UNITED
STATES SECURITIES AND EXCHANGE COMMISSION


Washington
D.C. 20549


FORM
10-Q





T
            Quarterly
      Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of
      1934 for the quarterly period ended December 31,
  2008





OR





£
            Transition
      Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of
      1934








Commission
File Number 0-25509





First
Federal Bankshares, Inc.


(Exact
name of Registrant as specified in its charter)





Delaware
                  
                  42-1485449(State
      or other jurisdiction of
                  
                  (I.R.S.
      employerincorporation
      or organization)
                  
                  identification
      number)329 Pierce Street, Sioux City,
      Iowa
                  
                  51101(Address
      of principal executive offices)
                  
                  (Zip
      Code)





712-277-0200


(Registrant's
telephone number)








Indicate
by check mark whether the Registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 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 þNO o


Indicate
by check mark whether the Registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.  See the definitions of “large accelerated filer,”
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act. (Check One):





Large
      accelerated filer  o
                Accelerated filer oNon-accelerated
      filer  o (Do not check if
      a smaller reporting company)
                
                Smaller
      reporting company þ





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


YES oNO þ





Indicate
the number of shares outstanding of each of the issuer's classes of common
stock, as of the latest practicable date.


Class
                
                Outstanding at February 18,
      2009Common
      Stock, $.01 par value
                
                3,304,471













FIRST
FEDERAL BANKSHARES, INC.





INDEX





PagePART I.
                                                                                
                                                                                FINANCIAL INFORMATIONITEM
      1.
                                                                                Financial Statements of First Federal Bankshares, Inc. and
      Subsidiaries
                                                                                
                                                                                1Consolidated Statements of Financial Condition at December 31,
      2008 and June 30, 2008Consolidated Statements of Operations for the three and six
      month periods ended December 31, 2008 and 2007
                                                                                
                                                                                2Consolidated
      Statements of Stockholders’ Equity for thesix month periods ended
      December 31, 2008 and 2007
                                                                                
                                                                                3Consolidated
      Statements of Comprehensive Loss for the three andsix month
      periods ended December 31, 2008 and 2007
                                                                                
                                                                                4Consolidated
      Statements of Cash Flows for thesix month periods ended December
      31, 2008 and 2007
                                                                                
                                                                                5Notes to Consolidated Financial
    Statements
                                                                                
                                                                                6ITEM 2.
                                                                                Management's Discussion and Analysis of Financial Condition and
      Results of Operations
                                                                                
                                                                                12ITEM 3.
                                                                                Quantitative and Qualitative Disclosures about Market
      Risk
                                                                                
                                                                                24ITEM 4T.
                                                                                Controls and Procedures
                                                                                
                                                                                24PART II.
                                                                                
                                                                                OTHER INFORMATION
                                                                                
                                                                                25ITEM 1.
                                                                                Legal Proceedings
                                                                                
                                                                                25ITEM 1A.
                                                                                Risk Factors
                                                                                
                                                                                25ITEM 2.
                                                                                Unregistered Sales of Equity Securities and Use of
      Proceeds
                                                                                
                                                                                25ITEM 3.
                                                                                Defaults upon Senior Securities
                                                                                
                                                                                25ITEM 4.
                                                                                Submission of Matters to a Vote of Security
    Holders
                                                                                
                                                                                25ITEM 5.
                                                                                Other Information
                                                                                
                                                                                25ITEM 6.
                                                                                Exhibits
                                                                                
                                                                                26Signatures
                                                                                
                                                                                27





Index




PARTI.          
          FINANCIAL  INFORMATIONITEM1.               FINANCIAL  STATEMENTSFirstFederal Bankshares, Inc. and
SubsidiariesConsolidated Statements
      of Financial Condition (Unaudited)December
      31,
                          
                          
                          June
      30,2008
                          
                          
                          2008ASSETSCash
      and due from banks
                          
                          $
                          13,456,623
                          
                          
                          $
                          12,491,282Interest-bearing deposits in other financial
      institutions
                          
                          
                          10,544,000
                          
                          
                          
                          -Cash and cash equivalents
                          
                          $
                          24,000,623
                          
                          
                          $
                          12,491,282Securities
      available-for-sale (amortized cost $95,907,241 and $101,872,241,
      respectively)
                          
                          
                          66,153,500
                          
                          
                          
                          84,229,406Securities
      held-to-maturity (fair value $6,241,200 and $7,031,673,
      respectively)
                          
                          
                          6,210,866
                          
                          
                          
                          6,999,724Mortgage
      loans held for sale
                          
                          
                          1,031,785
                          
                          
                          
                          1,102,250Loans
      receivable
                          
                          
                          369,997,322
                          
                          
                          
                          413,712,503Less allowance for loan
    losses
                          
                          
                          6,653,933
                          
                          
                          
                          5,893,793Net loans
                          
                          
                          363,343,389
                          
                          
                          
                          407,818,710Office
      property and equipment, net
                          
                          
                          16,533,746
                          
                          
                          
                          18,761,786Federal
      Home Loan Bank ("FHLB") stock, at cost
                          
                          
                          5,879,000
                          
                          
                          
                          4,283,000Foreclosed
      and repossessed assets
                          
                          
                          8,627,789
                          
                          
                          
                          873,159Accrued
      interest receivable
                          
                          
                          2,463,870
                          
                          
                          
                          2,534,503Deferred
      tax asset
                          
                          
                          14,639,000
                          
                          
                          
                          9,870,000Other assets
                          
                          
                          14,727,177
                          
                          
                          
                          16,042,504Total assets
                          
                          $
                          523,610,745
                          
                          
                          $
                          565,006,324LIABILITIES
      AND STOCKHOLDERS’ EQUITYLIABILITIESDeposit
      liabilities
                          
                          $
                          369,746,413
                          
                          
                          $
                          446,568,327Advances
      from FHLB and other borrowings
                          
                          
                          122,244,241
                          
                          
                          
                          81,636,814Advance
      payments by borrowers for taxes and insurance
                          
                          
                          760,584
                          
                          
                          
                          884,437Accrued
      interest payable
                          
                          
                          1,495,159
                          
                          
                          
                          1,800,967Accrued expenses and other
      liabilities
                          
                          
                          3,492,817
                          
                          
                          
                          2,124,234Total liabilities
                          
                          
                          497,739,214
                          
                          
                          
                          533,014,779COMMITMENTS
      AND CONTINGENCIESSTOCKHOLDERS’
      EQUITYPreferred
      stock, $.01 par value, authorized 1,000,000 shares; issued
      none
                          
                          
                          -
                          
                          
                          
                          -Common
      stock, $.01 par value, authorized 12,000,000 shares; issued 5,068,726
      shares
                          
                          
                          50,651
                          
                          
                          
                          50,639Additional
      paid-in capital
                          
                          
                          39,554,748
                          
                          
                          
                          39,505,397Retained
      earnings, substantially restricted
                          
                          
                          33,950,186
                          
                          
                          
                          32,581,696Treasury
      stock, at cost, 1,764,255 shares
                          
                          
                          (28,535,663
                          )
                          
                          
                          (28,535,663
                          )Accumulated
      other comprehensive (loss)
                          
                          
                          (18,655,741
                          )
                          
                          
                          (11,061,834
                          )Unearned ESOP
                          
                          
                          (492,650
                          )
                          
                          
                          (548,690
                          )Total stockholders’ equity
                          
                          
                          25,871,531
                          
                          
                          
                          31,991,545Total liabilities and stockholders’
      equity
                          
                          $
                          523,610,745
                          
                          
                          $
                          565,006,324See
      Notes to Consolidated Financial Statements.
  1
 Index
 
 FirstFederal Bankshares, Inc. and
SubsidiariesConsolidated
      Statements of Operations (Unaudited)Three
      months ended
                        
                        
                        Six
      months endedDecember
      31,
                        
                        
                        December
      31,2008
                        
                        
                        2007
                        
                        
                        2008
                        
                        
                        2007Interest
      income:Loans
      receivable
                        
                        $
                        5,844,689
                        
                        
                        $
                        7,402,818
                        
                        
                        $
                        12,056,747
                        
                        
                        $
                        14,833,267Investment
      securities
                        
                        
                        1,488,043
                        
                        
                        
                        1,994,426
                        
                        
                        
                        2,958,237
                        
                        
                        
                        4,019,237Deposits in other financial
      institutions
                        
                        
                        376
                        
                        
                        
                        7,609
                        
                        
                        
                        890
                        
                        
                        
                        58,049Total interest income
                        
                        
                        7,333,108
                        
                        
                        
                        9,404,853
                        
                        
                        
                        15,015,874
                        
                        
                        
                        18,910,553Interest
      expense:Deposits
                        
                        
                        2,395,581
                        
                        
                        
                        3,914,621
                        
                        
                        
                        4,934,449
                        
                        
                        
                        8,476,884Advances from FHLB and other
      borrowings
                        
                        
                        541,735
                        
                        
                        
                        1,288,960
                        
                        
                        
                        1,181,118
                        
                        
                        
                        2,152,937Total interest expense
                        
                        
                        2,937,316
                        
                        
                        
                        5,203,581
                        
                        
                        
                        6,115,567
                        
                        
                        
                        10,629,821Net
      interest income
                        
                        
                        4,395,792
                        
                        
                        
                        4,201,272
                        
                        
                        
                        8,900,307
                        
                        
                        
                        8,280,732Provision for loan losses
                        
                        
                        1,304,806
                        
                        
                        
                        492,389
                        
                        
                        
                        2,017,663
                        
                        
                        
                        513,037Net interest income after provision for loan
      losses
                        
                        
                        3,090,986
                        
                        
                        
                        3,708,883
                        
                        
                        
                        6,882,644
                        
                        
                        
                        7,767,695Non-interest
      income (loss):Service
      charges on deposit accounts
                        
                        
                        1,030,883
                        
                        
                        
                        834,553
                        
                        
                        
                        2,063,213
                        
                        
                        
                        1,617,851Service
      charges on commercial and consumer loans
                        
                        
                        41,546
                        
                        
                        
                        122,854
                        
                        
                        
                        80,022
                        
                        
                        
                        220,615Gain
      on sale of bank branch offices
                        
                        
                        5,569,830
                        
                        
                        
                        -
                        
                        
                        
                        5,569,830
                        
                        
                        
                        -Gain
      on sale of real estate held for development
                        
                        
                        -
                        
                        
                        
                        46,610
                        
                        
                        
                        -
                        
                        
                        
                        46,610Gain
      (loss) on sale of office property and equipment
                        
                        
                        (81,257
                        )
                        
                        
                        321
                        
                        
                        
                        (81,205
                        )
                        
                        
                        3,821Other-than-temporary
      impairment of investment securities
                        
                        
                        -
                        
                        
                        
                        (3,270,594
                        )
                        
                        
                        (1,799,719
                        )
                        
                        
                        (3,270,594
                        )Mortgage
      banking revenue
                        
                        
                        166,403
                        
                        
                        
                        176,995
                        
                        
                        
                        246,780
                        
                        
                        
                        370,871Earnings
      from bank owned life insurance
                        
                        
                        147,028
                        
                        
                        
                        138,119
                        
                        
                        
                        292,667
                        
                        
                        
                        274,674Other income
                        
                        
                        236,550
                        
                        
                        
                        265,723
                        
                        
                        
                        455,261
                        
                        
                        
                        559,165Total non-interest income
      (loss)
                        
                        
                        7,110,983
                        
                        
                        
                        (1,685,419
                        )
                        
                        
                        6,826,849
                        
                        
                        
                        (176,987
                        )Non-interest
      expense:Compensation
      and benefits
                        
                        
                        3,141,479
                        
                        
                        
                        2,824,927
                        
                        
                        
                        5,790,310
                        
                        
                        
                        5,631,128Office
      property and equipment
                        
                        
                        692,169
                        
                        
                        
                        700,616
                        
                        
                        
                        1,401,651
                        
                        
                        
                        1,401,863Data
      processing, ATM and debit card transaction costs,and other item processing
      expense
                        
                        
                        448,736
                        
                        
                        
                        416,693
                        
                        
                        
                        930,539
                        
                        
                        
                        786,702Professional,
      insurance and regulatory expense
                        
                        
                        468,721
                        
                        
                        
                        252,170
                        
                        
                        
                        819,446
                        
                        
                        
                        507,061Advertising,
      donations and public relations
                        
                        
                        347,153
                        
                        
                        
                        302,600
                        
                        
                        
                        569,600
                        
                        
                        
                        766,325Communications,
      postage and office supplies
                        
                        
                        199,008
                        
                        
                        
                        224,553
                        
                        
                        
                        400,866
                        
                        
                        
                        435,313Loss
      on other real estate owned
                        
                        
                        266,412
                        
                        
                        
                        14,006
                        
                        
                        
                        340,366
                        
                        
                        
                        68,707Other expense
                        
                        
                        228,165
                        
                        
                        
                        212,632
                        
                        
                        
                        439,912
                        
                        
                        
                        388,729Total non-interest expense
                        
                        
                        5,791,843
                        
                        
                        
                        4,948,197
                        
                        
                        
                        10,692,690
                        
                        
                        
                        9,985,828Income
      (loss) before income tax expense (benefit)
                        
                        
                        4,410,126
                        
                        
                        
                        (2,924,733
                        )
                        
                        
                        3,016,803
                        
                        
                        
                        (2,395,120
                        )Income tax expense
(benefit)
                        
                        
                        1,533,000
                        
                        
                        
                        (1,172,000
                        )
                        
                        
                        938,000
                        
                        
                        
                        (1,057,000
                        )Net income (loss)
                        
                        $
                        2,877,126
                        
                        
                        $
                        (1,752,733
                        )
                        
                        $
                        2,078,803
                        
                        
                        $
                        (1,338,120
                        )Per
      share information:Basic
      earnings (loss) per share
                        
                        $
                        0.87
                        
                        
                        $
                        (0.54
                        )
                        
                        $
                        0.63
                        
                        
                        $
                        (0.41
                        )Diluted
      earnings (loss) per share
                        
                        $
                        0.87
                        
                        
                        $
                        (0.54
                        )
                        
                        $
                        0.63
                        
                        
                        $
                        (0.41
                        )See
      Notes to Consolidated Financial Statements.
  2
 Index
 
 FirstFederal Bankshares, Inc. and
SubsidiariesConsolidated
      Statements of Stockholders' Equity  (Unaudited)Six
      MonthsEnded
      December 31,2008
                                          
                                          
                                          2007Capital
      Stock:Beginning
      of year balance
                                          
                                          $
                                          50,639
                                          
                                          
                                          $
                                          50,604Restricted
      shares vested: 1,200 and 2,062 shares, respectively
                                          
                                          
                                          12
                                          
                                          
                                          
                                          20End of period balance
                                          
                                          
                                          50,651
                                          
                                          
                                          
                                          50,624Additional
      paid-in capital:Beginning
      of year balance
                                          
                                          
                                          39,505,397
                                          
                                          
                                          
                                          39,230,016Stock
      compensation expense
                                          
                                          
                                          68,241
                                          
                                          
                                          
                                          90,361Stock
      appreciation (depreciation) of allocated ESOP shares
                                          
                                          
                                          (34,357
                                          )
                                          
                                          
                                          39,830Amortization
      of employee stock grants
                                          
                                          
                                          15,479
                                          
                                          
                                          
                                          27,672Restricted
      shares vested: 1,200 and 2,062 shares, respectively
                                          
                                          
                                          (12
                                          )
                                          
                                          
                                          (20
                                          )End of period balance
                                          
                                          
                                          39,554,748
                                          
                                          
                                          
                                          39,387,859Retained
      earnings, substantially restricted:Beginning
      of year balance
                                          
                                          
                                          32,581,696
                                          
                                          
                                          
                                          58,704,525Adoption
      of FIN 48
                                          
                                          
                                          -
                                          
                                          
                                          
                                          180,000Adoption
      of SFAS 156
                                          
                                          
                                          -
                                          
                                          
                                          
                                          79,374Adoption
      of EITF 06-04
                                          
                                          
                                          (710,313
                                          )
                                          
                                          
                                          -Net
      income (loss)
                                          
                                          
                                          2,078,803
                                          
                                          
                                          
                                          (1,338,120
                                          )Dividends
      paid on common stock: $0.21 per share in 2007
                                          
                                          
                                          -
                                          
                                          
                                          
                                          (682,395
                                          )End of period balance
                                          
                                          
                                          33,950,186
                                          
                                          
                                          
                                          56,943,384Treasury
      stock, at cost:Beginning
      of year balance
                                          
                                          
                                          (28,535,663
                                          )
                                          
                                          
                                          (26,885,723
                                          )Treasury
      stock acquired: 87,000 shares in 2007
                                          
                                          
                                          -
                                          
                                          
                                          
                                          (1,649,940
                                          )End of period balance
                                          
                                          
                                          (28,535,663
                                          )
                                          
                                          
                                          (28,535,663
                                          )Accumulated
      other comprehensive (loss):Beginning
      of year balance
                                          
                                          
                                          (11,061,834
                                          )
                                          
                                          
                                          (179,360
                                          )Net
      change in unrealized losses on securities available-for-sale,net of tax of
      $5,188,000 and $2,617,000, respectively
                                          
                                          
                                          (8,722,626
                                          )
                                          
                                          
                                          (4,400,461
                                          )Less
      reclassification adjustment for net realized losses included in net
      income,net of tax of $671,000 and $1,220,000, respectively
                                          
                                          
                                          1,128,719
                                          
                                          
                                          
                                          2,050,594End of period balance
                                          
                                          
                                          (18,655,741
                                          )
                                          
                                          
                                          (2,529,227
                                          )Unearned
      ESOP shares:Beginning
      of year balance
                                          
                                          
                                          (548,690
                                          )
                                          
                                          
                                          (664,840
                                          )ESOP shares allocated
                                          
                                          
                                          56,040
                                          
                                          
                                          
                                          58,880End of period balance
                                          
                                          
                                          (492,650
                                          )
                                          
                                          
                                          (605,960
                                          )Total stockholders' equity
                                          
                                          $
                                          25,871,531
                                          
                                          
                                          $
                                          64,711,017See
      Notes to Consolidated Financial Statements.
  3
 Index
 
 FirstFederal Bankshares, Inc. and
SubsidiariesConsolidated
      Statements of Comprehensive (Loss) (Unaudited)Three
      Months Ended
                            
                            
                            Six
      Months EndedDecember
      31,
                            
                            
                            December
      31,2008
                            
                            
                            2007
                            
                            
                            2008
                            
                            
                            2007Net
      income (loss)
                            
                            $
                            2,877,126
                            
                            
                            $
                            (1,752,733
                            )
                            
                            $
                            2,078,803
                            
                            
                            $
                            (1,338,120
                            )Net
      change in unrealized losses on securities available-for-sale net of tax of
      $3,132,000, $1,872,000,$5,188,000 and $2,617,000,
    respectively
                            
                            
                            (5,265,652
                            )
                            
                            
                            (3,147,575
                            )
                            
                            
                            (8,722,626
                            )
                            
                            
                            (4,400,461
                            )Less reclassification adjustment for net realized
      losses included in net income, net of tax of $671,000 for 2008 and
      $1,220,000 for 2007
                            
                            
                            -
                            
                            
                            
                            2,050,594
                            
                            
                            
                            1,128,719
                            
                            
                            
                            2,050,594Total comprehensive (loss)
                            
                            $
                            (2,388,526
                            )
                            
                            $
                            (2,849,714
                            )
                            
                            $
                            (5,515,104
                            )
                            
                            $
                            (3,687,987
                            )See
      Notes to Consolidated Financial Statements.
  4
 Index
  FirstFederal Bankshares, Inc. and
SubsidiariesConsolidated
      Statements of Cash Flows (Unaudited)
                              
                              Six
      months endedDecember
      31,2008
                              
                              
                              2007Cash
      flows from operating activities:Net
      income (loss)
                              
                              $
                              2,078,803
                              
                              
                              $
                              (1,338,120
                              )Adjustments
      to reconcile net income (loss) from operations to net cash provided by
      operating activities:Loans
      originated for sale to investors
                              
                              
                              (18,952,386
                              )
                              
                              
                              (33,347,000
                              )Proceeds
      from sale of loans originated for sale
                              
                              
                              18,899,897
                              
                              
                              
                              33,795,337Provision
      for losses on loans
                              
                              
                              2,017,663
                              
                              
                              
                              513,037Depreciation
      and amortization
                              
                              
                              582,398
                              
                              
                              
                              719,553Provision
      for deferred taxes
                              
                              
                              (252,000
                              )
                              
                              
                              208,000Equity-based
      compensation
                              
                              
                              105,403
                              
                              
                              
                              216,743Mortgage
      banking revenue
                              
                              
                              (246,780
                              )
                              
                              
                              (370,871
                              )Other-than-temporary
      impairment of investment securities
                              
                              
                              1,799,719
                              
                              
                              
                              3,270,594Gain
      on sale of bank branch office
                              
                              
                              (5,569,830
                              )
                              
                              
                              -Net
      (gain) loss on sale of office property and equipment
                              
                              
                              81,205
                              
                              
                              
                              (3,821
                              )Net
      gain on sale of real estate help for development
                              
                              
                              -
                              
                              
                              
                              (46,610
                              )Amortization
      of premiums and discounts on loans,mortgage-backed securities and
      investment securities
                              
                              
                              225,570
                              
                              
                              
                              (6,702
                              )(Increase)
      in accrued interest receivable
                              
                              
                              (569,562
                              )
                              
                              
                              (94,722
                              )Decrease
      in other assets
                              
                              
                              148,884
                              
                              
                              
                              223,812(Decrease)
      in accrued interest payable
                              
                              
                              (58,029
                              )
                              
                              
                              (212,627
                              )Increase
      (decrease) in accrued expenses and other liabilities
                              
                              
                              699,948
                              
                              
                              
                              (24,974
                              )Increase (decrease) in accrued taxes on
      income
                              
                              
                              1,414,014
                              
                              
                              
                              (1,269,748
                              )Net cash provided by operating
      activities
                              
                              
                              2,404,917
                              
                              
                              
                              2,231,881Cash
      flows from investing activities:Proceeds
      from maturities of securities held-to-maturity
                              
                              
                              784,036
                              
                              
                              
                              581,560Purchase
      of securities available-for-sale
                              
                              
                              (6,996,021
                              )
                              
                              
                              -Proceeds
      from maturities of securities available-for-sale
                              
                              
                              11,724,371
                              
                              
                              
                              8,254,638Purchase
      of FHLB stock
                              
                              
                              (1,596,000
                              )
                              
                              
                              (1,679,900
                              )Loans
      purchased
                              
                              
                              (1,770,000
                              )
                              
                              
                              (5,242,000
                              )Cash
      effect of bank branch office sales
                              
                              
                              (20,734,872
                              )
                              
                              
                              -Decrease
      in loans receivable
                              
                              
                              8,548,006
                              
                              
                              
                              11,108,283Proceeds
      from sale of property and equipment
                              
                              
                              92,469
                              
                              
                              
                              3,821Purchase
      of office property and equipment
                              
                              
                              (81,188
                              )
                              
                              
                              (2,833,387
                              )Proceeds
      from sale of foreclosed real estate
                              
                              
                              2,356,075
                              
                              
                              
                              235,154Expenditures
      on foreclosed real estate
                              
                              
                              (164,534
                              )
                              
                              
                              -Proceeds
      from sale of real estate held for development
                              
                              
                              -
                              
                              
                              
                              804,844Expenditures on real estate held for
      development
                              
                              
                              -
                              
                              
                              
                              (309,020
                              )Net cash provided by (used in) investing
      activities
                              
                              
                              (7,837,658
                              )
                              
                              
                              10,923,993Cash
      flows from financing activities:(Decrease)
      in deposits
                              
                              
                              (23,611,224
                              )
                              
                              
                              (56,210,358
                              )Proceeds
      from advances from FHLB and other borrowings
                              
                              
                              103,209,500
                              
                              
                              
                              85,885,467Repayment
      of advances from FHLB and other borrowings
                              
                              
                              (62,602,073
                              )
                              
                              
                              (45,428,965
                              )Net
      (decrease) in advance payments by borrowers for taxes and
      insurance
                              
                              
                              (54,121
                              )
                              
                              
                              (27,852
                              )Repurchase
      of common stock
                              
                              
                              -
                              
                              
                              
                              (1,649,940
                              )Cash dividends paid
                              
                              
                              -
                              
                              
                              
                              (682,395
                              )Net cash provided by (used in) financing
      activities
                              
                              
                              16,942,082
                              
                              
                              
                              (18,114,043
                              )Net
      increase (decrease) in cash and cash equivalents
                              
                              
                              11,509,341
                              
                              
                              
                              (4,958,169
                              )Beginning of year
                              
                              
                              12,491,282
                              
                              
                              
                              25,738,467End of year
                              
                              $
                              24,000,623
                              
                              
                              $
                              20,780,298SUPPLEMENTAL
      DISCLOSURE OF CASH FLOW INFORMATIONCash
      paid during the period for:Interest
                              
                              $
                              6,421,375
                              
                              
                              $
                              10,842,448Income
      taxes paid
                              
                              
                              -
                              
                              
                              
                              4,748SUPPLEMENTAL
      DISCLOSURE OF NONCASH INVESTING ANDFINANCING
      ACTIVITIESProperty
      acquired in settlement of loans
                              
                              
                              10,216,527
                              
                              
                              
                              1,742,224See
      Notes to Consolidated Financial Statements.
  5
 Index




FIRSTFEDERAL BANKSHARES, INC. and SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





Note
1.  Basis of presentation





The
consolidated financial statements as of and for the three and six month periods
ended December 31, 2008 and 2007, have been prepared pursuant to the rules and
regulations of the Securities and Exchange Commission.  Certain
information and footnote disclosure normally included in year-end financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been omitted pursuant to these rules and
regulations.  These consolidated financial statements should be read
in conjunction with the Company’s audited consolidated financial statements and
notes that are included in its Annual Report for the year ended June 30, 2008,
filed on Form 10-K.





In the
opinion of management of the Company, these financial statements reflect all
adjustments, consisting only of normal recurring accruals necessary to present
fairly these consolidated financial statements.  The results of
operations for the interim periods are not necessarily indicative of results
that may be expected for an entire year.





Certain
amounts previously reported have been reclassified to conform to the
presentation in these consolidated financial statements.  These
reclassifications did not affect previously reported net income or retained
earnings.





Critical
Judgments and Estimates   The Company describes all of its
significant accounting policies in Note 1 of the Company's Audited Consolidated
Financial Statements in its 2008 Annual Report on Form
10-K.   Particular attention should be paid to the Company’s
allowance for losses on loans, “other than temporary” impairment of investment
securities, valuation of deferred tax assets, and the fair value of financial
instruments, which are considered to be critical accounting policies, and which
require significant management judgments and estimates because of the inherent
uncertainties surrounding the subjective nature of these
areas.  Information on the impact loss allowances and “other than
temporary” losses have had on the Company's financial condition and results of
operations for the three and six month periods ended December 31, 2008 and 2007,
can be found below, in the sections entitled "Results of Operations – Provision
for Losses on Loans," “Financial Condition – Non-Performing and Classified
Assets,” and "Results of Operations – Other than Temporary
Impairment."





The
Company’s critical accounting policies and their application are periodically
reviewed by the Audit Committee and the full Board of Directors.





Note
2.  Organization





The
Company is the holding company for Vantus Bank (the “Bank”).  The
Company owns 100% of the Bank’s common stock.  Currently, the Company
engages in no other significant activities beyond its ownership of the Bank’s
common stock.





Note
3.  Use of Estimates





The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities at the date of
the financial statements, and the reported amounts of revenues and expenses
during the reporting period.  Actual results could differ from those
estimates.





Note
4.  Effect of New Accounting Standards





In
September 2006, the Emerging Issues Task Force ("EITF") reached a final
consensus on Issue 06-04, Accounting for Deferred Compensation
and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance
Arrangements.  In March 2007, the EITF reached a final
conclusion on Issue 06−10, Accounting for Collateral Assignment Split-Dollar
Life Insurance Arrangements.  The consensus stipulates that an
agreement by an employer to





6
 Index





share a
portion of the proceeds of a life insurance policy with an employee during the
postretirement period is a postretirement benefit arrangement required to be
accounted for.  The consensus concludes that the purchase of a
split-dollar life insurance policy does not constitute a settlement and,
therefore, a liability for the postretirement obligation must be recognized.
Issue 06-04 is effective for annual reporting periods beginning after December
15, 2007, with earlier adoption permitted.  The Company adopted EITF
06-04 on July 1, 2008.  EITF 06-04 allows the Company to record the
initial recognition of the liability through stockholders’
equity.  Upon the adoption of EITF 06-04 the Company’s stockholders’
equity decreased by approximately $710,000.  Ongoing expenses will be
recognized through the current year operations.  Management estimates
the first year’s expense will be approximately $30,000, or less than $0.01
earnings per share.





In September 2006, the FASB issued
Statement No. 157 (“SFAS 157”),Fair Value
Measurements.  SFAS 157 establishes a
framework for measuring fair value and expanding fair value measurement
disclosures. SFAS No. 157 also establishes a fair value hierarchy that
distinguishes between independent observable inputs and unobservable inputs
based on the best information available. When issued, SFAS No. 157 was effective
for fiscal years beginning after November 15, 2007.  In February 2008,
the FASB issued Staff Position (“FSP”) No. 157−2,Effective Date of
FASB Statement No. 157, to
allow entities to electively defer the effective date of SFAS No. 157 for
nonfinancial assets and liabilities, except for those items recognized or
disclosed at fair value on an annual or more frequently recurring basis, until
fiscal years beginning after November 15, 2008. Nonfinancial assets measured at
fair value on a nonrecurring basis include nonfinancial assets and liabilities
measured at fair value in the second step of a goodwill impairment test, as well
as intangible assets and other nonfinancial long−lived assets measured at fair
value for impairment assessment. The Company adopted SFAS No. 157 effective July
1, 2008 for financial assets and liabilities and elected to defer adoption of
SFAS No. 157 for nonfinancial assets and liabilities until July 1,
2009.  For the Company this deferral primarily applies to foreclosed
and repossessed assets.  In October 2008 the FASB issued Staff
Position No. 157-3,Determining the
Fair Value of a Financial Asset in a Market that is not Active,which amended SFAS 157.  FSP
No. 157-3 clarifies how the fair value of a financial instrument is determined
when the market for the financial asset is inactive.  FSP No. 157-3
was adopted by the Company effective as of September 30, 2008.





In January 2009, the FASB issued FSP
EITF 99-20-1, Amendments to
the Impairment Guidance of EITF 99-20.  This FSP amends the
impairment guidance in EITF 99-20, Recognition of Interest Income and
Impairment on Purchased Beneficial Interests and Beneficial Interest That
Continue to be Held by a Transferor in Securitized Financial Assetsto
align it with the impairment guidance within SFAS No. 115 by removing from EITF
99-20 the requirement to place exclusive reliance on market participants’
assumptions about future cash flows when evaluating an asset for “other than
temporary” impairment.  Both standards will now require that
assumptions about future cash flows consider reasonable management judgment
about the probability that the holder of an asset will be unable to collect all
amounts due.  FSP EITF 99-20-1 is effective for interim and annual
reporting periods ending December 15, 2008.





In February 2007, the FASB issued
Statement No. 159, (“SFAS 159”) The Fair Value Option for Financial
Assets and Financial Liabilities – Including an  amendment of FASB
Statement No. 115.  This Statement provides entities with an
option to report selected financial assets at fair value.  The
objective of the Statement is to improve financial reporting by providing
entities with the opportunity to mitigate volatility in earnings caused by
measuring related assets and liabilities differently without having to apply the
complex provisions of hedge accounting.  This Statement was effective
for the Company on July 1, 2008.  The Company did not elect to apply
the provisions of SFAS 159 to eligible items as of the date of
adoption.   As such, the adoption of SFAS  159 did not
impact the Company’s financial position, results of operations, or cash
flows.





In
September 2006, the FASB issued Statement No. 158, (“SFAS 158”), Employers’
Accounting for Defined Benefit Pension and Other Postretirement Plans – an
amendment of FASB Statements No. 87, 88, 106 and 132(R).  SFAS 158
requires a company that sponsors a postretirement benefit plan (other than a
multi-employer plan) to fully recognize, as an asset or liability, the
over-funded or under-funded status of its benefit plan in its balance
sheet.  The funded status is measured as the difference between the
fair value of the plan’s assets and its benefit obligation (projected benefit
obligation for pension plans and accumulated postretirement benefit obligation
for other postretirement benefit plans).  Currently, the funded status
of such plans is reported in the notes to the financial
statements.  This provision was effective for the Company on July 1,
2006.  In addition, SFAS No. 158 also requires a company to measure
its plan assets and benefit obligations as of its year end balance sheet date.
Currently, a company is permitted to choose a measurement date up to three
months prior to its year end to measure the plan assets and





7
 Index





obligations.  This
provision is effective for the Company on July 1, 2008.  Since the
Company participates in a multi-employer pension plan, it expects that the
adoption of SFAS 158 will not have a material impact on its financial position,
results of operation or cash flows.





Note
5.  Earnings (Loss) Per Share





The
following information was used in the computation of net earnings (loss) per
common share on both a basic and diluted basis for the periods
presented.





Three
      Months Ended
                  
                  
                  Six
      Months EndedDecember
      31,
                  
                  
                  December
      31,2008
                  
                  
                  2007
                  
                  
                  2008
                  
                  
                  2007Basic
      earnings (loss) per share computation:Net
      income (loss)
                  
                  $
                  2,877,126
                  
                  
                  $
                  (1,752,733
                  )
                  
                  $
                  2,078,803
                  
                  
                  $
                  (1,338,120
                  )Weighted average common shares
      outstanding
                  
                  
                  3,304,471
                  
                  
                  
                  3,236,718
                  
                  
                  
                  3,304,471
                  
                  
                  
                  3,248,309Basic earnings (loss) per
    share
                  
                  $
                  0.87
                  
                  
                  $
                  (0.54
                  )
                  
                  $
                  0.63
                  
                  
                  $
                  (0.41
                  )Diluted
      earnings (loss) per share computation: (1)Net
      income (loss)
                  
                  $
                  2,877,126
                  
                  
                  $
                  (1,752,733
                  )
                  
                  $
                  2,078,803
                  
                  
                  $
                  (1,338,120
                  )Weighted
      average common shares outstanding
                  
                  
                  3,304,471
                  
                  
                  
                  3,236,718
                  
                  
                  
                  3,304,471
                  
                  
                  
                  3,248,309Incremental option and recognition and retention
      plan shares using treasury stock method
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Diluted shares outstanding
                  
                  
                  3,304,471
                  
                  
                  
                  3,236,718
                  
                  
                  
                  3,304,471
                  
                  
                  
                  3,248,309Diluted earnings (loss) per
      share
                  
                  $
                  0.87
                  
                  
                  $
                  (0.54
                  )
                  
                  $
                  0.63
                  
                  
                  $
                  (0.41
                  )





(1)
            Common
      shares issuable upon exercise of options and vesting of recognition and
      retention plan shares have not been included in the computation for
      the three months and six months ended December 31, 2008 because their
      inclusion would have had an antidilutive
effect.








Note
6.  Dividends





No cash
dividends were paid during the three months ended December 31,
2008.





Note
7.  Fair Value Measurements





SFAS 157
defines fair value as the price that would be received to sell an asset or paid
to transfer a liability in an orderly transaction between market participants at
the measurement date. SFAS 157 also establishes a fair value hierarchy that
prioritizes the use of inputs used in valuation methodologies into the following
three levels:





•Level 1 Inputs— Unadjusted
quoted prices in active markets for identical assets or liabilities that the
reporting entity has the ability to access at the measurement date.





•Level 2 Inputs— Inputs other
than quoted prices included in Level 1 that are observable for the asset or
liability, either directly or indirectly. These might include quoted prices for
similar assets or liabilities in active markets, quoted prices for identical or
similar assets or liabilities in markets that are not active, inputs other than
quoted prices that are observable for the asset or liability (such as interest
rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are
derived principally from or corroborated by market data by correlation or other
means.





•Level 3 Inputs— Unobservable
inputs for determining the fair values of assets or liabilities that reflect an
entity’s own assumptions about the assumptions that market participants would
use in pricing the assets or liabilities.





Financial
assets and financial liabilities measured at fair value on a recurring basis as
of December 31, 2008 are as follows:





8
 Index




Description
                  
                  Total
                  
                  
                  Quoted Prices in Active Markets for Identical
      Assets (Level 1)
                  
                  
                  Significant Other Observable Inputs (Level
      2)
                  
                  
                  Significant Unobservable Inputs (Level
      3)Securities
      available-for-sale
                  
                  $
                  66,153,500
                  
                  
                  
                  -
                  
                  
                  $
                  37,869,868
                  
                  
                  $
                  28,283,632Mortgage
      servicing rights
                  
                  
                  499,267
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  499,267








The
following table presents the changes in securities available-for-sale with
significant unobservable inputs (Level 3) for the three months and six months
ended December 31, 2008:





Three Months
                  
                  
                  Six MonthsBeginning
      balance at October 1, 2008 and July 1, 2008, respectively
                  
                  $
                  34,426,616
                  
                  
                  $
                  39,437,752Total
      losses:Included
      in earnings
                  
                  
                  -
                  
                  
                  
                  (1,799,719
                  )Included in other comprehensive
      (loss)
                  
                  
                  (6,142,984
                  )
                  
                  
                  (9,354,401
                  )Ending balance
                  
                  $
                  28,283,632
                  
                  
                  $
                  28,283,632





The
following table presents the changes in mortgage servicing rights with
significant unobservable inputs (Level 3) for the three months and six months
ended December 31, 2008:





Three Months
                  
                  
                  Six MonthsBeginning
      balance at October 1, 2008 and July 1, 2008, respectively
                  
                  $
                  626,008
                  
                  
                  $
                  676,634Total
      losses:Included in earnings
                  
                  $
                  (126,741
                  )
                  
                  $
                  (177,367
                  )Ending balance
                  
                  $
                  499,267
                  
                  
                  $
                  499,267





A
description of the valuation methodologies used for instruments measured at fair
value, as well as the general classification of such instruments pursuant to the
valuation hierarchy, is set forth below.





In
general, fair value is based upon quoted market prices, where
available.  If such quoted market prices are not available, fair value
is based upon internally developed models or obtained from third parties that
primarily use, as inputs, observable market-based
parameters.  Valuation adjustments may be made to ensure that
financial instruments are recorded at fair value, or the lower of the cost or
fair value.  These adjustments may include unobservable
parameters.  Any such valuation adjustments have been applied
consistently over time.  The Company’s valuation methodologies may
produce a fair value calculation that may not be indicative of net realizable
value or reflective of future fair values as of December 31,
2008.  While management believes the Company’s valuation methodologies
are appropriate and consistent with other market participants, the use of
different methodologies or assumptions to determine the fair value of certain
financial instruments could result in a different estimate of fair value at the
reporting date.  One of the more subjective inputs to fair value in
inactive markets is the risk-adjusted discount rate utilized in the fair value
calculation.  Management has used risk-adjusted discount rates
reflecting the current illiquid markets over the expected life of the
securities, which we believe is appropriate yet conservative.





Investment Securities Available for
Sale. Certain investment securities available for sale are classified
within level 2 of the valuation hierarchy. The Company obtains fair value
measurements for investment securities from an independent pricing service. The
fair value measurements consider observable data that may include dealer quotes,
market spreads, cash flows, the U.S. Treasury yield curve, live trading levels,
trade execution data, market consensus prepayment speeds, credit information and
the bond’s terms and conditions, among other things.





In
certain cases, where the pricing service cannot obtain fair values and/or there
is limited activity or less transparency around inputs to the valuation,
investment securities are classified within level 3 of the valuation
hierarchy.  Upon adoption of SFAS 157 on July 1, 2008, the Company has
classified trust preferred collateralized debt obligations with a total fair
value of approximately $34.4 million and $28.3 million at September 30, 2008
and





9
 Index





December
31, 2008, respectively as level 3.  Because the market is inactive for
these securities, observable market data was not available.  The fair
value of these securities was determined by discounting the expected cash flows
over the life of the security.  The discount rate was determined by
observing discount rates of similar rated financial corporate debt securities as
published by third party broker/dealers.  Adjustments to this discount
rate were made for illiquidity and credit risk.





Mortgage Servicing
RightsThe fair value of mortgage servicing rights are
determined by an independent valuation service.  The valuation service
utilizes discounted cash flow modeling techniques, which consider observable
data that includes consensus prepayment speeds and the predominant risk
characteristics of the underlying loans including loan type, note rate and loan
term.





Certain
assets are measured at fair value on a nonrecurring basis, that is, they are
subject to fair value adjustments in certain circumstances (for example, when
there is evidence of impairment).  Financial assets and financial
liabilities measured at fair value on a nonrecurring basis as of December 31,
2008 were as follows:





Description
                  
                  Total
                  
                  
                  Quoted Prices in Active Markets for Identical
      Assets (Level 1)
                  
                  
                  Significant Other Observable Inputs
      (Level 2)
                  
                  
                  Significant Unobservable Inputs
      (Level 3)Loans
      receivable
                  
                  $
                  5,697,318
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  $
                  5,697,318





The
specific reserves for collateral dependent impaired loans are based on the fair
value of the collateral less estimated costs to sell.  The fair value
of collateral was determined based on appraisals.  In some cases,
adjustments were made to the appraised values due to various factors including
the age of the appraisal, age of comparables included in the appraisal, and
known changes in the market and in the collateral.  When significant
adjustments were based on unobservable inputs, the resulting fair value
measurement has been categorized as a Level 3 measurement.  Specific
reserves were calculated for impaired loans with an aggregate principal balance
of $7.5 million during the quarter ended December 31, 2008.  The
collateral underlying these loans had a fair value of $5.7 million less
estimated costs to sell of $540,000, resulting in a specific reserve in the
allowance for loan losses of $2.4 million.








Note
8.  “Other than Temporary” Impairment on Investment
Securities





The
investment portfolio (except for those securities accounted for under FSP EITF
99-20-1 – see the following paragraph) is evaluated quarterly for
other-than-temporary declines in the market value of individual investment
securities.  Consideration is given to the length of time and the extent to
which fair value has been less than cost, the financial condition and near term
prospects of the issuer, the investment rating of the security, the expected
cash flows, the intent and ability of the Company to hold the investment for a
period of time sufficient to allow for any anticipated recovery in fair value,
and other factors.  Generally, no one factor is considered presumptive or
determinative, but rather all factors are considered based on their relative
weighting.  As these factors and considerations change, the assessment of
other-than-temporary impairment is reconsidered, which may result in additional
securities being considered other-than-temporarily impaired in future
periods.





The
Company holds certain securities which are accounted for under FSP EITF 99-20 -
1 Amendments to the Impairment
Guidance of EITF 99-20.Under FSP EITF 99-20-1, these
securities are evaluated for “other than temporary” impairment using a method
which compares the present value of the estimated cash flows at the balance
sheet date to those at the date of purchase (or previous impairment date, if
applicable).  The discount rate used is assumed to be the discount
rate used at the time of purchase.  If the present value of the cash
flows at the balance sheet date is less than the purchase date, “other than
temporary” impairment is deemed to have occurred and a charge to earnings is
recorded to write down the security to market value at the balance sheet
date.  The write down of the asset is recorded as a
discount.





The
Company recognized $1.8 million in “other than temporary” impairment charges for
the six months ended December 31, 2008.  The “other than temporary”
impairment charge related to six trust-preferred pooled securities
that





10
 Index





the
Company owns.   Two bonds with an original par value of $6.0
million were downgraded from investment grade status to non-investment grade
status during the six months ended December 31, 2008,  resulting in an
“other than temporary” impairment charge of $0.2 million for the six months
ended December 31, 2008.  Two bonds with an original par value of $6.0
million incurred a $1.0 million “other than temporary” charge for the six months
ended December 31, 2008 due to differences between the expected cash flow and
the cash flow that a current market participant would use to evaluate these
securities as required by EITF 99-20.  In that analysis, the Company
assumed that the default rates of the underlying collateral would be similar to
the default rates experienced in the savings and loan crisis (1988 through 1992)
and then declining to a historical default rate which includes the
aforementioned five years.  If actual default rates are less than the
aforementioned scenario, the cash flows of the security will increase and may
equal what was expected when the security was purchased.  Two
securities with an original par value of $4.0 million incurred an “other than
temporary charge” of $0.6 million for the six months ended December 31,
2008.  This “other than temporary” impairment charge was a result of
the Office of Thrift Supervision (“OTS”) concluding these two securities are
over the loans to one borrower limit and the Company has agreed to sell the
portion of the securities that is over the loans to one borrower limit when
liquidity returns to the marketplace.  Since the Company does not have
the ability to hold these securities until market value recovery an “other than
temporary” impairment charge was recognized.





For
further discussion, please refer to Item 2 – Management’s Discussion and
Analysis of Financial Condition and Results of Operations “Financial Condition –
Securities Available-for-Sale and Held-to-Maturity” and “Financial Condition –
Stockholders’ Equity.”








Note
9.  Non-Performing Assets





Non-performing
assets at December 31, 2008 increased slightly to $19.8 million as compared to
$18.6 million at June 30, 2008.  Non-performing assets as a percentage
of total assets increased slightly from 3.30% at June 30, 2008, to 3.79% as of
December 31, 2008.  The increase in non-performing assets is due to a
$3.0 million loan for the purpose of developing residential lots in Minnesota,
partially offset by payoffs of non-accrual loans and the disposition of
foreclosed and repossessed assets during the current quarter.  The
following table sets forth information regarding non-accrual loans and other
non-performing assets at the dates indicated.








(Dollars in Thousands)
                
                December 31, 2008
                
                
                June 30, 2008Loans
      accounted for on a non-accrual basis:One-
      to four-family residential
                
                $
                1,257
                
                
                $
                1,167Multi-family
      residential
                
                
                -
                
                
                
                3,230Non-residential
      real estate
                
                
                9,336
                
                
                
                11,825Commercial
      business
                
                
                480
                
                
                
                1,428Consumer
                
                
                144
                
                
                
                99Total non-performing loans
                
                
                11,217
                
                
                
                17,749Foreclosed and repossessed
      assets
                
                
                8,628
                
                
                
                873Total non-performing assets
                
                $
                19,845
                
                
                
                18,622Restructured loans not included in other
      non-performing categories above
                
                $
                5,054
                
                
                $
                5,206Non-performing
      loans as a percentage of total loans
                
                
                3.03
                %
                
                
                4.29
                %Non-performing assets as a percentage of total
      assets
                
                
                3.79
                %
                
                
                3.30
                %








Note
10.  Bank Branch Office Sale





On
December 15, 2008, the Company sold its banking center in Grinnell, Iowa to
another financial institution.  Assets sold at book value totaled
$27.4 million.  The purchaser assumed liabilities that totaled $53.7
million and paid a 10.58% premium, or $5.6 million, on deposit balances totaling
$52.7 million.





11
 Index





ITEM2.
            MANAGEMENT'S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS





Forward-Looking
Statements





This
report may contain certain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended (the “Securities Act”),
and Section 21E of the Securities Exchange Act of 1934, as amended (the
“Exchange Act”), that involve substantial risks and
uncertainties.  When used in this report, or in the documents
incorporated by reference herein, the words “anticipate”, “believe”, “estimate”,
“expect”, “intend”, “may”, and similar expressions identify such forward-looking
statements.  Actual results, performance or achievements could differ
materially from those contemplated, expressed or implied by the forward-looking
statements contained herein.  These forward-looking statements are
based largely on the expectations of the Company’s management and are subject to
a number of risks and uncertainties, including but not limited to economic,
competitive, regulatory, and other factors affecting the Company’s operations,
markets, products and services, as well as expansion strategies and other
factors discussed elsewhere in this report filed by the Company with the
Securities and Exchange Commission (“SEC”).  Many of these factors are
beyond the Company’s control.





Results
of Operations





Quarter
Overview   The Company’s net income for the three months
ended December 31, 2008, was $2.9 million or $0.87 per diluted share compared to
a net loss of $1.8 million or $0.54 per diluted share in the same period last
year.  These amounts represent an annualized return on average assets
(“ROA”) of 2.10% and -1.12%, respectively, and an annualized return on average
equity (“ROE”) of 38.53% and -10.23%, respectively.





The
increase in net income for the three months ended December 31, 2008, as compared
to the three months ended December 31, 2007, was due to an $8.8 million increase
in non-interest income and a $195,000 increase in net interest
income.  These developments were partially offset by an $844,000
increase in non-interest expense, an $813,000 increase in provision for loan
losses, and a $2.7 million increase in income tax expense.





Six Month
OverviewThe Company’s net income for the six months
ended December 31, 2008, was $2.1 million or $0.63 per diluted share, compared
to a net loss of $1.3 million or $0.41 per diluted share in the same period last
year.   These amounts represent an ROA of 0.75% and -0.43%,
respectively, and an ROE of 13.25% and -3.88%, respectively.





The
increase in net income for the six months ended December 31, 2008, as compared
to the same period a year ago was due to a $7.0 million increase in non-interest
income and a $619,000 increase in net interest income.  These
developments were partially offset by a $707,000 increase in non-interest
expense, a $1.5 million increase in provision for loan losses, and a $2.0
million increase in income tax expense.





The
following paragraphs discuss the aforementioned changes in more detail along
with other changes in the components of net income during the three and six
month periods ended December 31, 2008.





Net Interest
Income Net interest income for three-month period ended December 31,
2008, was $4.4 million compared to $4.2 million for the three-month period ended
December 31, 2007.  The net interest margin improved 73 basis points
to 3.75% for the three months ended December 31, 2008, from 3.02% for the three
months ended December 31, 2007.  For the six-month period ended
December 31, 2008, net interest income was $8.9 million compared to $8.3 million
for the six-month period ended December 31, 2007.  The net interest
margin improved 75 basis points to 3.71% for the six months ended December 31,
2008, from 2.96% for the six months ended December 31, 2007.  The
increase in margin for both periods was due to a generally lower interest rate
environment that decreased the cost of the Company’s interest-bearing
liabilities faster than the yields on interest-earning assets.  The
margin improvement was partially offset by a decrease in the Company’s average
interest-earning assets.





The
following tables set forth information regarding the average balances of the
Company’s assets, liabilities, and equity, as well as the average yield on
assets and average cost of liabilities for the periods indicated.  The
information is based on daily average balances during the three-month and
six-month periods ended December 31, 2008 and 2007.





12
 Index




Three
      months ended December 31,2008
                    
                    
                    2007Average
                    
                    
                    
                    
                    
                    Average
                    
                    
                    Average
                    
                    
                    
                    
                    
                    Average(Dollars in thousands)
                    
                    Balance
                    
                    
                    Interest
                    
                    
                    Yield/Cost
                    
                    
                    Balance
                    
                    
                    Interest
                    
                    
                    Yield/CostInterest-earning
      assets:Loans
      receivable (1)
                    
                    $
                    393,040
                    
                    
                    $
                    5,845
                    
                    
                    
                    5.90
                    %
                    
                    $
                    434,846
                    
                    
                    $
                    7,403
                    
                    
                    
                    6.75
                    %Investment
      securities (2)
                    
                    
                    87,411
                    
                    
                    
                    1,488
                    
                    
                    
                    6.93
                    %
                    
                    
                    127,477
                    
                    
                    
                    1,994
                    
                    
                    
                    6.35
                    %Deposits in other financial
      institutions
                    
                    
                    5,544
                    
                    
                    
                    -
                    
                    
                    
                    0.03
                    %
                    
                    
                    745
                    
                    
                    
                    8
                    
                    
                    
                    4.05
                    %Total
      interest-earning assets
                    
                    
                    485,995
                    
                    
                    
                    7,333
                    
                    
                    
                    6.02
                    %
                    
                    
                    563,068
                    
                    
                    
                    9,405
                    
                    
                    
                    6.66
                    %Non-interest-earning assets
                    
                    
                    61,906
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    64,322Total assets
                    
                    $
                    547,901
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    $
                    627,390Interest-bearing
      liabilities:Deposit
      liabilities
                    
                    $
                    372,378
                    
                    
                    
                    2,395
                    
                    
                    
                    2.55
                    %
                    
                    $
                    411,313
                    
                    
                    
                    3,915
                    
                    
                    
                    3.78
                    %Borrowings
                    
                    
                    98,807
                    
                    
                    
                    542
                    
                    
                    
                    2.18
                    %
                    
                    
                    100,438
                    
                    
                    
                    1,289
                    
                    
                    
                    5.09
                    %Total
      interest-bearing liabilities
                    
                    
                    471,185
                    
                    
                    
                    2,937
                    
                    
                    
                    2.47
                    %
                    
                    
                    511,751
                    
                    
                    
                    5,204
                    
                    
                    
                    4.03
                    %Non-interest-bearing:Deposit
      liabilities
                    
                    
                    41,898
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    42,958Other liabilities
                    
                    
                    4,947
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    5,268Total
      liabilities
                    
                    
                    518,030
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    559,977Stockholders’ equity
                    
                    
                    29,871
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    67,413Total liabilities and stockholders'
      equity
                    
                    $
                    547,901
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    $
                    627,390Net interest income
                    
                    
                    
                    
                    
                    $
                    4,396
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    $
                    4,201Interest rate spread
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    3.55
                    %
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    2.63
                    %Net interest margin (3)
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    3.75
                    %
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    3.02
                    %Ratio of average interest-earning assets to
      average interest-bearing liabilities
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    103.14
                    %
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    110.03
                    %





(1)
            Average
      balances include nonaccrual loans and loans held for
      sale.  Interest income includes amortization of deferred loan
      fees, which is not material.


(2)
            Investment
      securities income is presented without the benefit of the tax effect of
      tax exempt income; yields are presented on a tax-effected
      basis.


(3)
            Net
      interest margin represents net interest income, tax-effected, as a
      percentage of average earning
assets.





13
 Index




Six
      months ended December 31,2008
                    
                    
                    2007Average
                    
                    
                    
                    
                    
                    Average
                    
                    
                    Average
                    
                    
                    
                    
                    
                    Average(Dollars in thousands)
                    
                    Balance
                    
                    
                    Interest
                    
                    
                    Yield/Cost
                    
                    
                    Balance
                    
                    
                    Interest
                    
                    
                    Yield/CostInterest-earning
      assets:Loans
      receivable (1)
                    
                    $
                    400,049
                    
                    
                    $
                    12,057
                    
                    
                    
                    5.98
                    %
                    
                    $
                    433,268
                    
                    
                    $
                    14,834
                    
                    
                    
                    6.79
                    %Investment
      securities (2)
                    
                    
                    90,944
                    
                    
                    
                    2,958
                    
                    
                    
                    6.62
                    %
                    
                    
                    129,913
                    
                    
                    
                    4,019
                    
                    
                    
                    6.28
                    %Deposits in other financial
      institutions
                    
                    
                    2,788
                    
                    
                    
                    1
                    
                    
                    
                    0.06
                    %
                    
                    
                    2,326
                    
                    
                    
                    58
                    
                    
                    
                    4.95
                    %Total
      interest-earning assets
                    
                    
                    493,781
                    
                    
                    
                    15,016
                    
                    
                    
                    6.06
                    %
                    
                    
                    565,507
                    
                    
                    
                    18,911
                    
                    
                    
                    6.66
                    %Non-interest-earning assets
                    
                    
                    58,086
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    63,303Total assets
                    
                    $
                    551,867
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    $
                    628,810Interest-bearing
      liabilities:Deposit
      liabilities
                    
                    $
                    381,434
                    
                    
                    
                    4,935
                    
                    
                    
                    2.57
                    %
                    
                    $
                    430,716
                    
                    
                    
                    8,477
                    
                    
                    
                    3.90
                    %Borrowings
                    
                    
                    90,489
                    
                    
                    
                    1,181
                    
                    
                    
                    2.59
                    %
                    
                    
                    83,126
                    
                    
                    
                    2,153
                    
                    
                    
                    5.14
                    %Total
      interest-bearing liabilities
                    
                    
                    471,923
                    
                    
                    
                    6,116
                    
                    
                    
                    2.57
                    %
                    
                    
                    513,842
                    
                    
                    
                    10,630
                    
                    
                    
                    4.10
                    %Non-interest-bearing:Deposit
      liabilities
                    
                    
                    43,929
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    42,680Other liabilities
                    
                    
                    4,623
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    5,383Total
      liabilities
                    
                    
                    520,475
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    561,905Stockholders’ equity
                    
                    
                    31,392
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    66,905Total liabilities and stockholders'
      equity
                    
                    $
                    551,867
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    $
                    628,810Net interest income
                    
                    
                    
                    
                    
                    $
                    8,900
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    $
                    8,281Interest rate spread
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    3.49
                    %
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    2.56
                    %Net interest margin (3)
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    3.71
                    %
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    2.96
                    %Ratio of average interest-earning assets to
      average interest-bearing liabilities
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    104.63
                    %
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    110.05
                    %


(1)
            Average
      balances include nonaccrual loans and loans held for
      sale.  Interest income includes amortization of deferred loan
      fees, which is not material.


(2)
            Investment
      securities income is presented without the benefit of the tax effect of
      tax exempt income; yields are presented on a tax-effected
      basis.


(3)
            Net
      interest margin represents net interest income, tax-effected, as a
      percentage of average earning
assets.








Provision for
Losses on LoansThe provision for loan
losses for the three months ended December 31, 2008, was $1.3 million as
compared to $492,000 for the quarter ended December 31, 2007.  For the
six months ended December 31, 2008, the provision for loan losses increased to
$2.0 million from $513,000 during the same time period last year.  The
increase was primarily due to the Company recognizing a specific allowance of
$785,000 on a loan for the development of residential properties in
Minnesota.  The project is behind schedule and an appraisal that was
received during the most recent quarter showed that the property has suffered a
significant decrease in the value of the project.  As a result, a
specific allowance was warranted.





The
Company’s allowance for loan losses totaled $6.7 million as of December 31,
2008, compared to $2.1 million as of December 31, 2007.  The Company’s
methodology for establishing allowance for loan loss is heavily influenced by
the level of the Company’s non-performing and classified
loans.  Non-performing loans and classified assets have increased over
the last year due to the well-publicized difficulties in the overall markets for
commercial and residential real estate.  Although management believes
that the Company’s present level of allowance for loan losses is adequate, there
can be no assurance that future adjustments to the allowance will not be
necessary, which could adversely affect the Company’s results of
operations.  For additional discussion, refer to “Financial Condition
– Non-Performing and Classified Assets.”





The
following table summarizes the activity in the Company’s allowance for loan
losses for the three and six months ended December 31, 2008 and
2007.





14
 Index




Three
      months ended
                  
                  
                  Six
      months endedDecember
      31,
                  
                  
                  December
      31,(Dollars in Thousands)
                  
                  2008
                  
                  
                  2007
                  
                  
                  2008
                  
                  
                  2007Balance
      at beginning of period
                  
                  $
                  5,487
                  
                  
                  $
                  1,743
                  
                  
                  $
                  5,894
                  
                  
                  $
                  1,797Provision
      for loan losses
                  
                  
                  1,305
                  
                  
                  
                  492
                  
                  
                  
                  2,018
                  
                  
                  
                  513Charge-offs:Commercial
      real estate loans
                  
                  
                  -
                  
                  
                  
                  (182
                  )
                  
                  
                  (221
                  )
                  
                  
                  (182
                  )Commercial
      business loans
                  
                  
                  -
                  
                  
                  
                  (15
                  )
                  
                  
                  (860
                  )
                  
                  
                  (71
                  )Consumer loans
                  
                  
                  (158
                  )
                  
                  
                  (33
                  )
                  
                  
                  (220
                  )
                  
                  
                  (79
                  )Total
      loans charged-off
                  
                  
                  (158
                  )
                  
                  
                  (230
                  )
                  
                  
                  (1,301
                  )
                  
                  
                  (332
                  )Recoveries
                  
                  
                  20
                  
                  
                  
                  51
                  
                  
                  
                  43
                  
                  
                  
                  78Charge-offs, net of
    recoveries
                  
                  
                  (138
                  )
                  
                  
                  (179
                  )
                  
                  
                  (1,258
                  )
                  
                  
                  (254
                  )Balance at end of period
                  
                  $
                  6,654
                  
                  
                  $
                  2,056
                  
                  
                  $
                  6,654
                  
                  
                  $
                  2,056Allowance
      for loan losses to total loans
                  
                  
                  1.80
                  %
                  
                  
                  0.47
                  %
                  
                  
                  1.80
                  %
                  
                  
                  0.47
                  %Allowance
      for loan losses to non-performing loans
                  
                  
                  59.32
                  %
                  
                  
                  68.81
                  %
                  
                  
                  59.32
                  %
                  
                  
                  68.81
                  %Net
      annualized charge-offs to average loans outstanding
                  
                  
                  0.14
                  %
                  
                  
                  0.16
                  %
                  
                  
                  0.63
                  %
                  
                  
                  0.12
                  %




Non-Interest
Income  Excluding “other than temporary” write downs,
non-interest income totaled $7.1 million for the three months ended December 31,
2008, compared to $1.6 million during the same period in 2007.  For
the six months ended December 31, 2008, non-interest income totaled $8.6 million
compared to $3.1 million for the six month period ended December 31,
2007.  The following paragraphs discuss the principal components of
non-interest income and the primary reasons for the changes from 2007 to
2008.


.


Service Charges on Deposit
Accounts Service charges on deposits increased $200,000 to
$1.0 million for the three month period ended December 31, 2008, as compared to
the same period in the previous year.  For the six months ended
December 31, 2008, service charges on deposit accounts totaled $2.1 million as
compared to $1.6 million for the six months ended December 31,
2007.  The increase was due to a higher level of overdraft and
interchange fees collected on debit card transactions.  The higher
level of fees collected was primarily due to a significant increase in the
number of checking accounts opened over the last year.





Service Charges on Commercial and
Consumer Loans   Service charges on commercial and
consumer loans decreased $81,000 to $42,000 for the three month period ended
December 31, 2008, as compared to the same period in the previous
year.  For the six months ended December 31, 2008, service charges on
loans decreased $141,000 to $80,000.  The decrease was primarily due
to a reduction in the collection of prepayment penalties on commercial and
commercial real estate loans during the current periods as compared to the
previous periods.





Gain of Sale of Bank BranchesOn December 15, 2008, the Bank completed the sale of its Grinnell, Iowa,
branch office to Lincoln Savings Bank. As a result of this transaction, the Bank
recognized a gain on sale of $5.6 million.





“Other than Temporary”
ImpairmentThe Company’s “other than temporary”
impairment charges for the three months ended December 31, 2008, were zero
compared to $3.3 million for the three months ended December 31,
2007.  For the six months ended December 31, 2008, “other than
temporary” impairment charges were $1.8 million compared to $3.3 million for the
six months ended December 31, 2007.  The “other than temporary”
impairment charge for the six month period ended December 31, 2008, is related
to six trust-preferred pooled securities that the Company
owns.   Two bonds with an original par value of $6.0 million were
downgraded from investment grade status to non-investment grade status during
fiscal year 2008 resulting in an “other than temporary” impairment charge of
$0.2 million for the six months ended December 31, 2008.  Two bonds
with an original par value of $6.0 million incurred a $1.0 million “other than
temporary” charge due to differences between the expected cash flow and the cash
flow that a current market participant would use to evaluate these securities as
required by FSP EITF 99-20-1.  In that analysis, the Company assumed
that the default rates of the underlying collateral would be similar to the
default rates experienced in the savings and loan crisis (1988 through 1992) and
then declining to a historical default rate which includes the aforementioned
five years.  If actual default rates are less than the aforementioned
scenario, the cash flows of the security will increase and may equal what was
expected when the security was purchased.  Two securities with an
original par value of $4.0 million incurred an “other than temporary charge” of
$0.6 million for the six months





15
 Index





ended
December 31, 2008.  This “other than temporary” impairment charge was
a result of the Office of Thrift Supervision (“OTS”) concluding these two
securities are over the loans to one borrower limit and the Company has agreed
to sell the portion of the securities that is over the loans to one borrower
limit when liquidity returns to the marketplace.  Since the Company
does not have the ability to hold these securities until market value recovery
an “other than temporary” impairment charge was recognized.  Please
refer to “Financial Condition - Securities Available-for-Sale and
Held-to-Maturity” for more information.





Mortgage Banking
Revenue   Mortgage banking revenue consists of gain on
sale, collection of loan fees, and mortgage servicing
income.  Mortgage banking revenue declined to $166,000 for the three
months ended December 31, 2008, from $177,000 for the three months ended
December 31, 2007.  For the six months ended December 31, 2008,
mortgage banking revenue declined to $247,000 from $371,000 for the six months
ended December 31, 2007.  These decreases were due to declines in the
market value of the Company’s mortgage servicing portfolio during the respective
periods due to a falling interest rate environment.  These declines
were partially offset by an increase in fixed rate mortgage origination volumes
also due to the overall decline in market interest rates.





Earnings from Bank Owned Life
InsuranceEarnings from bank owned life insurance
increased $9,000 to $147,000 for the three months ended December 31,
2008.  For the six months ended December 31, 2008, earnings for bank
owned life insurance increased $18,000 to $293,000 from $275,000 during the same
period last year.  These changes were attributable to an increase in
the investment yield of the underlying insurance policies.





Other IncomeOther income
decreased $29,000 to $237,000 during the three month period ended December 31,
2008, as compared to the same period in the previous year. For the six months
ended December 31, 2008, other income declined to $455,000 from $559,000 for the
six months ended December 31, 2007. The change was primarily due to a decrease
in sales of the Company’s fixed annuity and mutual funds.




Non-Interest
ExpenseNon-interest expense for the three months ended December 31,
2008, was $5.8 million compared to $4.9 million for the three months ended
December 31, 2007. For the six months ended December 31, 2008, non-interest
expense totaled $10.7 million compared to $10.0 million for the same period a
year ago. The following paragraphs discuss the principal components of
non-interest expense and the primary reasons for the changes from 2007 to
2008.





Personnel
Expense    Compensation and employee benefits was
$3.1 million for the three months ended December 31, 2008, compared to $2.8
million for the three months ended December 31, 2007.  The increase in
compensation and benefit expense was partially attributed to one time costs
associated with a reorganization plan that was implemented during the current
quarter.  The reorganization reduced the full time equivalent
employees by approximately 15% and management anticipates a savings of
approximately $2.0 million a year.





Office Property and
Equipment   Office property and equipment expense
decreased $8,000 to $692,000 for the three months ended December 31, 2008, as
compared to the same period in the previous year.  For the six months
ended December 31, 2008 and 2007, office property and equipment expense totaled
$1.4 million.





Data Processing, ATM and Debit Card
Transaction Costs, and Other Item Processing
ExpenseData processing, ATM and debit card
transaction costs increased to $449,000 for the three months
ended         December 31, 2008,
from $417,000 for the three months ended December 31,
2007.    For the six months ended December 31, 2008, data
processing, ATM and debit card transaction costs increased to $931,000 from
$787,000 for the six months ended December 31, 2007.  This increase
was partially due to the increased number of new checking accounts opened during
the last twelve months as compared to the previous year.  In addition,
the Company has been successful at increasing the number of internet and mobile
banking users and the number of debit card transactions has
increased.  As a result, processing costs to service these channels
have increased as compared to the previous year.





Professional, Insurance, and
RegulatoryProfessional, insurance and regulatory
expense for the three months ended December 31, 2008, increased to $469,000 from
$252,000 for the same period a year ago.  For the six months ended
December 31, 2008, professional, insurance, and regulatory expense increased
$313,000 to $819,000 as compared to the six months ended December 31,
2007.  The increase in expense for both periods is primarily due to
costs incurred from clarifications of “mark-to-market” or “fair value”
accounting rules and consulting costs associated with the sale of the Grinnell,
Iowa branch.





16
 Index





Advertising, Donations, and Public
RelationsExpenses related to advertising, donations and
public relations increased to $347,000 for the three months ended December 31,
2008, from $303,000 for the three months ended December 31, 2007.  The
increase was primarily due to an increase in donations and public relation
expense during the current quarter as compared to the same time frame a year
ago.  For the six months ended December 31, 2008, advertising,
donations and public relations expense decreased to $570,000 from $766,000 for
the six months ended December 31, 2007.  The decrease in expense was
due to non-recurring costs related to the Bank’s name change that occurred in
the previous year.





Communication, Postage, and Office
SuppliesCommunications, postage, and office supplies
expense decreased by $26,000 from $225,000 for the three months ended December
31, 2007, to $199,000 for the three months ended December 31,
2008.  For the six months ended December 31, 2008, communication
postage and office supply expense decreased $34,000 to $401,000 as compared to
last year.   These decreases were primarily due to costs
associated with the Bank’s name change that occurred in the previous
year.  In addition, the Company has been successful in switching the
delivery of account statements from paper to electronic delivery.





Loss on other real estate
ownedLoss on other real estate owned increased to
$266,000 for the three months ended December 31, 2008, compared to $14,000 for
the three months ended December 31, 2007.  For the six months ended
December 31, 2008, loss on other real estate owned totaled $340,000 compared to
$69,000 for the six months ended December 31, 2007.  The increase in
expense was due to an overall decline in real estate market values on properties
the Company has received in foreclosure.





Other Non-Interest
ExpenseOther non-interest expense increased from
$213,000 for the three months ended December 31, 2007, to $228,000 for the three
months ended December 31, 2008.  For the six months ended December 31,
2008, other expense increased to $440,000 compared to $389,000 for the six
months ended December 31 2007.  This increase was due to costs
incurred by the Company to dispose of foreclosed property.





Income Tax
Expense(Benefit)Income tax expense for the three months ended December 31, 2008, was $1.5
million compared to income tax benefit of $1.2 million for the three months
ended December 31, 2007.   For the six months ended December 31,
2008, income tax expense was $938,000 compared to income tax benefit of $1.1
million for the six months ended December 31, 2007.  The income tax
expense or (benefit) for the three months ended December 31, 2008 and 2007,
represented 35% and (40%) of pre-tax income (loss), respectively.  The
income tax expense or (benefit) for the six months ended December 31, 2008 and
2007 represented 31% and (44%) of pre-tax income (loss),
respectively.  The effective tax rate decreased primarily due to tax
exempt income becoming a larger percentage of pretax income.








Financial
Condition





Overview
Total assets decreased by $41.4 million or 7%, to $523.6 million at December 31,
2008, from $565.0 million at June 30, 2008.  On December 15, 2008, the
Company completed the sale of its Grinnell, Iowa branch (“Branch”) to Lincoln
Savings Bank.  Lincoln Savings Bank purchased at book value: the
Branch, including equipment, furniture and fixtures associated with the Branch;
the loans associated with the Branch; and the Bank's ATM located at Grinnell
College.  As of the closing date these assets totaled $27.4
million.  In addition, Lincoln Savings Bank assumed certain
liabilities; primarily, the deposits housed at the Branch, and paid a 10.58%
premium, or $5.6 million, on $52.7 million in deposits.  As of the
closing date, the liabilities assumed by Lincoln Savings Bank totaled $53.7
million.





Securities
Available-for-Sale and Held-for-InvestmentTotal
securities decreased by $18.9 million to $72.4 million at December 31, 2008,
from $91.2 million at June 30, 2008.  The decrease was primarily due
to the decline in market value of the Company’s trust preferred Collateralized
Debt Obligations (“CDOs”).  Trust preferred CDOs represent a
participation interest in a pool of trust preferred debt or subordinated notes
of banks, thrifts, insurance companies and REITS.  As of December 31,
2008, the collateral of the CDOs purchased by the Company are approximately 76%
bank, 24% insurance companies, and less than one percent was either homebuilders
or real estate investment trusts (“REITS”).  Investments were
generally rated “A” or “triple-B” by independent rating agencies at the time of
purchase.





17
 Index





Federal
law and regulation generally permit the Bank to invest up to 35% of
its assets in commercial paper and corporate debt securities. Notwithstanding
this investment limit, guidance issued by the Office of Thrift Supervision
("OTS") imposes lower limits on such investments. 
The Company was advised by the OTS that the aggregate
amount of the Company's portfolio of trust-preferred pooled securities
exceeds OTS regulatory guidelines. The Company filed a plan with the OTS on
May 15, 2008, to come into compliance with such regulatory guidelines and
the timeframe for doing so.  As part of such plan, the Company asked
the OTS’ approval to allow the Company to retain such securities,
notwithstanding the regulatory guidelines. On September 25, 2008, the Company
received a letter from the OTS that stated the OTS had no objection to the
Company’s plan.  However, the OTS did conclude two bonds were in
excess of the OTS’ loans to one borrower limit (LTOB).  As a result,
the Company classified the portion over the LTOB limit as “other than
temporarily impaired” at September 30, 2008 due to a lack of ability by the
Company to hold these securities to maturity and/or forecasted
recovery.  The Company intends to sell these two securities over the
LTOB limit when liquidity returns to the market place.  Please refer
to “Results of Operations – Other than Temporary Impairment,” above, and
“Financial Condition – Stockholders’ Equity,” below, for additional discussion
relating to the Company’s trust-preferred securities (“TPSs”)
portfolio.





The table
below sets forth information regarding the Company’s trust preferred
collateralized debt obligations at December 31, 2008.





Issuer
                                                                          
                                                                          Original Rating
Moodys/Fitch
                                                                          
                                                                          
                                                                          Current Rating Moodys/Fitch
                                                                          
                                                                          Payment in Kind (1)
                                                                          
                                                                          Amortized Cost
                                                                          
                                                                          
                                                                          Market Value
                                                                          
                                                                          
                                                                          Unrealized Gain/(Loss)
                                                                          
                                                                          
                                                                          OTTI charge for six months ended December 31,
      2008TPS
      considered "other than temporarily" impaired:Security
      A
                                                                          
                                                                          Baa2/BBB
                                                                          
                                                                          
                                                                          Ba1/BBB
                                                                          
                                                                          No
                                                                          
                                                                          $
                                                                          429,816
                                                                          
                                                                          
                                                                          $
                                                                          420,000
                                                                          
                                                                          
                                                                          
                                                                          (9,816
                                                                          )
                                                                          
                                                                          
                                                                          219,816Security
      B (2)
                                                                          
                                                                          A3/A-
                                                                          
                                                                          
                                                                          Baa3/A-
                                                                          
                                                                          Yes
                                                                          
                                                                          
                                                                          781,848
                                                                          
                                                                          
                                                                          
                                                                          781,848
                                                                          
                                                                          
                                                                          
                                                                          -
                                                                          
                                                                          
                                                                          
                                                                          240,776Security
      C (2)
                                                                          
                                                                          A3/A-
                                                                          
                                                                          
                                                                          Baa1/A-
                                                                          
                                                                          Yes
                                                                          
                                                                          
                                                                          1,492,283
                                                                          
                                                                          
                                                                          
                                                                          1,492,283
                                                                          
                                                                          
                                                                          
                                                                          -
                                                                          
                                                                          
                                                                          
                                                                          311,607Security
      D
                                                                          
                                                                          NR/BBB
                                                                          
                                                                          
                                                                          NR/BBB
                                                                          
                                                                          Yes
                                                                          
                                                                          
                                                                          478,160
                                                                          
                                                                          
                                                                          
                                                                          471,207
                                                                          
                                                                          
                                                                          
                                                                          (6,953
                                                                          )
                                                                          
                                                                          
                                                                          97,901Security
      E
                                                                          
                                                                          NR/BBB
                                                                          
                                                                          
                                                                          NR/BBB
                                                                          
                                                                          Yes
                                                                          
                                                                          
                                                                          2,029,906
                                                                          
                                                                          
                                                                          
                                                                          1,040,826
                                                                          
                                                                          
                                                                          
                                                                          (989,080
                                                                          )
                                                                          
                                                                          
                                                                          894,619Security
      F
                                                                          
                                                                          NR/BBB
                                                                          
                                                                          
                                                                          NR/CCC
                                                                          
                                                                          Yes
                                                                          
                                                                          
                                                                          590,000
                                                                          
                                                                          
                                                                          
                                                                          590,000
                                                                          
                                                                          
                                                                          
                                                                          -
                                                                          
                                                                          
                                                                          
                                                                          35,000TPS
      not considered "other than temporarily" impaired:Security
      B
                                                                          
                                                                          A3/A-
                                                                          
                                                                          
                                                                          Baa3/A-
                                                                          
                                                                          Yes
                                                                          
                                                                          
                                                                          7,300,000
                                                                          
                                                                          
                                                                          
                                                                          3,731,341
                                                                          
                                                                          
                                                                          
                                                                          (3,568,659
                                                                          )Security
      C
                                                                          
                                                                          A3/A-
                                                                          
                                                                          
                                                                          Baa1/A-
                                                                          
                                                                          Yes
                                                                          
                                                                          
                                                                          7,300,000
                                                                          
                                                                          
                                                                          
                                                                          3,277,699
                                                                          
                                                                          
                                                                          
                                                                          (4,022,301
                                                                          )Security
      I
                                                                          
                                                                          A2/A
                                                                          
                                                                          
                                                                          A2/A
                                                                          
                                                                          No
                                                                          
                                                                          
                                                                          5,969,817
                                                                          
                                                                          
                                                                          
                                                                          3,747,498
                                                                          
                                                                          
                                                                          
                                                                          (2,222,319
                                                                          )Security
      J
                                                                          
                                                                          A2/A
                                                                          
                                                                          
                                                                          A2/A
                                                                          
                                                                          No
                                                                          
                                                                          
                                                                          1,977,336
                                                                          
                                                                          
                                                                          
                                                                          1,381,993
                                                                          
                                                                          
                                                                          
                                                                          (595,343
                                                                          )Security
      K
                                                                          
                                                                          A3/A-
                                                                          
                                                                          
                                                                          Baa1/A
                                                                          
                                                                          Yes
                                                                          
                                                                          
                                                                          1,983,791
                                                                          
                                                                          
                                                                          
                                                                          674,024
                                                                          
                                                                          
                                                                          
                                                                          (1,309,767
                                                                          )Security
      L
                                                                          
                                                                          NR/BBB
                                                                          
                                                                          
                                                                          NR/BBB
                                                                          
                                                                          Yes
                                                                          
                                                                          
                                                                          5,157,781
                                                                          
                                                                          
                                                                          
                                                                          1,694,457
                                                                          
                                                                          
                                                                          
                                                                          (3,463,324
                                                                          )Security
      M
                                                                          
                                                                          A3/A-
                                                                          
                                                                          
                                                                          A3/A-
                                                                          
                                                                          No
                                                                          
                                                                          
                                                                          4,953,605
                                                                          
                                                                          
                                                                          
                                                                          3,269,380
                                                                          
                                                                          
                                                                          
                                                                          (1,684,225
                                                                          )Security
      N
                                                                          
                                                                          NR/BBB
                                                                          
                                                                          
                                                                          NR/BBB
                                                                          
                                                                          Yes
                                                                          
                                                                          
                                                                          3,003,586
                                                                          
                                                                          
                                                                          
                                                                          901,076
                                                                          
                                                                          
                                                                          
                                                                          (2,102,510
                                                                          )Security
      O
                                                                          
                                                                          NR/BBB
                                                                          
                                                                          
                                                                          NR/BBB
                                                                          
                                                                          No
                                                                          
                                                                          
                                                                          5,000,000
                                                                          
                                                                          
                                                                          
                                                                          2,050,000
                                                                          
                                                                          
                                                                          
                                                                          (2,950,000
                                                                          )Security P
                                                                          
                                                                          A3/A-
                                                                          
                                                                          
                                                                          Baa2/A-
                                                                          
                                                                          No
                                                                          
                                                                          
                                                                          6,000,000
                                                                          
                                                                          
                                                                          
                                                                          2,760,000
                                                                          
                                                                          
                                                                          
                                                                          (3,240,000
                                                                          )$
                                                                          54,447,929
                                                                          
                                                                          
                                                                          $
                                                                          28,283,632
                                                                          
                                                                          
                                                                          $
                                                                          (26,164,297
                                                                          )
                                                                          
                                                                          $
                                                                          1,799,719





(1) The
structure of these securities allows for payment in kind or the capitalization
of interest to principal.


(2)
Portion of the security that is over the Bank's Loans to One Borrower
Limit.








The investment portfolio is evaluated
quarterly for other-than-temporary declines in the market value of individual
investment securities.  Consideration is given to the length of time and
the extent to which fair value has been less than cost, the financial condition
and near term prospects of the issuer, the investment rating of the security,
the expected cash flows, the intent and ability of the Company to hold the
investment for a period of time sufficient to allow for any anticipated recovery
in fair value, and other factors.  Generally, no one factor is considered
presumptive or determinative, but rather all factors are considered based on
their relative weighting.  As these factors and





18
 Index





considerations
change, the assessment of other-than-temporary impairment is reconsidered, which
may result in additional securities being considered other-than-temporarily
impaired in future periods.





Loans
Receivable  Loans receivable decreased by $43.7 million to
$370.0 million as of December 31, 2008, from $413.8 million at June 30,
2008.  The decrease is partially attributable the aforementioned sale
of the branch in Grinnell, Iowa.    The following table sets
forth information regarding the Company’s loan portfolio, by type of loan, on
the dates indicated.








December
      31, 2008
                  
                  
                  June
      30, 2008(Dollars in Thousands)
                  
                  Amount
                  
                  
                  %
                  
                  
                  Amount
                  
                  
                  %One-
      to four-family residential (1)
                  
                  $
                  92,926
                  
                  
                  
                  25.59
                  
                  
                  $
                  111,933
                  
                  
                  
                  27.45Multi-family
      residential (1)
                  
                  
                  36,818
                  
                  
                  
                  10.13
                  
                  
                  
                  40,451
                  
                  
                  
                  9.92Non-residential
      real estate (1)
                  
                  
                  112,244
                  
                  
                  
                  30.89
                  
                  
                  
                  132,794
                  
                  
                  
                  32.56Commercial
      business loans
                  
                  
                  53,859
                  
                  
                  
                  14.82
                  
                  
                  
                  62,217
                  
                  
                  
                  15.26Home
      equity and second mortgage loans
                  
                  
                  30,931
                  
                  
                  
                  8.51
                  
                  
                  
                  33,003
                  
                  
                  
                  8.09Auto
      loans
                  
                  
                  4,771
                  
                  
                  
                  1.31
                  
                  
                  
                  4,648
                  
                  
                  
                  1.14Other
      non-mortgage loans (2)
                  
                  
                  38,182
                  
                  
                  
                  10.51
                  
                  
                  
                  28,700
                  
                  
                  
                  7.04Loans in process, unearned discounts and
      premiums,and net deferred loan fees and costs
                  
                  
                  266
                  
                  
                  
                  0.07
                  
                  
                  
                  (33
                  )
                  
                  
                  (0.01
                  )Subtotal
                  
                  
                  369,997
                  
                  
                  
                  101.83
                  
                  
                  
                  413,713
                  
                  
                  
                  101.45Allowance for  loan
      losses
                  
                  
                  (6,654
                  )
                  
                  
                  (1.83
                  )
                  
                  
                  (5,894
                  )
                  
                  
                  (1.45
                  )Total loans, net
                  
                  $
                  363,343
                  
                  
                  
                  100.00
                  
                  
                  $
                  407,819
                  
                  
                  
                  100.00





(1)
Includes construction loans.


(2)
Includes other secured and unsecured personal loans.








Office property
and equipmentOffice property and equipment decreased from $18.8 million
at June 30, 2008, to $16.5 million at December 31, 2008. The decrease is
primarily attributable the aforementioned sale of the branch in Grinnell, Iowa
and depreciation of the Company’s office equipment.




FHLB Stock
The Company’s FHLB stock increased from $4.3 million at June 30, 2008, to $5.9
million at December 31, 2008. The increase was a direct result of the increase
in FHLB advances, which increases the level of FHLB stock required to be
held.




Foreclosed and
Repossessed AssetsForeclosed and repossessed assets increased to $8.6
million at December 31, 2008 compared to $0.9 million at June 30, 2008. The
increase was primarily due to two large commercial real estate relationships
consisting of five different projects entering into foreclosure proceedings.
However, the amount of foreclosed and repossessed assets decreased from the
prior quarter. At September 30, 2008, foreclosed and repossessed assets were
$9.9 million. Please refer to “Financial Condition - Non-Performing and
Classified Assets” for more detail.




Deferred Tax
AssetThe Company’s deferred tax asset increased from $9.9 million at
June 30, 2008 to $14.6 million at December 31, 2008. The increase was primarily
due to deferred tax assets related to unrealized losses on available-for-sale
securities.




Deposit
Liabilities Deposit liabilities decreased by $76.8 million, to $369.7
million at December 31, 2008, from $446.6 million at June 30, 2008. The decrease
in deposits was largely due to the aforementioned sale of the branch in
Grinnell, Iowa. In addition, there was an overall decline in the average balance
of all deposit accounts.





19
 Index




December
      31, 2008
                
                
                June
      30, 2008(Dollars in Thousands)
                
                Amount
                
                
                %
                
                
                Amount
                
                
                %Non-interest-bearing
      checking
                
                $
                40,452
                
                
                
                10.94
                
                
                $
                48,490
                
                
                
                10.86Interest-bearing
      checking accounts
                
                
                71,941
                
                
                
                19.46
                
                
                
                98,410
                
                
                
                22.04Money
      market accounts
                
                
                36,441
                
                
                
                9.86
                
                
                
                54,539
                
                
                
                12.21Savings
      accounts
                
                
                20,530
                
                
                
                5.55
                
                
                
                24,959
                
                
                
                5.59Certificates of deposit
                
                
                200,382
                
                
                
                54.19
                
                
                
                220,170
                
                
                
                49.30Total deposits
                
                $
                369,746
                
                
                
                100.00
                
                
                $
                446,568
                
                
                
                100.00








FHLB Advances and
Other BorrowingsThe Company’s FHLB advances and other borrowings
increased $40.6 million, to $122.2 million at December 31, 2008, from $81.6
million at June 30, 2008. The increase was due to increased borrowings to assist
in the funding of Grinnell, Iowa branch sale.




Stockholders’
Equity Total stockholders’ equity decreased by $6.1 million from $32.0
million at June 30, 2008, to $25.9 million at December 31, 2008. The decrease
was attributable to an increase in accumulated other comprehensive loss
partially offset by an increase in retained earnings. The increase in
accumulated other comprehensive loss was caused by a decline in the fair value
of the Company’s remaining TPS portfolio. The cash flows of the Company’s TPSs
are derived from trust preferred securities and subordinated debt issued by
well-diversified pools of banks and thrifts (76%), insurance companies (24%),
and REIT/homebuilders (1%). The Company’s TPS securities are secured through a
combination of subordination from lower classes within the TPS structures, as
well as over-collateralization of available future contractual cash
flows.




Continued
volatility in the market value for the Company’s investment portfolio, whether
caused by changes in market perceptions of credit risk or actual defaults in the
Company’s investment portfolio, could result in significant fluctuations in the
value of these securities. This could have a material adverse impact on the
Company’s accumulated other comprehensive loss and stockholders’ equity
depending on the direction of the fluctuations. Furthermore, future downgrades
or defaults in the Company’s investment portfolio could result in future
classifications of these securities as “other than temporarily impaired”. This
could have a material adverse impact on the Company’s future earnings,
stockholders’ equity, and regulatory capital.




Non-Performing
and Classified AssetsNon-performing assets at December 31, 2008,
increased slightly to $19.8 million as compared to $18.6 million at June 30,
2008. Non-performing assets as a percentage of total assets increased slightly
from 3.30% at June 30, 2008, to 3.79% as of December 31, 2008. The increase in
non-performing assets is due to a $3.0 million loan for the purpose of
developing residential lots in Minnesota partially offset by payoffs of
non-accrual loans and the disposition of foreclosed and repossessed assets
during the current quarter. The following table sets forth information regarding
non-accrual loans and other non-performing assets at the dates
indicated.





20
 Index




(Dollars in Thousands)
                
                December 31, 2008
                
                
                June 30, 2008Loans
      accounted for on a non-accrual basis:One-
      to four-family residential
                
                $
                1,257
                
                
                $
                1,167Multi-family
      residential
                
                
                -
                
                
                
                3,230Non-residential
      real estate
                
                
                9,336
                
                
                
                11,825Commercial
      business
                
                
                480
                
                
                
                1,428Consumer
                
                
                144
                
                
                
                99Total non-performing loans
                
                
                11,217
                
                
                
                17,749Foreclosed and repossessed
      assets
                
                
                8,628
                
                
                
                873Total non-performing assets
                
                $
                19,845
                
                
                
                18,622Restructured loans not included in other
      non-performing categories above
                
                $
                5,054
                
                
                $
                5,206Non-performing
      loans as a percentage of total loans
                
                
                3.03
                %
                
                
                4.29
                %Non-performing assets as a percentage of total
      assets
                
                
                3.79
                %
                
                
                3.30
                %








As of
December 31, 2008, the Company’s adversely classified assets totaled $35.0
million (which includes non-performing loans in the above table) compared to
$24.2 million, as of June 30, 2008.  Adversely classified assets
include loans rated “Substandard”, “Doubtful”, or “Loss”, as well as foreclosed
and repossessed assets.  Although the Company’s classified assets
increased, management believes the allowance for loan loss was
adequate.





The
Company was closely monitoring six classified assets totaling $30.6 million that
are included in the $35.0 million total.  These loan relationships
were classified “Substandard” as of that date.  The following
paragraphs contain a brief discussion of each relationship.





In 2005,
the Company originated a loan to an investor group for the purchase and
renovation of an existing office building into condominiums in Des
Moines.  The current balance of this loan is $7.6
million.  Condominium sales have been slow and the project has not met
its sales targets.  As a result, capital injections were made by the
investor group to improve cash flow, service the debt, and complete the
renovation.  Management has classified this loan “Substandard.” The
loan remains on accrual status.   Management does not anticipate
a loss on this loan at this time.





The
Company originated a total of $8.5 million of loans to various real estate
projects in Des Moines, Iowa that had a common guarantor.  The
guarantor has experienced financial difficulties.  As a result cash
flow was not sufficient to service the debt.  As a result, the Company
foreclosed on all properties and the relationship was transferred to foreclosed
and repossessed assets.  Some properties have been sold which has
brought the balance down to $7.1 million.  Management does not
anticipate a loss on this loan at this time.





In
October 2003, the Company purchased a $3.3 million loan.  The borrower
is a real estate holding company for a formal wear manufacturer and
distributor.  The borrower recently has been delinquent with
payments.  In addition, the Company has had difficulty receiving
financial statements from the borrower.  As a result, management has
classified this loan as “Substandard” and is on non-accrual
status.  Management does not anticipate a loss on this loan at this
time.





In
October 2007, the Company originated loans totaling $3.1 million for the
development of residential properties in Minnesota.  The project is
behind schedule and a recent appraisal revealed a significant decrease in the
value of the project.  As a result, the loan was placed on non-accrual
and a specific allowance of $785,000 was recorded.





In May
2007, the Company purchased a participation in a $33.0 million loan for
construction of a bio-diesel plant in south-eastern Nebraska.  The
current balance is $3.2 million.  In February 2008 the Company was
notified that the parent company was having financial difficulties and was
unable to support this project.  As a result, the plant has not been
completed.  The bank group has agreed to allow the borrower to use
escrow funds and proceeds from the sale





21
 Index





of raw
materials in order to complete the project.  Construction was expected
to be completed by June of 2008.  The deadline was not met and the
bank group decided to start foreclosure proceedings.  Management has
classified this loan as “Substandard” and it was placed on non-accrual
status.  Management does not anticipate a loss on this loan at this
time.





In 2007,
the Company originated a $2.4 million loan for the construction of commercial
properties.  The project is behind schedule due to numerous weather
related delays.  Management has classified this loan “Substandard” and
it is on non-accrual status.  In addition, there is currently a
$700,000 specific allowance on this loan relationship.





In August
2003, the Company purchased a loan to a garage door company in
Colorado.  The balance at December 31, 2008 was $1.6
million.  Cash flow from the business is not sufficient to service the
debt.  The guarantors have injected cash into the business to keep the
loan current.  However, recently, the loan has become
delinquent.  As a result, management has classified this loan as
“Substandard”.  The loan remains on accrual
status.   Management does not anticipate a loss on this loan at
this time.





In 2003,
the Company originated a $1.3 million loan for development of land in Des
Moines, Iowa.  The current principal balance of this loan is $0.9
million.  The Company foreclosed on all properties and the
relationship was transferred to foreclosed and repossessed
assets.   There has been further deterioration of the market
value of this property.  As a result, during the most recent quarter,
management decided to write down this asset by $200,000.  This expense
is reflected as “loss on other real estate owned” on the income
statement.





Liquidity
and Capital





The Bank
is required to maintain specified amounts of capital pursuant to regulations
promulgated by the OTS.  The Bank's objective is to maintain its
regulatory capital in an amount sufficient to be classified in the highest
regulatory capital category (i.e., as a "well-capitalized"
institution).  At December 31, 2008, the Bank's regulatory capital
exceeded all regulatory minimum requirements, as well as the amount required to
be classified as a "well-capitalized" institution.  However, due to
the risks associated with the Company’s trust preferred portfolio, and the
increased level of non-performing assets, the Company and the OTS have agreed,
among other things, to increase the required levels for the Company’s tier one
risk based capital and total risk based capital levels to 8.15% and 12.00%,
respectively, by September 30, 2009, which exceed the standard required levels
of 6.00% and 10.00%, respectively, to be considered “well
capitalized”.  The Bank's actual and required capital amounts as of
December 31, 2008, and June 30, 2008, were as follows:





22
 Index




December 31, 2008To
      Be WellCapitalized
      UnderFor
      Capital
                                      
                                      
                                      Prompt
      CorrectiveActual
                                      
                                      
                                      Adequacy Purposes
                                      
                                      
                                      Action ProvisionsAmount
                                      
                                      
                                      Ratio
                                      
                                      
                                      Amount
                                      
                                      
                                      Ratio
                                      
                                      
                                      Amount
                                      
                                      
                                      RatioDollars
      in ThousandsTangible
      capital
                                      
                                      $
                                      43,124
                                      
                                      
                                      
                                      7.96%
                                      
                                      
                                      $
                                      8,126
                                      
                                      
                                      
                                      1.50%
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -Tier
      1 leverage (core)
                                      
                                      
                                      43,124
                                      
                                      
                                      
                                      7.96
                                      
                                      
                                      
                                      21,668
                                      
                                      
                                      
                                      4.00
                                      
                                      
                                      $
                                      27,085
                                      
                                      
                                      
                                      5.00%Tier
      1 risk-based capital
                                      
                                      
                                      43,124
                                      
                                      
                                      
                                      9.86
                                      
                                      
                                      
                                      17,493
                                      
                                      
                                      
                                      4.00
                                      
                                      
                                      
                                      26,240
                                      
                                      
                                      
                                      6.00Risk-based
      capital
                                      
                                      
                                      47,381
                                      
                                      
                                      
                                      10.83
                                      
                                      
                                      
                                      34,986
                                      
                                      
                                      
                                      8.00
                                      
                                      
                                      
                                      43,733
                                      
                                      
                                      
                                      10.00June 30, 2008To
      Be WellCapitalized
      UnderFor
      Capital
                                      
                                      
                                      Prompt
      CorrectiveActual
                                      
                                      
                                      Adequacy Purposes
                                      
                                      
                                      Action ProvisionsAmount
                                      
                                      
                                      Ratio
                                      
                                      
                                      Amount
                                      
                                      
                                      Ratio
                                      
                                      
                                      Amount
                                      
                                      
                                      RatioDollars
      in ThousandsTangible
      capital
                                      
                                      $
                                      41,605
                                      
                                      
                                      
                                      7.23%
                                      
                                      
                                      $
                                      8,628
                                      
                                      
                                      
                                      1.50%
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -Tier
      1 leverage (core)
                                      
                                      
                                      41,605
                                      
                                      
                                      
                                      7.23
                                      
                                      
                                      
                                      23,009
                                      
                                      
                                      
                                      4.00
                                      
                                      
                                      $
                                      28,761
                                      
                                      
                                      
                                      5.00%Tier
      1 risk-based capital
                                      
                                      
                                      41,605
                                      
                                      
                                      
                                      8.94
                                      
                                      
                                      
                                      18,617
                                      
                                      
                                      
                                      4.00
                                      
                                      
                                      
                                      27,925
                                      
                                      
                                      
                                      6.00Risk-based
      capital
                                      
                                      
                                      45,848
                                      
                                      
                                      
                                      9.85
                                      
                                      
                                      
                                      37,233
                                      
                                      
                                      
                                      8.00
                                      
                                      
                                      
                                      46,542
                                      
                                      
                                      
                                      10.00







Should
some of the Company’s investment securities become “other than temporarily”
impaired, this would reduce regulatory capital and depending on the amount
involved, could reduce the Bank’s capital position to “under-capitalized” which
would subject the Bank to a number of regulatory sanctions including a
prohibition on dividends or other capital distributions restrictions from
borrowing from the Federal Reserve System discount window and the requirement to
file a capital plan which could require the Bank to shrink its asset size, raise
additional equity or other actions to bring the Bank to regulatory capital
compliance.




The
actual amount of regulatory capital reductions triggered would depend on which
securities are determined to be “other than temporarily” impaired, the fair
value of those securities at the time that the impairment is determined (prices
generally decline on impaired securities) and whether related deferred tax asset
would be allowable.  Such amounts could exceed the unrealized loss at
December 31, 2008.





The
Company is also required by OTS regulation to maintain sufficient liquidity to
assure its safe and sound operation.  The Company's primary sources of
liquidity are deposits obtained through its branch office network, borrowings
from the FHLB and other sources, amortization, maturity, and prepayment of
outstanding loans and investments, and sales of loans and other
assets.  During the six months ended December 31, 2008, the Company
used these sources of funds to fund loan commitments, purchase loans, and cover
maturing liabilities and deposit withdrawals.  The Company had a total
of $43.2 million of loan commitments outstanding as of December 31,
2008.   In addition, at December 31, 2008, the Company had $135.5
million in certificates of deposit, $112.5 million in FHLB advances, and $5.5
million in other borrowings that were scheduled to mature within one
year.





Management
believes that the Company has adequate resources to fund all of these
obligations as well as the loan commitments it makes in the normal course of its
business.  The Company also believes it can adjust the rates it offers
on certificates of deposit and other customer deposits to retain these deposits
in changing interest rate environments.  Management is not aware of
any known trends, events or uncertainties that will have or are reasonably
likely to have a material effect on the Company’s or the Bank’s liquidity,
capital or operations, nor is management aware of any current recommendations by
regulatory authorities which, if implemented would have a material effect on the
Company’s or the Bank’s liquidity, capital or operations.





23
 Index





The
following table presents, as of December 31, 2008, the expected future payments
of the Bank’s contractual obligations.


Payments Due in:(In thousands)
                  
                  Less than One Year
                  
                  
                  One Year to Less Than Three
      Years
                  
                  
                  Three Years to Less Than Five
      Years
                  
                  
                  Five Years or Greater
                  
                  
                  TotalFHLB
      advances
                  
                  $
                  112,500
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  $
                  1,250
                  
                  
                  $
                  113,750Other
      borrowings (1)
                  
                  
                  5,494
                  
                  
                  
                  -
                  
                  
                  $
                  3,000
                  
                  
                  
                  -
                  
                  
                  
                  8,494Operating
      lease
                  
                  
                  140
                  
                  
                  $
                  302
                  
                  
                  
                  325
                  
                  
                  
                  209
                  
                  
                  
                  976Data
      processing
                  
                  
                  758
                  
                  
                  
                  841
                  
                  
                  
                  50
                  
                  
                  
                  -
                  
                  
                  
                  1,649Off-balance-sheet (2)
                  
                  
                  43,197
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  43,197Total
                  
                  $
                  162,089
                  
                  
                  $
                  1,143
                  
                  
                  $
                  3,375
                  
                  
                  $
                  1,459
                  
                  
                  $
                  168,066


(1)
            Includes
      securities sold under repurchase
agreements.


(2)
            Includes
      commitments to extend credit, net of commitments to sell
      loans.








Off-Balance
Sheet Arrangements





In
addition to the normal course of operations, the Company engages in a variety of
financial transactions that, in accordance with accounting principles generally
accepted in the United States of America are not recorded in our financial
statements.  These transactions involve, to varying degrees, elements
of credit, interest rate and liquidity risk.  Such transactions are
used primarily to manage customers’ requests for funding and take the form of
loan commitments, lines of credit and letters of credit.  For the six
months ended December 31, 2008, the Company engaged in no off-balance sheet
transactions reasonably likely to have a material effect on our financial
condition, results of operations or cash flows.





ITEM3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK





This
disclosure is not required under smaller reporting company
requirements.





ITEM4T. CONTROLS AND PROCEDURES





Under the
supervision and with the participation of the Company’s management, including
its Chief Executive Officer and Chief Financial Officer, the Company evaluated
the effectiveness of the design and operation of its disclosure controls and
procedures (as defined in Rules 13a-15(e)and 15d-15(e) under the Exchange Act)
as of the end of the period covered by this report.  Any controls and
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control
objectives.  Based on such evaluation, the Chief Executive Officer and
Chief Financial Officer concluded that, as of the end of the period covered by
this report, the Company’s disclosure controls and procedures were effective to
ensure that information required to be disclosed in the reports that the Company
files or submits under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange
Commission’s rules and forms.





Under the
supervision and with the participation of the Company’s management, including
its Chief Executive Officer and Chief Financial Officer, the Company also
conducted an evaluation of the Company’s internal control over financial
reporting to determine whether any changes occurred during the Company’s fiscal
quarter ended December 31, 2008, that have materially affected, or are
reasonably likely to materially affect, the Company’s internal control over
financial reporting. Based on such evaluation, the Chief Executive Officer and
Chief Financial Officer concluded that, as of the end of the period covered by
this report, there have been no significant changes in the Company’s internal
control over financial reporting that occurred during the Company’s first fiscal
quarter that have materially affected, or are reasonably likely to materially
affect, the Company’s internal control over financial reporting.





24
 Index





PARTII. OTHER
INFORMATION





ITEM1.  Legal Proceedings





There are
various claims and lawsuits in which the Company is periodically involved
incidental to the Company's business.  In the opinion of management,
no material loss is expected from any of such pending claims or
lawsuits.




ITEM1A. Risk Factors





This
disclosure is not required under smaller reporting company
requirements.





ITEM2.  Unregistered Sales of Equity Securities and Use of
Proceeds





There
were no sales of unregistered securities during the three months ended December
31, 2008.





There
were no share repurchases during the quarter ended December 31,
2008.





ITEM3.  Default upon Senior Securities





None.





ITEM4.  Submission of Matters to a Vote of Security
Holders





The
Company convened its 2008 Annual Meeting of Stockholders on December 18,
2008.  At the meeting, the Stockholders of the Company considered and
voted on the following proposals:





Ballot No.
1.  The election of three directors, each to serve as a
director for a three-year term and until their respective successors shall have
been elected and shall qualify.   Ballot one results are
presented in the following table.





Percentage
      oftotal
      Voted SharesDirector
                  
                  For
                  
                  
                  Withheld
                  
                  
                  Voted in FavorArlene
      T. Curry
                  
                  
                  2,292,994
                  
                  
                  
                  479,288
                  
                  
                  
                  82.7
                  %Gary
      L. Evans
                  
                  
                  2,308,697
                  
                  
                  
                  463,585
                  
                  
                  
                  83.3
                  %Allen
      J. Johnson
                  
                  
                  2,312,622
                  
                  
                  
                  459,660
                  
                  
                  
                  83.4
                  %








Ballot No.
2.  The ratification of McGladrey & Pullen, LLP as the
independent registered public accounting firm of the Company for the fiscal year
ending June 30, 2009.





BrokerFor
                  
                  
                  Against
                  
                  
                  Abstain
                  
                  Non-VotesNumber
      of Votes
                  
                  
                  2,633,499
                  
                  
                  
                  121,004
                  
                  
                  
                  17,779%
      of Total Shares Voted
                  
                  
                  95.6
                  %
                  
                  
                  4.4
                  %








ITEM5.  Other Information





(a) Not
applicable.


(b) Not
applicable.





25
 Index





ITEM6.  Exhibits





Exhibit 10
                
                Change
      in Control Agreement – Levon L. MathewsExhibit 31.1
                
                Certification
      of Chief Executive Officer Pursuant to Section 302Exhibit 31.2
                
                Certification
      of Chief Financial Officer Pursuant to Section 302Exhibit 32
                
                Certification
      Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
      the Sarbanes-Oxley Act of
2002




26
 Index





SIGNATURES





Pursuant to the requirements of the
Securities Exchange Act of 1934, the Registrant has duly caused this report to
be signed by the undersigned thereunto duly authorized.








FIRST
FEDERAL BANKSHARES, INC.








DATE:  February
      23, 2009
                  
                  BY:
                  /s/LevonL.MathewsLevon
      L. MathewsPresident
      and Chief Executive OfficerDATE:  February
      23, 2009
                  
                  BY:
                  /s/ Michael S. ModerskiMichael
      S. ModerskiSenior
      Vice President, Chief Financial Officerand
      Treasurer






27