or more from the Company’s amortized cost basis.





Securities pledged had a fair value of $53,980,996 and $66,089,701 at March 31, 2011 and December 31, 2010, respectively and were pledged to secure public deposits and balances in excess of the deposit insurance limit on certain customer accounts.




4.
FAIR VALUE OF FINANCIAL INSTRUMENTS





The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of FASB ASC 820, “Financial Instruments”. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is necessarily required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.





The following methods and assumptions were used by the Company in estimating fair values of financial instruments:





Interest-bearing Bank Balances– Interest-bearing bank balances mature within one year and are carried at cost which are estimated to be reasonably close to fair value.





Money Market Investments– The fair value of these securities approximates their carrying value due to the relatively short time to maturity





Investment Securities, Available For Sale– The estimated fair value of these securities is determined by using available market information and appropriate valuation methodologies. The estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange.




15




Loans Receivable- The fair value of commercial and construction loans is approximated by the carrying value as the loans are tied directly to the Prime Rate and are subject to change on a daily basis, subject to the applicable interest rate floors. The fair value of the remainder of the portfolio is determined by discounting the future cash flows of the loans using the appropriate discount rate.





Other Financial Assets- The fair value of these assets, principally accrued interest receivable, approximates their carrying value due to their short maturity.





Non-Interest Bearing and Interest Bearing Deposits - The fair value disclosed for non-interest bearing deposits is equal to the amount payable on demand at the reporting date. The fair value of interest bearing deposits is based upon the current rates for instruments of the same remaining maturity. Interest bearing deposits with a maturity of greater than one year are estimated using a discounted cash flow approach that applies interest rates currently being offered.





Other Liabilities - The estimated fair value of other liabilities, which primarily include accrued interest payable, approximates their carrying amount.





The carrying amounts and estimated fair values of financial instruments, at March 31, 2011 and December 31, 2010 are as follows:





March 31, 2011


December 31, 2010Carrying


Fair


Carrying


FairAmount


Value


Amount


ValueFinancial Assets:Cash and cash equivalents

$
37,660,747


$
37,660,747


$
28,764,987


$
28,764,987Investment securities, available for sale


117,364,785



117,364,785



121,307,907



121,307,907Loans receivable


78,596,930



79,674,706



80,261,004



81,526,941Other financial assets


624,239



624,239



673,967



673,967Total Financial Assets

$
234,246,701


$
235,324,477


$
231,007,865


$
232,273,802Financial Liabilities:Non-interest bearing deposits

$
70,942,860


$
70,942,860


$
66,626,755


$
66,626,755Interest bearing deposits


139,562,801



139,516,616



140,779,902



140,634,427Other liabilities


15,881



15,881



19,039



19,039Total Financial Liabilities

$
210,521,542


$
210,475,357


$
207,425,696


$
207,280,221




ASC 825 establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:





Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.





Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.





Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing and asset or liability.




16




The fair value of securities available for sale is determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs).




Fair Value Measurements at March 31, 2011 UsingTotal


Quoted Prices in

Active Markets for

Identical Assets

(Level 1)


Significant

Other

Observable

Inputs

(Level 2)


Significant

Unobservable

Inputs

(Level 3)Assets:FNMA MBS - Residential

$
3,373,331


$
—


$
3,373,331


$
—GNMA MBS - Residential


3,903,266



—



3,903,266



—Whole Loan MBS-Residential


1,114,327



—



1,114,327



—Collateralized mortgage obligations


108,973,861



—



108,973,861



—Total Available for saleSecurities

$
117,364,785


$
—


$
117,364,785


$
—





Fair Value Measurements at December 31, 2010 UsingTotal


Quoted Prices in

Active Markets for

Identical Assets

(Level 1)


Significant

Other

Observable

Inputs

(Level 2)


Significant

Unobservable

Inputs

(Level 3)Assets:FNMA MBS - Residential

$
3,571,217


$
—


$
3,571,217


$
—GNMA MBS - Residential


4,081,112



—



4,081,112



—Whole Loan MBS-Residential


1,235,501



—



1,235,501



—Collateralized mortgage obligations


112,420,077



—



112,420,077



—Total Available for saleSecurities

$
121,307,907


$
—


$
121,307,907


$
—




Certain financial assets and financial liabilities are measured at fair value on a nonrecurring basis, that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment).





17




Assets and Liabilities Measured on a Non-Recurring Basis
  Assets and liabilities measured at fair value on a non-recurring basis are summarized below:
  Impaired loans are reported at the fair value of the underlying collateral if repayment is expected solely from the collateral. Collateral values are estimated using Level 3 inputs based on internally customized discounting criteria and updated appraisals when received.




Fair Value Measurements at March 31, 2011 UsingTotal


Quoted Prices in

Active Markets for

Identical Assets

(Level 1)


Significant

Other

Observable

Inputs

(Level 2)


Significant

Unobservable

Inputs

(Level 3)Assets:Impaired loans

$
629,084


—


—


$
629,084


Fair Value Measurements at December 31, 2010 UsingTotal


Quoted Prices in

Active Markets for

Identical Assets

(Level 1)


Significant

Other

Observable

Inputs

(Level 2)


Significant

Unobservable

Inputs

(Level 3)Assets:Impaired loans

$
643,758


—


—


$
643,758




As of March 31, 2011, we had two impaired loans with specific reserves that were collateral dependent. Collateral dependent impaired loans, which are measured for impairment using the fair value of the collateral, had a carrying amount of $721,555, with a valuation allowance of $92,471.





As of December 31, 2010, we had two impaired loans with specific reserves that were collateral dependent. Collateral dependent impaired loans, which are measured for impairment using the fair value of the collateral, had a carrying amount of $727,217, with a valuation allowance of $83,459.




18




5.
LOANS RECEIVABLE, NET





Loans receivable, net at March 31, 2011 and December 31, 2010 are summarized as follows:





March 31,


December 31,2011


2010Commercial loans (principally variable rate):Secured

$
1,108,776


$
1,393,532Unsecured


12,176,011



12,924,378Total commercial loans


13,284,787



14,317,910Real estate loans:Commercial


58,662,519



58,204,596Residential


2,455,644



2,460,114Total real estate loans


61,118,163



60,664,710Construction loans (net of undisbursed funds of $2,770,500 and $2,672,000, respectively)


4,794,500



5,874,500Consumer loans


491,890



533,860Other loans


451,745



386,750943,635



920,610Total loans receivable


80,141,085



81,777,730Less:Unearned loans fees, net


(242,557
)


(239,506
)Allowance for loan losses


(1,301,598
)


(1,277,220
)Total

$
78,596,930


$
80,261,004





Nonaccrual loans outstanding at March 31, 2011 and December 31, 2010 are summarized as follows:





March 31,


December 31,2011


2010Nonaccrual loans:Unsecured commercial loans

$
—


$
37,706Commercial real estate


2,068,392



4,064,281Residential real estate


2,273,650



2,276,306Construction


—



—Total nonaccrual loans

$
4,342,042


$
6,378,293





March 31,


December 31,2011


2010Interest income that would have been recorded during the period on nonaccrual loans outstanding in accordance with original terms

$
82,467


$
469,484




At March 31, 2011 and December 31, 2010, there were no loans 90 days past due and still accruing interest.




19




The
following table presents the aging of the   past due loan balances as of March 31, 2011 and December 31, 2010 by class
of loan:




March 31, 2011Total


30-59
Days

Past Due


60-89
Days

Past Due


Greater

than 90 Days

Past Due


Total

Past Due


Loans

Not

Past DueCommercial loans:Unsecured

$
12,176,011


$
29,757


$
2,133


$
—


$
31,890


$
12,144,121Secured


1,108,776



—



—



—



—



1,108,776Real Estate loansCommercial


58,662,519



1,133,680



1,850,000



2,068,392



5,052,072



53,610,447Residential


2,455,644



—



28,710



2,273,650



2,302,360



153,284Construction loans


4,794,500



397,500



—



—



397,500



4,397,000Consumer loans


491,890



2,768



370



—



3,138



488,752Other loans


451,745



2,167



—



—



2,167



449,578Total loans

$
80,141,085


$
1,565,872


$
1,881,213


$
4,342,042


$
7,789,127


$
72,351,958
  December 31, 2010Total


30-59
Days

Past Due


60-89
Days

Past Due


Greater

than 90 Days

Past Due


Total

Past Due


Loans

Not

Past DueCommercial loans:Unsecured

$
12,924,378


$
46,562


$
42,708


$
37,706


$
126,976


$
12,797,402Secured


1,393,532



—



—



—



—



1,393,532Real Estate loansCommercial


58,204,596



3,103,589



277,960



4,064,281



7,445,830



50,758,766Residential


2,460,114



—



—



2,276,306



2,276,306



183,808Construction loans


5,874,500



795,000



—



—



795,000



5,079,500Consumer loans


533,860



11,277



—



—



11,277



522,583Other loans


386,750



2,279



—



—



2,279



384,471Total loans

$
81,777,730


$
3,958,707


$
320,668


$
6,378,293


$
10,657,668


$
71,120,062




Nonaccrual loans include smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.





Individually impaired loans were as follows:




March 31,


December 31,2011


2010Loans with no allocated allowance for loan losses:Commercial real estate

$
39,033


$
39,377Loans with allocated allowance for loan losses:Commercial and financial


41,037



36,837Commercial real estate


721,555



3,448,695$
801,625


$
3,524,909Amount of the allowance for loan losses allocated:Commercial and financial

$
4,104


$
7,367Commercial real estate


92,471



83,459$
96,575


$
90,826





20





The following table sets forth certain information about impaired loans at:




March 31,


December 31,2011


2010Average of individually impaired loans during year

$
2,593,352


$
813,419Interest income recognized during time period that loans were impaired, using cash-basis method of accounting

$
—


$
—




Credit Quality Indicators:





The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debts such as: current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis is performed on a quarterly basis. The Company uses the following definitions for risk ratings:





Special Mention.Loans categorized as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position as some future date.





Substandard.Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.





Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristics that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and vales, highly questionable and improbable.





The following table sets forth at March 31, 2011 and December 31, 2010, the aggregate carrying value of our assets categorized as Special Mention, Substandard and Doubtful according to asset type:




At March 31, 2011Special








NotMention


Substandard


Doubtful


Classified


TotalCommercial Loans:Secured

$
—


$
—


$
—


$
1,108,776


$
1,108,776Unsecured


210,772



283,506



—



11,681,733



12,176,011Commercial Real Estate


3,794,301



7,863,898



—



47,004,320



58,662,519Residential Real Estate


28,710



2,273,650



—



153,284



2,455,644Construction


397,500



—



—



4,397,000



4,794,500Consumer


18,302



—



—



473,588



491,890Other


9,061



—



—



442,684



451,745Total loans

$
4,458,646


$
10,421,054


$
—


$
65,261,385


$
80,141,085




21




At December 31, 2010Special








NotMention


Substandard


Doubtful


Classified


TotalCommercial Loans:Secured

$
—


$
—


$
—


$
1,393,532


$
1,393,532Unsecured


459,160



37,706



—



12,427,512



12,924,378Commercial Real Estate


4,250,511



5,623,816



—



48,330,269



58,204,596Residential Real Estate


—



2,276,306



—



183,808



2,460,114Construction


—



—



—



5,874,500



5,874,500Consumer


18,117



—



—



515,743



533,860Other


12,096



—



—



374,654



386,750Total loans

$
4,739,884


$
7,937,828


$
—


$
69,100,018


$
81,777,730




The activity in the allowance for loan losses, for the three months ended March 31, 2011 and the year ended December 31, 2010 are summarized as follows:




March 31,


December 31,2011


2010Beginning balance

$
1,277,220


$
1,063,454Charge-offs:Commercial Loans:Unsecured


(37,797
)


(15,765
)Consumer


—



(4,863
)Other


—



(2,084
)Total charge-offs


(37,797
)


(22,712
)Recoveries:Commercial Loans:Unsecured


23,675



79,119Commercial Real Estate


5,000



1,050Consumer


—



2,000Other


3,500



14,309Total recoveries


32,175



96,478Provision


30,000



140,000Ending balance

$
1,301,598


$
1,277,220





22





The following table presents the balance in the allowance for loan losses and the recorded balance in loans, by portfolio segment, and based on impairment method as of March 31, 2011 and December 31, 2010:
 
 March 31, 2011Commercial

Commercial



Commerical

Residential

OtherUnsecured

Secured

Construction

Real Estate

Real Estate

Loans

TotalAllowance for loan losses:Ending allowance balance attributable to loansIndividually evaluated for impairment

$
28,351

$
—

$
—

$
230,548

$
—

$
—

$
258,899Collectively evaluated for impairment


471,929


10,320


40,709


484,238


5,874


29,629


1,042,699Total ending allowance balance

$
500,280

$
10,320

$
40,709

$
714,786

$
5,874

$
29,629

$
1,301,598Loans:Individually evaluated for impairment

$
283,506

$
—

$
—

$
7,863,898

$
2,273,650

$
—

$
10,421,054Collectively evaluated for impairment


11,892,505


1,108,776


4,794,500


50,798,621


181,994


943,635


69,720,031Total ending loans balance

$
12,176,011

$
1,108,776

$
4,794,500

$
58,662,519

$
2,455,644

$
943,635

$
80,141,085
 
 December 31, 2010Commercial

Commercial



Commerical

Residential

OtherUnsecured

Secured

Construction

Real Estate

Real Estate

Loans

TotalAllowance for loan losses:Ending allowance balance attributable to loansIndividually evaluated for impairment

$
7,541

$
—

$
—

$
132,511

$
1,717

$
—

$
141,769Collectively evaluated for impairment


513,412


13,486


52,138


520,851


5,457


30,107


1,135,451Total ending allowance balance

$
520,953

$
13,486

$
52,138

$
653,362

$
7,174

$
30,107

$
1,277,220Loans:Individually evaluated for impairment

$
37,706

$
—

$
—

$
5,623,816

$
2,276,306

$
—

$
7,937,828Collectively evaluated for impairment


12,886,672


1,393,532


5,874,500


52,580,780


183,808


920,610


73,839,902Total ending loans balance

$
12,924,378

$
1,393,532

$
5,874,500

$
58,204,596

$
2,460,114

$
9 20,610

$
81,777,730
 
 Item 2
  Management’s Discussion and Analysis of Financial Condition and Results of Operations
  Financial Condition at March 31, 2011
  Total assets were $238,190,909 at March 31, 2011, an increase of $2,937,210, or 1.3%, from December 31, 2010.  The increase resulted from the investment of funds available to us as the result of an increase in deposits and retained earnings. The deposit increase was caused generally by our efforts to grow our franchise and specifically by the deposit increases at our branch offices. We invested these funds primarily in cash and cash equivalents.  The principal changes resulting in the net increase in assets can be summarized as follows:
 
 ●
a $8,895,760 net increase in cash and cash equivalents, partially offset by●
a $3,943,122 net decrease in investment securities available for sale and●
a $1,664,074 net decrease in net loans receivable.
  In addition to these changes in major asset categories, we also experienced changes in other asset categories due to normal fluctuations in operations.  We had a slight increase in gross loans receivable but a slight decrease in net loans receivable because we increased our allowance for loan losses.
  Our deposits (including escrow deposits) were $210,505,661 at March 31, 2011, an increase of $3,099,004 or 1.49%, from December 31, 2010 as a result of our active solicitation of retail deposits to increase funds for investment.  The increase in deposits resulted from increases of $4,214,731 in non-interest demand deposits, $1,014,134 in savings accounts, $858,319 in time deposits, $679,458 in money market accounts and $101,374 in escrow deposits, partially offset by a decrease of $3,769,012 in NOW accounts.
  23
  Total stockholders’ equity was $26,134,872 at March 31, 2011, an increase of $90,016, or 0.35%, from December 31, 2010.  The increase reflected: (i) $323,075 net increase in retained earnings due to net income of $431,791 for the three months ended March 31, 2011 partially offset by $108,716 of dividends paid in 2011; (ii) a decrease in the net unrealized gain on securities available for sale of $281,966; and (iii) a reduction of $42,270 in Unearned ESOP shares reflecting the gradual payment of the loan we made to fund the ESOP’s purchase of our stock.
  The unrealized gain on securities available for sale is excluded from the calculation of regulatory capital.  Management does not anticipate selling securities in this portfolio, but changes in market interest rates or in the demand for funds may change management’s plans with respect to the securities portfolio.  If there is a material increase in interest rates, the market value of the available for sale portfolio may decline. Management believes that the principal and interest payments on this portfolio, combined with the existing liquidity, will be sufficient to fund loan growth and potential deposit outflow.
  The Dodd-Frank Wall Street Reform and Consumer Protection Law
  On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Law was adopted. It has been described as the greatest legislative change in the supervision of financial institutions since the 1930s. Its effect on Victory State Bank and VSB Bancorp, Inc. cannot now be judged with certainty because the law requires over 200 regulatory rulemakings and over 50 agency studies. However, we believe that the following areas, among others, will be or may be significant to our future operations:
 
 1.
The law exempts smaller reporting companies filing with the Securities and Exchange Commission, such as our company, from the internal controls attestation rules of Section 404(b) of the Sarbanes-Oxley Act. Thus far, we have incurred expenses to prepare for compliance but we have not been governed by Section 404(b) due to temporary SEC extensions of the compliance deadline. The permanent exemption means that we will not be required to incur the expense of actual compliance as long as we continue to qualify as a smaller reporting company.2.
Securities brokers may not vote shares held in “street name” unless they receive instructions from their customers on the election of directors, executive compensation or any other significant matter, as determined by the SEC. This may increase our costs of holding annual stockholder meetings if it becomes necessary for us to retain the services of a proxy solicitor to increase shareholder participation in our meetings or to obtain approval of matters that the Board presents to stockholders.3.
At least every three years, we will be required to submit to our stockholders, for a non-binding vote, our executive compensation. This requirement may increase the cost of holding some stockholder meetings. The law also requires that the SEC implement other requirements for enhanced compensation disclosures.  The SEC adopted a temporary exemption for smaller reporting companies, such as our company, until annual meetings occurring on or after January 21, 2013.4.
The law includes a number of changes to expand FDIC insurance coverage, as well as changes to the premiums banks must pay for insurance coverage, and the requirements applicable to the reserve ratio (the ratio of the deposit insurance fund to the amount of insured deposits). One important change is that, in the future, deposit insurance premiums we pay will be based upon total assets minus tangible capital, rather than based upon deposits. Since we do not use material borrowings to provide funds for asset growth, and we do not have material intangible assets that are excluded from capital such as goodwill, we anticipate that our share of the total deposit premiums to be collected may decrease as the result of this change. However, other factors, such as required replenishment of the current reserve fund, which has a negative reserve ratio and which must be increased to 1.35% of total insured deposits by September 30, 2020, as well as future failures of banks that may further deplete the fund, may result in an increase in our future deposit insurance premium.  The FDIC must provide an offset for smaller banks negating the adverse effect of requiring a reserve ratio in excess of 1.15%, but reaching even the 1.15% ratio may require additional burdens on smaller banks. The FDIC approved final regulations implementing these changes on February 25, 2011, effective April 1, 2011.  According to the FDIC, the substantial majority of banks will see reduced deposit insurance premiums as a result of the new rules.  We believe that will be the case for us as long as all other relevant factors remain unchanged.
 
 24
 5.
The law increases the amount of each customer’s deposits that are subject to FDIC insurance. The general limit has been permanently increased from $100,000 to $250,000. In addition, non-interest bearing transaction accounts will be fully insured, without limit, from December 31, 2010 to January 1, 2013.6.
The law repeals the prohibition on paying interest on demand deposit accounts, effective in July 2011. Interest-free demand deposits represent a substantial portion of our deposit base. Once the prohibition on paying interest on such deposits becomes effective, competitive pressures may require that we offer interest checking accounts to businesses in order to retain deposits. That could have a direct adverse effect on our cost of funds. Although current market interest rates are very low, and such deposits are unlikely to carry high rates of interest, an increase in market interest rates could result in significant additional costs in order to maintain the level of such deposits.7.
The law makes interstate branching by banks much easier than in the past. We have no plans to branch outside New York State, but the law facilitates out of state banks branching into our market area, thus potentially increasing competition.8.
The law creates a new federal agency – the Consumer Financial Protection Bureau– which will have substantial authority to regulate consumer financial transactions. Our loans are primarily made to businesses rather than individual consumers, so the bureau will not have a direct effect on many of our loan transactions. However, the bureau also has authority to regulate other non-loan consumer transactions, such as deposits and electronic banking transactions.  The implementation of new consumer regulations may increase our operating costs in a manner we cannot predict until regulations are adopted.
  The Current Economic Turmoil
  The economy in the United States, including the economy in Staten Island, was and may still be in a recession.  Although some analysts report that the economy is recovering, the extent and speed of the recovery is far from clear and some analysts predict a darker road ahead. There is substantial stress on many financial institutions and financial products. The federal government has intervened by making hundreds of billions of dollars in capital contributions to the banking industry. We draw a substantial portion of our customer base from local businesses, especially those in the building trades and related industries. Our customers have been adversely affected by the economic downturn, and if adverse conditions in the local economy continue, it will become more difficult for us to conduct prudent and profitable business in our community.
  Making permanent residential mortgage loans is not a material part of our business, and our investments in mortgage-backed securities and collateralized mortgage obligations have been made with a view towards avoiding the types of securities that are backed by low quality mortgage-related assets. However, one of the primary focuses of our local business is receiving deposits from, and making loans to, businesses involved in the construction and building trades industry on Staten Island. Construction loans represented a significant component of our loan portfolio, reaching 39.8% of total loans at year end 2005. As we monitored the economy and the strength of the local construction industry, we elected to reduce our portfolio of construction loans. By March 31, 2011, the percentage had declined to 6.1%. However, developers and builders provide not only a source of loans, but they also provide us with deposits and other business. If the weakness in the economy continues or worsens, then that could have a substantial adverse effect on our customers and potential customers, making it more difficult for us to find satisfactory loan opportunities and low-cost deposits. This could compel us to invest in lower yielding securities instead of higher-yielding loans and could also reduce low cost funding sources such as checking accounts and require that we replace them with higher cost deposits such as time deposits. Either or both of those shifts could reduce our net income.
  25
 Changes in FDIC Assessment Rates
  The Bank is a member of the FDIC.  As insurer, the FDIC is authorized to conduct examinations of, and to require reporting by, FDIC-­insured institutions.  It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious threat to the FDIC.
  In the past three years, there have been many failures and near-failures among financial institutions. The number of FDIC-insured banks that have failed has increased, and the FDIC insurance fund reserve ratio, representing the ratio of the fund to the level of insured deposits, has declined due to losses caused by bank failures. As a result, the FDIC has increased its deposit insurance premiums on remaining institutions, including well-capitalized institutions like Victory State Bank, in order to replenish the insurance fund.  If bank failures continue to occur, and more so if the level of failures increases, the FDIC insurance fund may further decline, and the FDIC would be required to continue to impose higher premiums on healthy banks. Thus, despite the prudent steps we may take to avoid the mistakes made by other banks, our costs of operations may increase as a result of those mistakes by others.
  Our FDIC regular insurance premium was $80,357 in the first quarter of 2011 compared to $79,563 in the first quarter of 2010, an increase of 1.0%.  As required by The Dodd –Frank Wall Street Reform and Consumer Protection Law (the “Dodd-Frank” Act), the FDIC has recently revised its deposit insurance premium assessment rates.  Our Bank, even though we are in the lowest regulatory risk category, will be subject to an assessment rate between five (5) and nine (9) basis points per annum. In general, the rates are applied to our bank’s total assets less tangible capital, in contrast to the former rule which applied the assessment rate to our level of deposits.
  Despite the deposit insurance premium change and the special assessment, the fund created to pay the cost of resolving failed banks currently has a negative balance. The Dodd-Frank Act requires that the FDIC must increase the ratio of the FDIC insurance fund to estimated total insured deposits to 1.35% by September 30, 2020. The FDIC believes that most banks will pay a lower total assessment under the new system than under the former system, and it appears likely that will apply to Victory State Bank. However, if bank failures in the future exceed FDIC estimates, or other estimates that the FDIC makes turn out to be incorrect, and the losses to the insurance fund increase, the FDIC could be forced to increase insurance premiums. Such an increase would increase our non-interest expense.
  As a result of the Dodd-Frank Act, non-interest bearing demand deposits, together with certain attorney trust account deposits commonly known in New York as IOLA accounts, will have the benefit of unlimited federal deposit insurance until December 31, 2012. Since the Dodd-Frank Act also authorized banks to pay interest on commercial demand deposits beginning in June 2011, commercial depositors will have to choose between earning interest on their demand deposits or having the benefit of unlimited deposit insurance coverage. In addition, the increase in the general FDIC insurance limit from $100,000 to $250,000 was made permanent.
  The FDIC may terminate the deposit insurance of any insured depository institution, including the Bank, if it determines, after a hearing, that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed by an agreement with the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC. Management is aware of no existing circumstances that would result in termination of the Bank’s deposit insurance.
  26
  Possible Adverse Effects on Our Net Income Due to Fluctuations in Market Rates
  Our principal source of income is the difference between the interest income we earn on interest-earning assets, such as loans and securities, and our cost of funds, principally interest paid on deposits. These rates of interest change from time to time, depending upon a number of factors, including general market interest rates. However, the frequency of the changes varies among different types of assets and liabilities. For example, for a five-year loan with an interest rate based upon the prime rate, the interest rate may change every time the prime rate changes. In contrast, the rate of interest we pay on a five-year certificate of deposit adjusts only every five years, based upon changes in market interest rates.
  In general, the interest rates we pay on deposits adjust more slowly than the interest rates we earn on loans because our loan portfolio consists primarily of loans with interest rates that fluctuate based upon the prime rate. In contrast, although many of our deposit categories have interest rates that could adjust immediately, such as interest checking accounts and savings accounts, changes in the interest rates on those accounts are at our discretion. Thus, the rates on those accounts, as well as the rates we pay on certificates of deposit, tend to adjust more slowly. As a result, the declines in market interest rates that occurred through the end of 2008 initially had an adverse effect on our net income because the yields we earn on our loans declined more rapidly than our cost of funds. However, many of our prime-based loans have minimum interest rates, or floors, below which the interest rate does not decline despite further decreases in the prime rate. As our loans reached their interest rate floors, our loan yields stabilized while our deposit costs continued to decline.  This had a positive effect on our net interest income.
  When market interest rates begin increasing, which we expect will occur at some point in the future, we anticipate an initial adverse effect on our net income. We anticipate that this will occur because our deposit rates should begin to rise, while loan yields remain relatively steady until the prime rate increases sufficiently that our loans begin to reprice above their interest rate floors.  For most of our prime-rate based loans, this will not occur until the prime rate increases above 6%.  Once our loan rates exceed the interest rate floors, increases in market interest rates should increase our net interest income because our cost of deposits should probably increase more slowly than the yields on our loans. However, customer preferences and competitive pressures may negate this positive effect because customers may choose to move funds into higher-earning deposit types as higher interest rates make them more attractive, or competitors offer premium rates to attract deposits.  We also have a substantial portfolio of investment securities with fixed rates of interest, most of which are mortgage-backed securities with an estimated average life of not more than 5 years.
  Results of Operations for the Three Months Ended March 31, 2011 and March 31, 2010
  Our results of operations depend primarily on net interest income, which is the difference between the income we earn on our loan and investment portfolios and our cost of funds, consisting primarily of interest we pay on customer deposits. Our operating expenses principally consist of employee compensation and benefits, occupancy expenses, professional fees, advertising and marketing expenses and other general and administrative expenses.  Our results of operations are significantly affected by general economic and competitive conditions, particularly changes in market interest rates, government policies and actions of regulatory authorities.
  General. We had net income of $431,791 for the quarter ended March 31, 2011, compared to net income of $432,222 for the comparable quarter in 2010.  The principal categories which make up the 2011 net income are:
 
 ●
Interest income of $2,477,982●
Reduced by interest expense of $226,670●
Reduced by a provision for loan losses of $30,000●
Increased by non-interest income of $607,703●
Reduced by non-interest expense of $2,033,050●
Reduced by income tax expense of $364,174
 
 27
  We discuss each of these categories individually and the reasons for the differences between the quarters ended March 31, 2011 and 2010 in the following paragraphs.
  Interest Income.Interest income was $2,477,982 for the quarter ended March 31, 2011, compared to $2,561,725 for the quarter ended March 31, 2010, a decrease of $83,743, or 3.3%.  The main reason for the decline was a 61 basis point decrease in the yield on investment securities, partially offset by a $2,727,841 increase in average balance between the periods, which caused a $149,670 decline in interest income on investment securities.  On the positive side, interest income on loans increased by $63,996 as the average balance of loans increased between the periods.
  We had a $2,310,214 increase in average balance and a 4 basis point increase in the average yield on loans from the quarter ended March 31, 2010 to the quarter ended March 31, 2011,  The increase in the average balance was the result of our efforts to increase our loan portfolio.  Our average non-performing loans decreased by $2.5 million, for the quarter ending March 31, 2011 from the same period in 2010 which contributed to the  increase in our average loan yield.  The interest rate floors on our loans have helped to stabilize interest income from the loan portfolio, but these floors will have the effect of limiting increases in our income until the prime rate rises above 6%.
  We experienced a 61 basis point decrease in the average yield on our investment securities portfolio, from 4.09% to 3.48%, due to the purchase of new investment securities at lower market rates than the yields on the principal paydowns we received.  The average balance of our investment portfolio increased by $2,727,841, or 2.4%, between the periods.  The investment securities portfolio represented 80.2% of average non-loan interest earning assets in the 2011 period compared to 78.3% in the 2010 period as we deliberately limited our investment of available funds in investment securities due to the low yields available to us and our desire to avoid locking in those low yields for long periods while maintaining flexibility when interest rates eventually increase.
  The average yield on other interest earning assets (principally overnight investments) increased 4 basis points from 0.12% for the quarter ended March 31, 2010 to 0.16% for the quarter ended March 31, 2011, partially offset by a decrease in average balance of other interest earning assets of $2,846,213 from the quarter ended March 31, 2010 to the quarter ended March 31, 2011.
  Interest Expense. Interest expense was $226,670 for the quarter ended March 31, 2011, compared to $273,315 for the quarter ended March 31, 2010, a decrease of $46,645 or 17.1%. The decrease was primarily the result of a reduction in the rates we paid on deposits, principally on time deposits, reflecting a 24 basis point decrease in the cost of time deposits between the periods, due to the continuing low market interest rates. With market rates remaining at very low levels, customer time deposits continue to be renewed or replaced with new deposits at lower rates. As a result, our average cost of funds, excluding the effect of interest-free demand deposits, decreased to 0.65% from 0.79% between the periods.
  Net Interest Income Before Provision for Loan Losses. Net interest income before the provision for loan losses was $2,251,312 for the quarter ended March 31, 2011, compared to $2,288,410 for the quarter ended March 31, 2010, a decrease of $37,098, or 1.6%.  The decrease was primarily because the reduction in our interest income was greater than the reduction in our cost of funds when comparing the quarter ended March 31, 2011 to the same period ended 2010.  The average yield on interest earning assets declined by 22 basis points, while the average cost of funds declined by 14 basis points.  The reduction in the yield on assets was principally due to the 61 basis point drop in the yield on investment securities, as new securities were purchased at market rates significantly below the rates on securities repaid or matured.  The decline in the cost of funds was driven principally by the 24 basis point drop in the cost of time deposits.
  28
  Our net interest margin decreased to 3.96% for the quarter ended March 31, 2011 from 4.09% in the same period of 2010.  The interest rate margin decreased when we reinvested the proceeds from payments on investment securities at lower rates because of the continued decline in market interest rates.  The margin is higher than the spread because it takes into account the effect of interest free demand deposits and capital.
  Provision for Loan Losses.We took a provision for loan losses of $30,000 for the quarter ended March 31, 2011 compared to a provision for loan losses of $90,000 for the quarter ended March 31, 2010.  The $60,000 decrease in the provision was due to our evaluation of our loan portfolio and the low level of charge-offs in the 2011 period.  A number of factors justified the reduction.  We experienced a decrease of $2,540,831 in non-performing loans from $6,882,873 at March 31, 2010 to $4,342,042 at March 31, 2011.  Most of those loans are secured by real estate.  We individually evaluated the non-performing mortgage loans based primarily upon updated appraisals and we determined that the level of our allowance was appropriate to address inherent losses.  In addition, we had recoveries (which are added back to the allowance for loan losses) of $32,175 in the first quarter of 2011, as compared to $24,394 in the first quarter of 2010.  We are aggressively collecting charged-off loans in an effort to recover the amounts charged off whenever we believe that collection efforts are likely to be fruitful.
  The provision for loan losses in any period depends upon the amount necessary to bring the allowance for loan losses to the level management believes is appropriate, after taking into account charge offs and recoveries. Our allowance for loan losses is based on management’s evaluation of the risks inherent in our loan portfolio and the general economy. Management periodically evaluates both broad categories of performing loans and problem loans individually to assess the appropriate level of the allowance.
  Although management uses available information to assess the appropriateness of the allowance on a quarterly basis in consultation with outside advisors and the board of directors, changes in national or local economic conditions, the circumstances of individual borrowers, or other factors, may change, increasing the level of problem loans and requiring an increase in the level of the allowance. Overall, our allowance for loan losses increased from $1,161,562 or 1.49% of total loans, at March 31, 2010 to $1,301,598 or 1.62% of total loans, at March 31, 2011.  There can be no assurance that a higher level, or a higher provision for loan losses, will not be necessary in the future.
 
 Non-interest Income.Non-interest income was $607,703 for the quarter ended March 31, 2011, compared to $601,674 during the same period last year.  The $6,029, or 1.0%, increase in non-interest income was a direct result of an increase in loan fees, as we collected late fees on loans that were previously non-accrual, which was partially offset by $18,464 decrease in service charges on deposits due to normal fluctuation in non-sufficient fund fees.
  Non-interest Expense. Non-interest expense was $2,033,050 for the quarter ended March 31, 2011, compared to $2,003,376 for the quarter ended March 31, 2010, an increase of $29,674 or 1.2%. The principal shifts in the individual categories were:
 
 ●

a
$16,387 increase in salaries and benefits as a result of higher benefit costs and normal raises for existing
employees;●

a $14,251 increase in professional fees due to use of an independent contractor;●

a $12,773 increase in occupancy expenses because of the larger expense to clear snowfall in the first quarter of 2011; partially offset by●

a $24,535 decrease in legal expense due to a lower level of collections and a recovery of legal fees previously expensed on an non-accrual loan.
 
 In addition to these changes, we also experienced changes in the various other non-interest expenses categories due to normal fluctuations in operations.
  29
  Income Tax Expense. Income tax expense was $364,174 for the quarter ended March 31, 2011, compared to income tax expense of $364,486 for the same period ended 2010.  Our effective tax rate for the quarter ended March 31, 2011 was 45.8% and for the quarter ended March 31, 2010 was 45.7%.
  VSB Bancorp, Inc.

Consolidated Average Balance Sheets

(unaudited)Three








ThreeMonths Ended








Months EndedMarch 31, 2011








March 31, 2010Average





Yield/


Average





Yield/Balance


Interest


Cost(1)


Balance


Interest


Cost(1)Assets:Interest-earning assets:Loans receivable

$
81,967,735


$
1,454,292



7.12
%

$
79,657,521


$
1,390,296



7.08
%Investment securities, afs


117,997,488



1,012,552



3.48



115,269,647



1,162,222



4.09Other interest-earning assets


29,137,683



11,138



0.16



31,983,896



9,207



0.12Total interest-earning assets


229,102,906



2,477,982



4.36



226,911,064



2,561,725



4.58Non-interest earning assets


7,037,555









9,146,946Total assets

$
236,140,461










$
236,058,010Liabilities and equity:Interest-bearing liabilities:Savings accounts

$
16,046,503



12,696



0.32


$
14,964,564



11,460



0.31Time accounts


63,672,474



121,506



0.77



64,468,177



160,117



1.01Money market accounts


28,058,147



59,379



0.86



29,005,089



62,486



0.87Now accounts


32,594,336



33,089



0.41



32,725,644



39,252



0.49Total interest-bearing liabilities


140,371,460



226,670



0.65



141,163,474



273,315



0.79Checking accounts


67,565,709









67,545,187Escrow deposits


347,297









419,279Total deposits


208,284,466









209,127,940Other liabilities


1,675,380









1,929,055Total liabilities


209,959,846









211,056,995Equity


26,180,615









25,001,015Total liabilities and equity

$
236,140,461








$
236,058,010Net interest income/net interest

rate spread





$
2,251,312



3.71
%





$
2,288,410



3.79
%Net interest earning assets/net

interest margin

$
88,731,446







3.96
%

$
85,747,590







4.09
%Ratio of interest-earning assets

to interest-bearing liabilities


1.63
x










1.61
xReturn on Average Assets (1)


0.73
%








0.74
%Return on Average Equity (1)


6.56
%








7.01
%Tangible Equity to Total Assets


10.97
%








10.45
%
  (1) Ratios have been annualized.
  30
 Liquidity and Capital Resources
 
 Our primary sources of funds are increases in deposits, proceeds from the repayment of investment securities, and the repayment of loans. We use these funds to purchase new investment securities and to fund new and renewing loans in our loan portfolio.  Remaining funds are invested in short-term liquid assets such as overnight federal funds loans and bank deposits.
  During the three months ended March 31, 2011, we had a net increase in total deposits of $3,099,004 due to increases of $4,214,731 in non-interest demand deposits, $1,014,134 in savings accounts, $858,319 in time deposits, $679,458 in money market accounts and $101,374 in escrow deposits, partially offset by a decrease of $3,769,012 in NOW accounts.  These are all what are commonly known as “retail” deposits that we obtain through the efforts of our branch network rather than “wholesale” deposits that some banks obtain from deposit brokers.  We also received proceeds from repayment of investment securities of $9,431,300.  We used $6,075,129 of available funds to purchase new investment securities and we had a net loan decrease of $1,667,929.  These changes resulted in an overall increase in cash and cash equivalents of $8,895,760.
  In contrast, during the three months ended March 31, 2010, we had a net increase in total deposits of $1,664,732 due to increases of $1,032,292 in money market accounts, $882,528 in NOW accounts, $193,394 in time deposits, $67,083 in escrow deposits and $39,593 in savings accounts, partially offset by a decrease of $550,158 in non-interest demand deposits.  We also received proceeds from repayment of investment securities of $10,242,054.  We used $8,941,161 of available funds to purchase new investment securities and we had a net loan decrease of $868,869.  These changes resulted in an overall increase in cash and cash equivalents of $4,923,248.
  At March 31, 2011, cash and cash equivalents represented 15.8% of total assets.  We have increased our cash and cash equivalents to help buffer the adverse effects of potential, future rising interest rates.  We anticipate, based upon historical experience that these funds, combined with cash inflows we anticipate from payments on our loan and investment securities portfolios, will be sufficient to fund loan growth and unanticipated deposit outflows.  As noted above, the federal legal prohibition on paying interest on demand deposit accounts has been repealed effective July 2011.  Depending upon competitive pressures, we may need to implement interest-paying business checking in order to maintain demand deposits at historical levels or to increase such deposits.
  As a secondary source of liquidity, at March 31, 2011 we had $117.4 million of investment securities classified available for sale.  The disposition of these securities prior to maturity is an option available to us in the event, which we believe is unlikely, that our primary sources of liquidity and expected cash flows are insufficient to meet our need for funds. Additionally, we have the ability to borrow funds at the Federal Home Loan Bank of New York and the Federal Reserve Bank of New York using securities in our investment portfolio as collateral if the need arises.  Based upon our assets size and the amount of our securities portfolio that qualifies as eligible collateral, we had more than $77.1 million of unused borrowing capability from the FHLBNY at March 31, 2011. Victory State Bank also has a $2 million unsecured credit facility with Atlantic Central Bankers Bank, which the Bank has not drawn upon.  We do not anticipate a need for additional capital resources and do not expect to raise funds through a stock offering in the near future. We have sufficient resources to allow us to continue to make loans as appropriate opportunities arise without having to rely on government funds to support our lending activities.
  Victory State Bank satisfied all capital ratio requirements of the Federal Deposit Insurance Corporation at March 31, 2011, with a Tier I Leverage Capital ratio of 10.39%, a Tier I Capital to Risk-Weighted Assets ratio of 26.07%, and a Total Capital to Risk-Weighted Assets ratio of 27.32%.
  VSB Bancorp, Inc. satisfied all capital ratio requirements of the Federal Reserve at March 31, 2011, with a Tier I Leverage Capital ratio of 10.58%, a Tier I Capital to Risk-Weighted Assets ratio of 26.60%, and a Total Capital to Risk-Weighted Assets ratio of 27.85%.
  31
  The following table sets forth our contractual obligations and commitments for future lease payments, time deposit maturities and loan commitments.
 
 Contractual Obligations and Commitments at March 31, 2011Contractual Obligations

Payment due by PeriodLess than


One to three


Four to five


After


Total AmountsOne Year


years


years


five years


committedMinimum annual rental payments undernon-cancelable operating leases

$
414,966


$
839,084


$
745,943


$
948,119


$
2,948,112Remaining contractual maturities of timedeposits


52,911,665



7,443,976



4,147,641



-



64,503,282Total contractual cash obligations

$
53,326,631


$
8,283,060


$
4,893,584


$
948,119


$
67,451,394
 
 Other commitments

Amount of Commitment Expiration by PeriodLess than


One to three


Four to five


After


Total AmountsOne Year


years


years


five years


committedLoan commitments

$
23,216,414


$
4,130,785


$
—


$
—


$
27,347,199
 
 Our loan commitments shown in the above table represent both commitments to make new loans and obligations to make additional advances on existing loans, such as construction loans in process and lines of credit. Substantially all of these commitments involve loans with fluctuating interest rates, so the outstanding commitments do not expose us to interest rate risk upon fluctuation in market rates.
  Non-Performing Loans
  Management closely monitors non-performing loans and other assets with potential problems on a regular basis. We had thirteen non-performing loans, totaling $4,342,042 at March 31, 2011, compared to seventeen non-performing loans, totaling $6,378,293 at December 31, 2010.  The following is information about the six largest non-performing loans, totaling $3,686,343, or 84.9% of our non-performing loans, in outstanding principal balance at March 31, 2011.  Management believes it has taken appropriate steps with a view towards maximizing recovery and minimizing loss, if any, on these loans.
 
 ●
$2,200,000 in two residential mortgage loans that are fully secured.  We have entered into modified repayment arrangements with the borrowers and we have obtained confessions of judgment.  The loan is secured by a first mortgage and second mortgage on a residential property and first mortgages on two commercial properties. We have commenced foreclosure proceedings.●
$499,000 in a loan to a local business, which is secured by a first mortgage and a second mortgage on commercial real estate collateral.  The loan is also secured by the personal guaranties of the principals and a security interest in the business.  We are seeking to enter into a modified payment arrangement.●
$391,335 in a loan to a local business in which we are a participant in the loan with another bank.  We are not the lead lender.  The loan is in arrears and the lead lender has commenced a foreclosure action.  The loan is secured by a first mortgage on a commercial building, a security interest in the business, and the personal guaranties of the principals.●
$330,221 in a net loan to a local business, which is secured by a first mortgage on two parcels of commercial real estate.  The loan has been sent to our attorneys for collection.  We also have a security interest in the business as well as the personal guaranty of the principal.●
$265,787 in a net loan to a local business, which is secured by a first mortgage on commercial real estate collateral.  We have entered into modified repayment arrangements with the borrowers and we have obtained confessions of judgment.  We maintain a security interest in the business as well as the personal guaranty of the principal.  The borrower is current under the modified payments terms.
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  From time to time, the Bank will enter into agreements with borrowers to modify the terms of their loans when we believe that a modification will maximize our recovery.  In most cases, we do not agree to reduce the rate of interest or forgive the repayment of principal when we agree to loan modification, and we did not do so in any of the modifications described above. Instead, we seek to modify terms on an interim basis to allow the borrower to reduce payments for a short duration and thus give the borrower an opportunity to get back on its feet.
  If loans with modifications are on non-accrual status when they are modified, we do not immediately restore them to accruing status.  For those loans, as well as other loans on non-accrual status when the borrower makes payments, we initially record payments received either as a reduction of principal or as interest received on a cash basis. The choice between those alternatives depends upon the magnitude of the concessions, if any, we have given to the borrower, the nature of the collateral and the related loan to value ratio, and other factors affecting the likelihood that we will continue to receive regular payments. After a period of consistent on-time performance, the loan may be restored to accruing status. The length of on-time performance required to restore a loan to accruing status varies from a minimum of six months on loans with minor modifications or less-severe weaknesses to as long as a year or more on loans for which we have granted more significant concessions to the borrower or which otherwise have more significant weaknesses.
  Critical Accounting Policies and Judgments
  We are required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the amounts of revenues and expenses during the reporting period.  The allowance for loan losses, prepayment estimates on the mortgage-backed securities and Collateralized Mortgage Obligation portfolios, contingencies and fair values of financial instruments are particularly subject to change and to management’s estimates. Actual results can differ from those estimates and may have an impact on our financial statements.
  Item 4 –Controls and Procedures
  Evaluation of Disclosure Controls and Procedures: As of March 31, 2011, we undertook an evaluation of our disclosure controls and procedures under the supervision and with the participation of Raffaele M. Branca, President and CEO and Jonathan B. Lipschitz, Vice President and Controller.  Disclosure controls are the systems and procedures we use that are designed to ensure that information we are required to disclose in the reports we file or submit under the Securities Exchange Act of 1934 (such as annual reports on Form 10-K and quarterly periodic reports on Form 10-Q) is recorded, processed, summarized and reported, in a manner which will allow senior management to make timely decisions on the public disclosure of that information. Mr. Branca and Mr. Lipschitz concluded that our current disclosure controls and procedures are effective in ensuring that such information is (i) collected and communicated to senior management in a timely manner, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Since our last evaluation of our disclosure controls, we have not made any significant changes in, or taken corrective actions regarding, either our internal controls or other factors that could significantly affect those controls.
  We intend to continually review and evaluate the design and effectiveness of our disclosure controls and procedures and to correct any deficiencies that we may discover. Our goal is to ensure that senior management has timely access to all material financial and non-financial information concerning our business so that they can evaluate that information and make determinations as to the nature and timing of disclosure of that information. While we believe the present design of our disclosure controls and procedures is effective to achieve this goal, future events may cause us to modify our disclosure controls and procedures.
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  Part II
  Item 1 – Legal Proceedings
  VSB Bancorp, Inc. is not involved in any pending legal proceedings. The Bank, from time to time, is involved in routine collection proceedings in the ordinary course of business on loans in default. Management believes that such other routine legal proceedings in the aggregate are immaterial to our financial condition or results of operations.
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  Signature Page
  In accordance with the requirements of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
  VSB Bancorp, Inc.Date: May 10, 2011

/s/ Raffaele M. BrancaRaffaele M. BrancaPresident, CEO and Principal Executive OfficerDate: May 10, 2011

/s/ Jonathan B. LipschitzJonathan B. Lipschitz,Vice President, Controller and PrincipalAccounting Officer
 
 EXHIBIT INDEX
 
 ExhibitNumber

Description of Exhibit31.1

Rule 13A-14(a)/15D-14(a) Certification of Chief Executive Officer31.2

Rule 13A-14(a)/15D-14(a) Certification of Principal Accounting Officer32.1

Certification by CEO pursuant to 18 U.S.C. 1350.32.2

Certification by Principal Accounting Officer pursuant to 18 U.S.C. 1350.
 
 --------------------------------------------
  Item 6 - Exhibits
  ExhibitNumber

Description of Exhibit31.1

Rule 13A-14(a)/15D-14(a) Certification of Chief Executive Officer31.2

Rule 13A-14(a)/15D-14(a) Certification of Principal Accounting Officer32.1

Certification by CEO pursuant to 18 U.S.C. 1350.32.2

Certification by Principal Accounting Officer pursuant to 18 U.S.C. 1350.
  35