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**UNITED STATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-K/A**

**(AmendmentNo. 1)**

 

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

 

**For the fiscal year ended December 31, 2009**

 

**OR**

 

**o****         TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

 

**For the transition period from                    to                    **

 

**Commission File No.:****  0-28312**

 

**First Federal Bancshares of Arkansas, Inc.**

(Exact name of registrant as specified in its charter)

 

| **Texas**                          | ** ** | **71-0785261**          |
|------------------------------------|------------|-------------------------|
| (State  or other jurisdiction      |       | (I.R.S.  Employer       |
| of  incorporation or organization) |       | Identification  Number) |

 

| **1401 Highway 62-65 North** |       |        |
|------------------------------|------------|-------------|
| **Harrison, Arkansas**       | ** ** | **72601**   |
| (Address)                    |       | (Zip  Code) |

 

Registrant’s telephone number, including area code:**  (870) 741-7641**

 

Securitiesregistered pursuant to Section 12(b) of the Act:

 

| **Common Stock (par value $.01 per share)** | ** ** | **The Nasdaq Stock Market LLC** |
|---------------------------------------------|------------|---------------------------------|
| (Title  of Class)                           |       | (Exchange  on which registered) |

 

Securitiesregistered pursuant to Section 12(g) of the Act **None**

 

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act.  Yes o No x

 

Indicateby check mark if the registrant is not required to file reports pursuant to Section 13or Section 15(d) of the Act. Yes o No x

 

Indicate by check markwhether the Registrant (1) has filed all reports required by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the Registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.  Yes x  No o

 

Indicate by check markwhether the registrant has submitted electronically and posted on its corporateWeb site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter)during the preceding 12 months (or for such shorter period that the registrantwas required to submit and post such files). Yes o No o

 

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K ( §229.405 of this chapter) is not contained herein, and will not be contained, tothe best of Registrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of this Form 10-K orany amendment to this Form 10-K.  x

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company.  See the definitions of “large acceleratedfiler,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2of the Exchange Act.  (Check one):

 

| Large  Accelerated Filer o |   | Accelerated  Filer o    |
|---------------------------------|--------|------------------------------|
|                            |   |                         |
| Non-accelerated  Filer o        |   | Smaller  reporting company x |

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12B-2 of theAct).  Yes o  No x

 

As of June 30, 2009,the aggregate value of the 4,037,386 shares of Common Stock of the Registrantissued and outstanding on such date, which excludes 809,399 shares held bydirectors and officers of the Registrant as a group, was approximately $15.9million.  This figure is based on thelast sales price of $3.93 per share of the Registrant’s Common Stock on June 30,2009.

 

Number of shares of CommonStock outstanding as of July 20, 2010: **4,846,785**

 

**DOCUMENTS INCORPORATED BY REFERENCE**

 

Listhereunder the following documents incorporated by reference and the Part ofthe Form 10-K into which the document is incorporated.

 

 

** **

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**Explanatory Note**

 

We are filing this Amendment No. 1 to ourAnnual Report on Form 10-K for the year ended December 31, 2009 (the “Amendment”),originally filed with the Securities and Exchange Commission (the “SEC”) on April 15,2010, to restate our impaired loan footnote disclosure included in Note 5 tothe Consolidated Financial Statements. Subsequent to the issuance of the Company’s 2009 consolidated financialstatements included in its Annual Report on Form 10-K, managementidentified an error in the disclosure of impaired loans.  Impaired loansof $20.5 million and $16.1 million were omitted from the previously presenteddisclosure as of December 31, 2009 and 2008, respectively.  Theseamounts primarily represent impaired non-homogeneous loans less than $500,000and borrower relationships less than $1.0 million.  The disclosedamounts of impaired loans without a valuation allowance and impaired loans witha valuation allowance previously presented have been restated to include theseimpaired loans.  The previously omitted loans did not impact theconsolidated statements of financial condition, operations or cash flows forthe years ended December 31, 2009 or 2008.

 

ThisAmendment is solely limited to correcting the error described above.

 

Thefollowing items have been amended as a result of the restatement:

 

Part II— Item 8 — Financial Statements and Supplementary Data

 

Pursuantto the rules of the SEC, Item 15 of Part IV has also beenamended to contain the currently dated certifications from the Company’sPrincipal Executive Officer and Principal Financial Officer as required by Section 302and 906 of the Sarbanes Oxley Act of 2002. The certifications of the Company’s Principal Executive Officer andPrincipal Financial Officer are attached to this Amendment as Exhibits 31.1,31.2, 32.1 and 32.2.

 

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**First Federal Bancshares ofArkansas, Inc.**

**Form 10-K/A**

**For the Year Ended December 31, 2009**

 
| **PART II.** |                                         |   |   |
|-------------------|----------------------------------------------|--------|--------|
| Item 8.           | Financial Statements and  Supplementary Data |   | 4      |
| Item 9A.          | Controls and  Procedures                     |   | 37     |
| ** **        |                                         |   |   |
| **PART IV.** |                                         |   |   |
| Item 15.          | Exhibits  and Financial Statement Schedules  |   | 39     |

 

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**Item8.  Financial Statements andSupplementary Data.**

 

**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

Tothe Board of Directors and Stockholders of

FirstFederal Bancshares of Arkansas, Inc.

Harrison,AR

 

Wehave audited the accompanying consolidated statements of financial condition ofFirst Federal Bancshares of Arkansas, Inc. and subsidiaries (the “Company”)as of December 31, 2009 and 2008, and the related consolidated statementsof operations, stockholders’ equity, and cash flows for each of the three yearsin the period ended December 31, 2009.  These financial statementsare the responsibility of the Company’s management.  Our responsibility isto express an opinion on the financial statements based on our audits.

 

Weconducted our audits in accordance with the standards of the Public CompanyAccounting Oversight Board (United States).  Those standards require thatwe plan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement.  An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements.  An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation.  We believe thatour audits provide a reasonable basis for our opinion.

 

Inour opinion, such consolidated financial statements present fairly, in allmaterial respects, the financial position of First Federal Bancshares ofArkansas, Inc. and subsidiaries as of December 31, 2009 and 2008, andthe results of their operations and their cash flows for each of the threeyears in the period ended December 31, 2009, in conformity with accountingprinciples generally accepted in the United States of America.

 

The accompanying consolidated financial statementshave been prepared assuming that the Company will continue as a going concern.As discussed in Note 2 to the consolidated financial statements, the Company’ssignificant operating losses in 2009, significant levels of criticized assets,and decline in capital levels raise substantial doubt about its ability tocontinue as a going concern.  The Company has entered into a writtenagreement with the Office of Thrift Supervision (OTS) which requires the Companyto meet certain minimum capital requirements by December 31, 2010. The Company plans to file a capital plan with the OTS by the agreed upondeadline of June 30, 2010.  Failure to meet the capital requirementsincluded in the capital plan would expose the Company to regulatory sanctionsthat may include further restrictions on operations and growth, mandatory assetdispositions and liquidation.  Management’s plans concerning these mattersare also discussed in Note 2 to the consolidated financial statements. Theconsolidated financial statements do not include any adjustments that mightresult from the outcome of this uncertainty.

 

Wehave also audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the Company’s internal control overfinancial reporting as of December 31, 2009, based on the criteriaestablished in *Internal Control—IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission and our report dated April 15, 2010 expressed anunqualified opinion on the Company’s internal control over financial reporting.

 

 

/s/ Deloitte & Touche LLP

 

LittleRock, AR

April 15,2010, July 23, 2010 as to the effects of the restatement discussed in Note5

 

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**FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.**

 

**CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION**

**DECEMBER 31, 2009 AND 2008**

**(In thousands, except share data)**

 
| ** **                                                                                                                                                                                                                                                               | ** ** | **2009** | ** ** | **2008** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| **ASSETS**                                                                                                                                                                                                                                                               |       |     |       |     |       |
| Cash  and cash equivalents:                                                                                                                                                                                                                                              |       |     |       |     |       |
| Cash  and collection items                                                                                                                                                                                                                                               |       | $        | 9,735      |     | $          | 9,359 |   |
| Interest  bearing deposits with banks                                                                                                                                                                                                                                    |       | 12,414   |       | 8        |       |
|                                                                                                                                                                                                                                                                     |       |     |       |     |       |
| Total  cash and cash equivalents                                                                                                                                                                                                                                         |       | 22,149   |       | 9,367    |       |
|                                                                                                                                                                                                                                                                     |       |     |       |     |       |
| Investment  securities—                                                                                                                                                                                                                                             |       |     |       |     |       |
| Held  to maturity, at amortized cost (fair value at December 31, 2009and 2008, of $132,509 and $136,055, respectively)                                                                                                                                              |       | 135,531  |       | 136,412  |       |
| Federal  Home Loan Bank stock—at cost                                                                                                                                                                                                                               |       | 3,125    |       | 4,825    |       |
| Loans  receivable, net of allowance at December 31, 2009and 2008, of $32,908 and $6,441, respectively                                                                                                                                                               |       | 481,542  |       | 566,537  |       |
| Loans  held for sale                                                                                                                                                                                                                                                     |       | 1,012    |       | 1,586    |       |
| Accrued  interest receivable                                                                                                                                                                                                                                             |       | 4,229    |       | 6,701    |       |
| Real  estate owned - net                                                                                                                                                                                                                                                 |       | 35,155   |       | 22,385   |       |
| Office  properties and equipment - net                                                                                                                                                                                                                                   |       | 23,567   |       | 24,694   |       |
| Cash  surrender value of life insurance                                                                                                                                                                                                                                  |       | 21,226   |       | 20,412   |       |
| Prepaid  expenses and other assets                                                                                                                                                                                                                                       |       | 3,534    |       | 2,253    |       |
|                                                                                                                                                                                                                                                                     |       |     |       |     |       |
| TOTAL                                                                                                                                                                                                                                                                    |       | $        | 731,070    |     | $          | 795,172 |   |
|                                                                                                                                                                                                                                                                     |       |     |       |     |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                                            |       |     |       |     |       |
|                                                                                                                                                                                                                                                                     |       |     |       |     |       |
| LIABILITIES:                                                                                                                                                                                                                                                             |       |     |       |     |       |
| Deposits:                                                                                                                                                                                                                                                                |       |     |       |     |       |
| Interest  bearing                                                                                                                                                                                                                                                        |       | $        | 598,968    |     | $          | 590,465 |   |
| Noninterest  bearing                                                                                                                                                                                                                                                     |       | 25,656   |       | 27,538   |       |
|                                                                                                                                                                                                                                                                     |       |     |       |     |       |
| Total  deposits                                                                                                                                                                                                                                                          |       | 624,624  |       | 618,003  |       |
|                                                                                                                                                                                                                                                                     |       |     |       |     |       |
| Other  borrowings                                                                                                                                                                                                                                                        |       | 59,546   |       | 92,212   |       |
| Advance  payments by borrowers for taxes and insurance                                                                                                                                                                                                                   |       | 695      |       | 810      |       |
| Other  liabilities                                                                                                                                                                                                                                                       |       | 2,905    |       | 11,030   |       |
|                                                                                                                                                                                                                                                                     |       |     |       |     |       |
| Total  liabilities                                                                                                                                                                                                                                                       |       | $        | 687,770    |     | $          | 722,055 |   |
|                                                                                                                                                                                                                                                                     |       |     |       |     |       |
| STOCKHOLDERS’  EQUITY:                                                                                                                                                                                                                                              |       |     |       |     |       |
| Preferred  stock, no par value, 5,000,000 shares authorized; Series A fixed rate  cumulative perpetual; liquidation preference of $1,000 per share; 16,500  shares issued and outstanding at December 31, 2009 and none outstanding  at December 31, 2008 |       | $        | 16,195     |     | —     |   |
| Common  stock, $.01 par value—20,000,000 shares authorized; 10,307,502shares issued; 4,846,785 shares outstanding at  December 31, 2009 and 2008                                                                                                               |       | 103      |       | 103      |       |
| Additional  paid-in capital                                                                                                                                                                                                                                              |       | 56,986   |       | 56,627   |       |
| Retained  earnings—substantially restricted                                                                                                                                                                                                                         |       | 40,634   |       | 87,005   |       |
|                                                                                                                                                                                                                                                                     |       | 113,918  |       | 143,735  |       |
| Treasury  stock—at cost; 5,460,717 shares at December 31, 2009 and 2008                                                                                                                                                                                        |       | (70,618  | )          | (70,618  | )          |
|                                                                                                                                                                                                                                                                     |       |     |       |     |       |
| Total  stockholders’ equity                                                                                                                                                                                                                                         |       | 43,300   |       | 73,117   |       |
|                                                                                                                                                                                                                                                                     |       |     |       |     |       |
| TOTAL                                                                                                                                                                                                                                                                    |       | $        | 731,070    |     | $          | 795,172 |   |

 

Seenotes to consolidated financial statements.

 

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**FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.**

 

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**YEARS ENDED DECEMBER 31, 2009, 2008, AND 2007**

**(In thousands, except earnings per share)**

 
| ** **                                                           | ** ** | **2009** | ** ** | **2008** | ** ** | **2007** | ** ** |
|----------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| INTEREST  INCOME:                                                    |       |     |       |     |       |     |       |
| Loans  receivable                                                    |       | $        | 29,491     |     | $          | 36,799   |       | $ | 45,473 |   |
| Investment  securities:                                              |       |     |       |     |       |     |       |
| Taxable                                                              |       | 5,542    |       | 5,966    |       | 3,350    |       |
| Nontaxable                                                           |       | 990      |       | 794      |       | 721      |       |
| Other                                                                |       | 20       |       | 388      |       | 882      |       |
| Total  interest income                                               |       | 36,043   |       | 43,947   |       | 50,426   |       |
|                                                                 |       |     |       |     |       |     |       |
| INTEREST  EXPENSE:                                                   |       |     |       |     |       |     |       |
| Deposits                                                             |       | 13,272   |       | 18,549   |       | 23,873   |       |
| Other  borrowings                                                    |       | 1,983    |       | 3,553    |       | 4,311    |       |
|                                                                 |       |     |       |     |       |     |       |
| Total  interest expense                                              |       | 15,255   |       | 22,102   |       | 28,184   |       |
|                                                                 |       |     |       |     |       |     |       |
| NET  INTEREST INCOME                                                 |       | 20,788   |       | 21,845   |       | 22,242   |       |
|                                                                 |       |     |       |     |       |     |       |
| PROVISION  FOR LOAN LOSSES                                           |       | 44,365   |       | 5,710    |       | 4,028    |       |
|                                                                 |       |     |       |     |       |     |       |
| NET  INTEREST INCOME (LOSS) AFTER PROVISION FOR LOAN LOSSES          |       | (23,577  | )          | 16,135   |       | 18,214   |       |
|                                                                 |       |     |       |     |       |     |       |
| NONINTEREST  INCOME:                                                 |       |     |       |     |       |     |       |
| Deposit  fee income                                                  |       | 5,293    |       | 5,413    |       | 4,989    |       |
| Earnings  on life insurance policies                                 |       | 814      |       | 1,962    |       | 763      |       |
| Gain  on sale of loans                                               |       | 597      |       | 354      |       | 823      |       |
| Other                                                                |       | 1,413    |       | 1,688    |       | 1,194    |       |
|                                                                 |       |     |       |     |       |     |       |
| Total  noninterest income                                            |       | 8,117    |       | 9,417    |       | 7,769    |       |
|                                                                 |       |     |       |     |       |     |       |
| NONINTEREST  EXPENSES:                                               |       |     |       |     |       |     |       |
| Salaries  and employee benefits                                      |       | 11,495   |       | 12,770   |       | 13,231   |       |
| Net  occupancy expense                                               |       | 2,722    |       | 2,657    |       | 2,325    |       |
| Real  estate owned, net                                              |       | 8,367    |       | 1,946    |       | 1,162    |       |
| FDIC  insurance                                                      |       | 1,690    |       | 374      |       | 76       |       |
| Data  processing                                                     |       | 1,466    |       | 1,431    |       | 1,513    |       |
| Professional  fees                                                   |       | 968      |       | 504      |       | 513      |       |
| Advertising  and public relations                                    |       | 385      |       | 900      |       | 1,145    |       |
| Postage  and supplies                                                |       | 713      |       | 804      |       | 857      |       |
| Other                                                                |       | 2,084    |       | 2,082    |       | 2,173    |       |
|                                                                 |       |     |       |     |       |     |       |
| Total  noninterest expenses                                          |       | 29,890   |       | 23,468   |       | 22,995   |       |
|                                                                 |       |     |       |     |       |     |       |
| INCOME  (LOSS) BEFORE INCOME TAXES                                   |       | (45,350  | )          | 2,084    |       | 2,988    |       |
|                                                                 |       |     |       |     |       |     |       |
| INCOME  TAX PROVISION (BENEFIT)                                      |       | 148      |       | (423     | )          | 345      |       |
|                                                                 |       |     |       |     |       |     |       |
| NET  INCOME (LOSS)                                                   |       | $        | (45,498    | )        | $          | 2,507    |       | $ | 2,643 |   |
|                                                                 |       |     |       |     |       |     |       |
| PREFERRED  STOCK DIVIDENDS AND ACCRETION OF PREFERRED STOCK DISCOUNT |       | 728      |       | —   |       | —   |       |
|                                                                 |       |     |       |     |       |     |       |
| NET  INCOME (LOSS) AVAILABLE TO COMMON SHAREHOLDERS                  |       | $        | (46,226    | )        | $          | 2,507    |       | $ | 2,643 |   |
|                                                                 |       |     |       |     |       |     |       |
| EARNINGS  (LOSS) PER COMMON SHARE:                                   |       |     |       |     |       |     |       |
| Basic                                                                |       | $        | (9.54      | )        | $          | 0.52     |       | $ | 0.54 |   |
|                                                                 |       |     |       |     |       |     |       |
| Diluted                                                              |       | $        | (9.54      | )        | $          | 0.52     |       | $ | 0.54 |   |

 

Seenotes to consolidated financial statements.

 

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**FIRSTFEDERAL BANCSHARES OF ARKANSAS, INC.**

 

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITY**

**YEARS ENDEDDECEMBER 31, 2009, 2008, AND 2007**

**(Inthousands, except share data)**

 
| ** **                                                                                              | ** ** | ** **          | ** ** | ** **       | ** ** | ** **     | ** ** | **Employee** | ** ** | ** **   | ** ** | ** **         | ** ** | ** **             | ** ** | ** ** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|---------------------|------------|------------------|------------|----------------|------------|--------------|------------|--------------|------------|--------------------|------------|------------------------|------------|------------|------------|
| ** **                                                                                              | ** ** | **Issued**          | ** ** | **Issued**       | ** ** | **Additional** | ** ** | **Stock**    | ** ** | ** **   | ** ** | ** **         | ** ** | ** **             | ** ** | **Total**  | ** ** |
| ** **                                                                                              | ** ** | **Preferred Stock** | ** ** | **Common Stock** | ** ** | **Paid-In**    | ** ** | **Benefit**  | ** ** | **Retained** | ** ** | **Treasury Stock** | ** ** | **Stockholders’** | ** ** |
| ** **                                                                                              | ** ** | **Shares**          | ** ** | **Amount**       | ** ** | **Shares**     | ** ** | **Amount**   | ** ** | **Capital**  | ** ** | **Plans**          | ** ** | **Earnings**           | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Equity** | ** ** |
| BALANCE  — January 1, 2007                                                                    |       | —              |       | $                | —     |           | 10,307,502 |         | $          | 103          |       | $                  | 56,617     |                   | $          | (72        | )          | $ | 88,068 |   | 5,468,540 |   | $ | (69,143 | ) | $ | 75,573 |   |
|                                                                                                    |       |                |       |             |       |           |       |         |       |         |       |               |       |                   |       |       |       |   |   |   |   |
| Net  income                                                                                             |       | —              |       | —           |       | —         |       | —       |       | —       |       | —             |       | 2,643                  |       | —     |       | — |   | 2,643 |   |
| Stock  compensation expense                                                                             |       | —              |       | —           |       | —         |       | —       |       | 9            |       | 30                 |       | —                 |       | —     |       | — |   | 39 |   |
| Tax  effect of stock compensation plans                                                                 |       | —              |       | —           |       | —         |       | —       |       | 481          |       | —             |       | —                 |       | —     |       | — |   | 481 |   |
| Purchase  of treasury stock — at cost                                                              |       | —              |       | —           |       | —         |       | —       |       | —       |       | —             |       | —                 |       | 101,542    |       | (2,312 | ) | (2,312 | ) |
| Treasury  shares reissued                                                                               |       | —              |       | —           |       | —         |       | —       |       | (454         | )          | —             |       | —                 |       | (106,965   | )          | 804 |   | 350 |   |
| Dividends  paid ($0.58 per share)                                                                       |       | —              |       | —           |       | —         |       | —       |       | —       |       | —             |       | (3,111                 | )          | —     |       | — |   | (3,111 | ) |
|                                                                                                    |       |                |       |             |       |           |       |         |       |         |       |               |       |                   |       |       |       |   |   |   |   |
| BALANCE  — December 31, 2007                                                                  |       | —              |       | —           |       | 10,307,502     |       | 103          |       | 56,653       |       | (42                | )          | 87,600                 |       | 5,463,117  |       | (70,651 | ) | 73,663 |   |
|                                                                                                    |       |                |       |             |       |           |       |         |       |         |       |               |       |                   |       |       |       |   |   |   |   |
| Net  income                                                                                             |       | —              |       | —           |       | —         |       | —       |       | —       |       | —             |       | 2,507                  |       | —     |       | — |   | 2,507 |   |
| Stock  compensation expense                                                                             |       | —              |       | —           |       | —         |       | —       |       | (18          | )          | 42                 |       | —                 |       | 1,600      |       | (19 | ) | 5 |   |
| Tax  effect of stock compensation plans                                                                 |       | —              |       | —           |       | —         |       | —       |       | (2           | )          | —             |       | —                 |       | —     |       | — |   | (2 | ) |
| Treasury  shares reissued                                                                               |       | —              |       | —           |       | —         |       | —       |       | (6           | )          | —             |       | —                 |       | (4,000     | )          | 52 |   | 46 |   |
| Dividends  paid ($0.64 per share)                                                                       |       | —              |       | —           |       | —         |       | —       |       | —       |       | —             |       | (3,102                 | )          | —     |       | — |   | (3,102 | ) |
|                                                                                                    |       |                |       |             |       |           |       |         |       |         |       |               |       |                   |       |       |       |   |   |   |   |
| BALANCE  — December 31, 2008                                                                  |       | —              |       | —           |       | 10,307,502     |       | 103          |       | 56,627       |       | —             |       | 87,005                 |       | 5,460,717  |       | (70,618 | ) | 73,117 |   |
|                                                                                                    |       |                |       |             |       |           |       |         |       |         |       |               |       |                   |       |       |       |   |   |   |   |
| Net  loss                                                                                               |       | —              |       | —           |       | —         |       | —       |       | —       |       | —             |       | (45,498                | )          | —     |       | — |   | (45,498 | ) |
| Issuance  of 16,500 shares of preferred stock and a warrant to purchase 321,847 shares  of common stock |       | 16,500              |       | 16,142           |       | —         |       | —       |       | 358          |       | —             |       | —                 |       | —     |       | — |   | 16,500 |   |
| Preferred  stock dividends                                                                              |       | —              |       | —           |       | —         |       | —       |       | —       |       | —             |       | (675                   | )          | —     |       | — |   | (675 | ) |
| Accretion  of preferred stock discount                                                                  |       | —              |       | 53               |       | —         |       | —       |       | —       |       | —             |       | (53                    | )          | —     |       | — |   | — |   |
| Stock  compensation expense                                                                             |       | —              |       | —           |       | —         |       | —       |       | 1            |       | —             |       | —                 |       | —     |       | — |   | 1 |   |
| Dividends  paid ($0.03 per common share)                                                                |       | —              |       | —           |       | —         |       | —       |       | —       |       | —             |       | (145                   | )          | —     |       | — |   | (145 | ) |
|                                                                                                    |       |                |       |             |       |           |       |         |       |         |       |               |       |                   |       |       |       |   |   |   |   |
| BALANCE  — December 31, 2009                                                                  |       | 16,500              |       | $                | 16,195     |           | 10,307,502 |         | $          | 103          |       | $                  | 56,986     |                   | $          | —     |       | $ | 40,634 |   | 5,460,717 |   | $ | (70,618 | ) | $ | 43,300 |   |

 

See notes to consolidatedfinancial statements.

 

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**FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.**

 

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**YEARS ENDED DECEMBER 31, 2009, 2008 AND 2007**

**(In thousands)**

 
| ** **                                                                                | ** ** | **2009**   | ** ** | **2008**   | ** ** | **2007**   | ** ** |
|-------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
|                                                                                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| OPERATING  ACTIVITIES:                                                                    |       |       |       |       |       |       |       |
| Net  income (loss)                                                                        |       | $          | (45,498    | )          | $          | 2,507      |       | $ | 2,643 |   |
| Adjustments  to reconcile net income (loss) to net cash provided by operating activities: |       |       |       |       |       |       |       |
| Provision  for loan losses                                                                |       | 44,365     |       | 5,710      |       | 4,028      |       |
| Provision  for real estate losses                                                         |       | 6,224      |       | 1,042      |       | 494        |       |
| Deferred  tax benefit                                                                     |       | (16,545    | )          | (657       | )          | (1,585     | )          |
| Deferred  tax valuation allowance                                                         |       | 18,124     |       | —     |       | —     |       |
| Accretion  of discounts on investment securities, net                                     |       | (96        | )          | (60        | )          | (16        | )          |
| Federal  Home Loan Bank stock dividends                                                   |       | (11        | )          | (131       | )          | (303       | )          |
| Gain  on disposition of fixed assets, net                                                 |       | (2         | )          | (18        | )          | (3         | )          |
| Loss  on sale of repossessed assets, net                                                  |       | 957        |       | 184        |       | 188        |       |
| Originations  of loans held for sale                                                      |       | (43,971    | )          | (23,788    | )          | (59,813    | )          |
| Proceeds  from sales of loans held for sale                                               |       | 45,142     |       | 25,388     |       | 58,903     |       |
| Gain  on sale of loans originated to sell                                                 |       | (597       | )          | (354       | )          | (823       | )          |
| Depreciation                                                                              |       | 1,484      |       | 1,484      |       | 1,399      |       |
| Amortization  of deferred loan costs, net                                                 |       | 388        |       | 366        |       | 435        |       |
| Earnings  on life insurance policies                                                      |       | (814       | )          | (782       | )          | (763       | )          |
| Stock  compensation expense                                                               |       | 1          |       | 5          |       | 39         |       |
| Changes  in operating assets and liabilities:                                             |       |       |       |       |       |       |       |
| Accrued  interest receivable                                                              |       | 2,472      |       | 2,341      |       | 957        |       |
| Prepaid  expenses and other assets                                                        |       | (2,301     | )          | 620        |       | 699        |       |
| Other  liabilities                                                                        |       | 289        |       | (12        | )          | 437        |       |
|                                                                                      |       |       |       |       |       |       |       |
| Net  cash provided by operating activities                                                |       | 9,611      |       | 13,845     |       | 6,916      |       |
|                                                                                      |       |       |       |       |       |       |       |
| INVESTING  ACTIVITIES:                                                                    |       |       |       |       |       |       |       |
| Purchases  of investment securities, held to maturity                                     |       | (130,367   | )          | (119,353   | )          | (41,488    | )          |
| Proceeds  from maturities/calls of investment securities, held to maturity                |       | 122,349    |       | 84,396     |       | 9,850      |       |
| Federal  Home Loan Bank stock purchased                                                   |       | (556       | )          | (261       | )          | —     |       |
| Federal  Home Loan Bank stock redeemed                                                    |       | 2,267      |       | —     |       | 2,959      |       |
| Loan  originations, net of repayments                                                     |       | 21,248     |       | 8,843      |       | 76,070     |       |
| Loan  participations purchased                                                            |       | (4,110     | )          | (4,880     | )          | (4,763     | )          |
| Loan  participations sold                                                                 |       | —     |       | 4,045      |       | 7,208      |       |
| Proceeds  from sales of real estate owned                                                 |       | 3,046      |       | 3,073      |       | 3,740      |       |
| Improvements  to real estate owned                                                        |       | 24         |       | (724       | )          | (763       | )          |
| Proceeds  from sales of office properties and equipment                                   |       | 2          |       | 30         |       | 10         |       |
| Purchases  of office properties and equipment                                             |       | (357       | )          | (1,927     | )          | (2,637     | )          |
|                                                                                      |       |       |       |       |       |       |       |
| Net  cash provided by (used in) investing activities                                      |       | 13,546     |       | (26,758    | )          | 50,186     |       |
|                                                                                           |            |            |            |            |            |            |            |  |  |  |

 

(Continued)

 

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**FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.**

** **

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**YEARS ENDED DECEMBER 31, 2009, 2008 AND 2007**

**(In thousands)**

 
| ** **                                                                        | ** ** | **2009** | ** ** | **2008** | ** ** | **2007** | ** ** |
|-----------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| FINANCING  ACTIVITIES:                                                            |       |     |       |     |       |     |       |
| Net  increase (decrease) in deposits                                              |       | $        | 6,621      |     | $          | (12,411  | )          | $ | (21,851 | ) |
| Advances  from Federal Home Loan Bank                                             |       | —   |       | 174,955  |       | 25,200   |       |
| Repayment  of advances from Federal Home Loan Bank                                |       | (46,636  | )          | (174,860 | )          | (63,418  | )          |
| Short-term  FHLB advances, net                                                    |       | 24,000   |       | —   |       | —   |       |
| Net  borrowings from Federal Reserve Bank                                         |       | (10,030  | )          | 10,030   |       | —   |       |
| Net  increase (decrease) in advance payments by borrowers for taxes and insurance |       | (115     | )          | 235      |       | (91      | )          |
| Proceeds  from issuance of preferred stock and related common stock warrants      |       | 16,500   |       | —   |       | —   |       |
| Purchase  of treasury stock                                                       |       | —   |       | —   |       | (2,312   | )          |
| Preferred  dividends paid                                                         |       | (570     | )          | —   |       | —   |       |
| Dividends  paid, common shares                                                    |       | (145     | )          | (3,102   | )          | (3,111   | )          |
| Stock  options exercised                                                          |       | —   |       | 46       |       | 350      |       |
|                                                                              |       |     |       |     |       |     |       |
| Net  cash used in financing activities                                            |       | (10,375  | )          | (5,107   | )          | (65,233  | )          |
|                                                                              |       |     |       |     |       |     |       |
| NET  INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                             |       | 12,782   |       | (18,020  | )          | (8,131   | )          |
|                                                                              |       |     |       |     |       |     |       |
| CASH  AND CASH EQUIVALENTS:                                                       |       |     |       |     |       |     |       |
| Beginning  of year                                                                |       | 9,367    |       | 27,387   |       | 35,518   |       |
|                                                                              |       |     |       |     |       |     |       |
| End  of year                                                                      |       | $        | 22,149     |     | $          | 9,367    |       | $ | 27,387 |   |
|                                                                              |       |     |       |     |       |     |       |
| SUPPLEMENTAL  DISCLOSURES OF CASH FLOW INFORMATION—                          |       |     |       |     |       |     |       |
| Cash  paid for:                                                                   |       |     |       |     |       |     |       |
| Interest                                                                          |       | $        | 15,690     |     | $          | 22,501   |       | $ | 28,483 |   |
|                                                                              |       |     |       |     |       |     |       |
| Income  taxes                                                                     |       | $        | 1,044      |     | $          | —   |       | $ | 1,157 |   |
|                                                                              |       |     |       |     |       |     |       |
| SUPPLEMENTAL  SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:             |       |     |       |     |       |     |       |
| Real  estate and other assets acquired in settlement of loans                     |       | $        | 24,710     |     | $          | 24,708   |       | $ | 12,283 |   |
|                                                                              |       |     |       |     |       |     |       |
| Loans  to facilitate sales of real estate owned                                   |       | $        | 2,011      |     | $          | 6,905    |       | $ | 1,689 |   |
|                                                                              |       |     |       |     |       |     |       |
| Investment  securities purchased—not settled                                 |       | $        | —     |     | $          | 8,995    |       | $ | 3,190 |   |
|                                                                              |       |     |       |     |       |     |       |
| Transfer  of real estate owned to office properties and equipment                 |       | $        | —     |     | $          | —   |       | $ | 2,648 |   |
|                                                                              |       |     |       |     |       |     |       |
| Preferred  dividends accrued                                                      |       | $        | 105        |     | $          | —   |       | $ | — |   |

 
| See notes to consolidated  financial statements. |   |   | (Concluded) |
|--------------------------------------------------|--------|--------|-------------|

 

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**FIRSTFEDERAL BANCSHARES OF ARKANSAS, INC.**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

**YEARSENDED DECEMBER 31, 2009, 2008, AND 2007**

 

**1.****                     ****SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES**

 

***Nature of Operations and Principles of Consolidation—***First FederalBancshares of Arkansas, Inc. (the “Company”) is a unitary holding companythat owns all of the stock of First Federal Bank (the “Bank”). The Bankprovides a broad line of financial products to individuals and small- tomedium-sized businesses. The consolidated financial statements also include theaccounts of the Bank’s wholly owned subsidiary, First Harrison ServiceCorporation (“FHSC”), which is inactive. Intercompany transactions have been eliminated in consolidation.

 

***Use of Estimates—***The preparation of financialstatements in conformity with accounting principles generally accepted in theUnited States of America requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenues and expenses during the reporting period.Actual results could differ from those estimates and such differences could besignificant. Valuation of real estate owned and the allowance for loan lossesare material estimates that are particularly susceptible to significant changein the near term.

 

***Cash and Cash Equivalents—***For the purpose ofpresentation in the consolidated statements of cash flows, cash and cashequivalents includes cash on hand and amounts due from depository institutions,which includes interest bearing amounts available upon demand.

 

***Investment Securities—***The Company classifiesinvestment securities into one of two categories: held to maturity or availablefor sale. The Company does not engage in trading activities. Debt securitiesthat the Company has the positive intent and ability to hold to maturity are classifiedas held to maturity and recorded at cost, adjusted for the amortization ofpremiums and the accretion of discounts.

 

Investment securities thatthe Company intends to hold for indefinite periods of time are classified asavailable for sale and are recorded at fair value. Unrealized holding gains andlosses are excluded from earnings and reported net of tax in othercomprehensive income. Investment securities in the available for sale portfoliomay be used as part of the Company’s asset and liability management practicesand may be sold in response to changes in interest rate risk, prepayment risk,or other economic factors. At December 31, 2009 and 2008, the Company didnot own any investment securities classified as available for sale.

 

Premiums are amortized intointerest income using the interest method to the earlier of maturity or calldate. Discounts are accreted into interest income using the interest methodover the period to maturity. The specific identification method of accountingis used to compute gains or losses on the sales of investment securities.

 

Declines in the fair valueof held to maturity and available for sale securities below their cost that aredeemed to be other than temporary are reflected in earnings as realized losses.In estimating other than temporary impairment losses, management considersindependent price quotations and the financial condition of the issuer.

 

***Loans Receivable—***The Bankoriginates and maintains loans receivable that are substantially concentratedin its lending territory (primarily Northwest and Northcentral Arkansas). Themajority of the Bank’s loans are residential mortgage loans and commercial realestate loans. The Bank’s policy calls for collateral or other forms ofrepayment assurance to be received from the borrower at the time of loanorigination. Such collateral or other form of repayment assurance is subject tochanges in economic value due to various factors beyond the control of theBank.

 

Loans receivable thatmanagement has the intent and ability to hold for the foreseeable future oruntil maturity or pay-off are stated at unpaid principal balances adjusted forany charge-offs, the allowance for loan losses, and any deferred loan fees orcosts. Deferred loan fees or costs and discounts on first mortgage loans areamortized or accreted to income using the level-yield method over the remainingperiod to contractual maturity.

 

Mortgage loans originatedand committed for sale in the secondary market are carried at the lower of costor estimated market value in the aggregate. Such loans are generally carried atcost due to the short period of time between funding and sale, generally two tothree weeks.

 

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The accrual of interest onloans is generally discontinued when, in management’s opinion, the borrower maybe unable to meet payments as they become due or when the loan becomes 90 dayspast due, whichever occurs first. When interest accrual is discontinued, allunpaid accrued interest is reversed against interest income. The interest onthese loans is accounted for on the cash basis until qualifying for return toaccrual. Loans are generally returned to accrual status when payments are madeto bring the loan less than 90 days past due and, in the opinion of management,collection of the remaining balance can be reasonably expected.  The Company may continue to accrue intereston certain loans that are 90 days past due or more if such loans are in theprocess of collection and collection is reasonably assured.

 

***Allowance for Loan Losses—***The allowance for loanlosses is established as losses are estimated to have occurred through aprovision for loan losses charged to earnings. Loan losses are charged againstthe allowance when management believes it is likely that a loan balance isuncollectible.  Subsequent recoveries, ifany, are credited to the allowance.

 

The allowance for loanlosses represents management’s estimate of incurred credit losses inherent inthe Company’s loan portfolio as of the balance sheet date.  The estimation of the allowance is based on avariety of factors, including past loan loss experience, the current creditprofile of the Company’s borrowers, adverse situations that have occurred thatmay affect the borrowers’ ability to repay, the estimated value of underlyingcollateral, and general economic conditions, including unemployment, bankruptcytrends, vacancy rates, and home sales. Losses are recognized when availableinformation indicates that it is probable that a loss has been incurred and theamount of the loss can be reasonably estimated. This evaluation is inherentlysubjective as it requires estimates that are susceptible to significantrevision as more information becomes available or conditions change.

 

A loan is consideredimpaired when, based on current information and events, it is probable that theBank will be unable to collect the scheduled payments of principal or interestwhen due according to the contractual terms of the loan agreement. Factorsconsidered by management in determining impairment include payment status,collateral value, and the probability of collecting scheduled principal andinterest payments when due. Loans that experience insignificant payment delaysand payment shortfalls generally are not classified as impaired. Managementdetermines the significance of payment delays and payment shortfalls on acase-by-case basis, taking into consideration all of the circumstancessurrounding the loan and the borrower, including the length of the delay, thereasons for the delay, the borrower’s prior payment record, and the amount ofthe short fall in relation to the principal and interest owed. Impairment ismeasured on a loan by loan basis by either the present value of expected futurecash flows discounted at the loan’s effective interest rate, the loan’sobtainable market price, or the fair value of the collateral if the loan iscollateral dependent.  Multifamilyresidential, commercial real estate, land and land development, and commercialloans that are delinquent or where the borrower’s total loan relationshipexceeds $1 million are evaluated on a loan-by-loan basis at least annually. Nonaccrual loansand troubled debt restructurings (“TDRs”) are also considered to be impairedloans.

 

Large groups of smallerbalance homogeneous loans are collectively evaluated for impairment.Accordingly, the Bank does not separately identify individual consumer andresidential loans which are not on nonaccrual status or TDRs******for impairment disclosures.  Homogeneous loans are those that areconsidered to have common characteristics that provide for evaluation on anaggregate or pool basis. The Bank considers the characteristics of (1) one-to four-family residential mortgage loans; (2) unsecured consumer loans;and (3) collateralized consumer loans to permit consideration of theappropriateness of the allowance for losses of each group of loans on a poolbasis. The primary methodology used to determine the appropriateness of theallowance for losses includes segregating certain specific, poorly performingloans based on their performance characteristics from the pools of loans as totype, valuing these loans, and then applying a loss factor to the remainingpool balance based on several factors including past loss experience, inherentrisks, and economic conditions in the primary market areas.

 

***Rate Lock Commitments—***The Bank enters intocommitments to originate loans whereby the interest rate on the loan isdetermined prior to funding (rate lock commitments). Rate lock commitments onmortgage loans that are intended to be sold are considered to be derivatives.Accordingly, such commitments, along with any related fees received from potentialborrowers, are recorded at fair value in derivative assets or liabilities, withchanges in fair value recorded in the net gain or loss on sale of mortgageloans. Fair value is based on fees currently charged to enter into similaragreements, and for fixed rate commitments also considers the differencebetween current levels of interest rates and the committed rates.

 

***Real Estate Owned, Net—***Real estate owned representsforeclosed assets held for sale and is initially recorded at estimated fairvalue less estimated costs to sell, establishing a new cost basis. Subsequentto foreclosure, management periodically performs valuations and the assets arecarried at the lower of carrying amount or fair value less costs to sell.Adjustments for estimated losses are charged to operations when any declinereduces the fair value to less than the carrying value.  Costs and expenses related to major additionsand improvements are capitalized while maintenance and repairs that do notextend the lives of the respective assets are expensed.

 

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***Office Properties and Equipment, Net—***Land is carriedat cost. Buildings and equipment are stated at cost less accumulateddepreciation and amortization. The Company computes depreciation using thestraight-line method over the estimated useful lives of the individual assets,which range from 3 to 40 years.

 

***Cash Surrender Value of Life Insurance—***Cash surrendervalue of life insurance represents life insurance purchased by the Bank on aqualifying group of officers with the Bank designated as owner and beneficiaryof the policies.  The yield on thesepolicies is used to offset a portion of employment benefit costs.  The policies are recorded on the consolidatedstatements of financial condition at their cash surrender values with changesin cash surrender values reported in noninterest income.  Death benefits in excess of the cashsurrender value are recorded in noninterest income at the time of death.

 

***Income Taxes—*** Deferred income tax assets and liabilitiesare determined using the liability (or balance sheet) method. Under thismethod, the net deferred tax asset or liability is determined based on the taxeffects of the temporary differences between the book and tax bases of thevarious statement of financial condition assets and liabilities and givescurrent recognition to changes in tax rates and laws.

 

***Interest Rate Risk—***The Bank’s asset base isexposed to risk including the risk resulting from changes in interest rates andchanges in the timing of cash flows. The Bank monitors the effect of such risksby considering the mismatch of the maturities of its assets and liabilities inthe current interest rate environment and the sensitivity of assets andliabilities to changes in interest rates. The Bank’s management has consideredthe effect of significant increases and decreases in interest rates andbelieves such changes, if they occurred, would be manageable and would notaffect the ability of the Bank to hold its assets as planned. However, the Bankis exposed to significant market risk in the event of significant and prolongedinterest rate changes.

 

***Earnings Per Common Share—***Basic earnings per sharerepresents income available to common stockholders divided by theweighted-average number of common shares outstanding during the period. Dilutedearnings per share reflects additional common shares that would have beenoutstanding if dilutive potential common shares had been issued, as well as anyadjustment to income that would result from the assumed issuance. Potentialcommon shares that may be issued by the Company relate solely to outstandingstock options and warrants, and are determined using the treasury stock method.

 

***Recent Accounting Pronouncements—*** On June 29, 2009, theFinancial Accounting Standards Board (“FASB”) issued *AccountingStandards Codification and the Hierarchy of Generally Accepted AccountingPrinciples* which establishes the *FASB Accounting StandardsCodification* (“ASC 105”) as the source of authoritative accountingprinciples recognized by the FASB to be applied by nongovernmental entities inthe preparation of financial statements in conformity with U.S. generally acceptedaccounting principles. The Statement is effective for financial statementsissued for interim and annual periods ending after September 15, 2009, formost entities. On the effective date, all non-SEC accounting and reportingstandards were superseded. The Company adopted this Statement beginning withthe quarterly period ended September 30, 2009, as required, and suchadoption did not have a material impact on the consolidated financialstatements of the Company.

 

In December 2007, theFASB issued ASC 810, formerly SFAS No. 160, *Noncontrolling Interests in Consolidated Financial Statements*,an amendment of ARB No. 51.  ThisStatement applies to all entities that prepare consolidated financialstatements, except not-for-profit organizations, but will affect only thoseentities that have an outstanding noncontrolling interest in one or moresubsidiaries or that deconsolidate a subsidiary.  This Statement was effective for fiscal yearsbeginning after January 1, 2009. The Company does not have any noncontrolling interests, therefore thisStatement did not have an impact on us.

 

In December 2007, theFASB issued ASC 805-10, formerly SFAS No. 141R, *Business Combinations.* The objective of this Statement is toimprove the relevance, representational faithfulness, and comparability of theinformation that a reporting entity provides in its financial reports about abusiness combination and its effects. To accomplish that, this Statementestablishes principles and requirements for how the acquirer:

 

a.                         Recognizes andmeasures in its financial statements the identifiable assets acquired, theliabilities assumed, and any noncontrolling interest in the acquiree

b.                        Recognizes andmeasures the goodwill acquired in the business combination or a gain from abargain purchase

c.                         Determines whatinformation to disclose to enable users of the financial statements to evaluatethe nature and financial effects of the business combination.

 

This Statement appliesprospectively to business combinations for which the acquisition date is on orafter the beginning of the first annual reporting period beginning on or after December 15,2008. An entity may not apply it 

 

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before that date.  We adopted ASC 805-10 as of January 1,2009.  The adoption of this Statement didnot have a material effect on the consolidated financial statements of theCompany.

 

In March 2008, the FASBissued ASC 815-10, formerly SFAS No. 161, *Disclosuresabout Derivative Instruments and Hedging Activities*, effective forfinancial statements issued for fiscal years beginning after November 15,2008. The objective of this Statement is to provide enhanced disclosures aboutderivative instruments and related hedging items.  We adopted ASC 815-10 as of January 1,2009.  The adoption of this Statement didnot have a material effect on the consolidated financial statements of theCompany.

 

Weadopted ASC 855-10, formerly FASB Statement 165, *SubsequentEvents*, effective for financial statements issued for periods endingafter June 15, 2009.  This Statementaddresses events that occur after the balance sheet date but before theissuance of the financial statements, distinguishes which subsequent eventsthat should be recognized in the financial statements, which nonrecognizedevents require disclosure and requires the disclosure of the date through whichsubsequent events were evaluated.  Seenote 23 for disclosure.

 

OnApril 9, 2009, the FASB issued ASC 825-10, formerly FASB Staff PositionFAS No. 107-1 and Accounting Principles Bulletin 28-1, *Interim Disclosures about Fair Value of FinancialInstruments,*which amendedFASB No. 107, *Disclosures about FairValue of Financial Instruments* and is effective for financialstatements issued for interim periods ending after June 15, 2009. * *TheStatement was amended to require that the existing annual fair value disclosurerequirements under *Disclosures about FairValue of Financial Instruments* be expanded to interim periods.  This Statement was adopted in thesecond quarter of 2009.

 

OnApril 9, 2009, the FASB issued ASC 320-10, formerly FSP FAS No. 115-2and FAS No. 124-2, *Recognition andPresentation of Other-Than-Temporary Impairments,*effective for financial statements issuedfor interim periods ending after June 15, 2009. * *The Statement wasamended to make significant changes to the Other Than Temporary Impairment (“OTTI”)assertions made related to debt securities. The FSP also provided foradditional interim disclosures related to OTTI on debt securities.  These Statements did not have amaterial effect on the consolidated financial statements of the Company.

 

OnApril 9, 2009, the FASB issued ASC 820-10, formerly FAS 157-4, *Determining Fair Value When the Volume and Level ofActivity for the Asset or Liability Have Significantly Decreased andIdentifying Transactions That Are Not Orderly*(FSP FAS 157-4), effective for financial statements issuedfor interim periods ending after June 15, 2009. * *The FSPprovides additional guidance on determining fair value in inactive markets forfinancial assets under *Fair ValueMeasurements.** *ThisStatement did not have a material effect on the consolidated financialstatements of the Company.

 

InJune 2009, the FASB issued two standards which change the way entitiesaccount for securitizations and special-purpose entities:  SFAS No. 166, *Accountingfor Transfers of Financial Assets,*(ASC 860) and SFAS No. 167, *Amendments to FASB Interpretation No. 46(R),*(ASC810).  SFAS No. 166 is a revision toSFAS No. 140, *Accounting for Transfersand Servicing of Financial Assets and Extinguishments of Liabilities,*andrequires more information about transfers of financial assets, includingsecuritization transactions, and where entities have continuing exposure to therisks related to transferred financial assets. This Statement eliminates the concept of a “qualifying special-purposeentity,” changes the requirements for derecognizing financial assets, andrequires additional disclosures.  SFAS No. 167is a revision to FASB Interpretation No. 46 (Revised December 2003), *Consolidation of Variable Interest Entities,*and changes howa reporting entity determines when an entity that is insufficiently capitalizedor is not controlled through voting (or similar rights) should beconsolidated.  The determination ofwhether a reporting entity is required to consolidate another entity is basedon, among other things, the other entity’s purpose and design and the reportingentity’s ability to direct the activities of the other entity that mostsignificantly impact the other entity’s economic performance.  These new standards require a number of newdisclosures.  SFAS No. 167 requiresa reporting entity to provide additional disclosures about its involvement withvariable interest entities and any significant changes in risk exposure due tothat involvement.  A reporting entitywill be required to disclose how its involvement with a variable interestentity affects the reporting entity’s financial statements.  SFAS No. 166 enhances informationreported to users of financial statements by providing greater transparencyabout transfers of financial assets and an entity’s continuing involvement intransferred financial assets.  These Statementswill be effective at the beginning of a reporting entity’s first fiscal yearbeginning after November 15, 2009. Early application is not permitted. The Company adopted these Statements on January 1, 2010.  The adoption of these Statements did not havea material effect on the consolidated financial statements of the Company.

 

InAugust 2009, the FASB issued ASU No. 2009-05, *“Fair ValueMeasurements and Disclosures, (ASC 820) — Measuring Liabilities at Fair Value”.*  This ASU provides amendments for fair valuemeasurements of liabilities.  It providesclarification that in circumstances in which a quoted price in an active marketfor the identical liability is not available, a reporting entity is required tomeasure fair value using one or more techniques.  ASU 2009-05 also 

 

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clarifiesthat when estimating the fair value of a liability, a reporting entity is notrequired to include a separate input or adjustment to other inputs relating tothe existence of a restriction that prevents the transfer of theliability.  ASU 2009-05 is effective forthe first reporting period (including interim periods) beginning after issuanceor fourth quarter 2009.  The adoption ofASU 2009-05 on January 1, 2010 did not have a material effect on theconsolidated financial statement of the Company.

 

**2.****                     ****GOINGCONCERN**

 

The consolidated financialstatements have been prepared on a going concern basis, which contemplates therealization of assets and the satisfaction of liabilities in the normal courseof business for the foreseeable future. However, the events and circumstancesdescribed below create an uncertainty about the Company’s ability to continueas a going concern.  The consolidatedfinancial statements do not include any adjustment that might result from theoutcome of this uncertainty.

 

The Company recorded a netloss of $45.5 million in 2009, primarily due to the level of nonperformingassets, the provision for loan losses of $44.4 million, real estate ownedexpenses of $8.4 million, and FDIC insurance premiums of $1.7 million.  Our losses are largely a result ofnonperforming loans and real estate owned. Our net loss also included theestablishment of a valuation allowance against the realization of our deferredtax asset of $18.1 million.

 

At December 31, 2009,the Company was below the regulatory minimum for total capital to risk weightedassets and above the regulatory minimums for tangible, core, and tier 1 riskbased capital.  On April 12, 2010,the Company and the Bank each consented to the terms of Cease and Desist Ordersissued by the OTS (the “Bank Order” and the “Company Order” and, together, the “Orders”).  The Orders impose certain operationsrestrictions on the Company and, to a greater extent, the Bank, includinglending and dividend restrictions.  TheOrders also require the Company and the Bank to take certain actions, includingthe submission to the OTS of capital plans and business plans to, among otherthings, preserve and enhance the capital of the Company and the Bank andstrengthen and improve the consolidated Company’s operations, earnings andprofitability.  The Bank Orderspecifically requires the Bank to achieve and maintain, by December 31,2010, a tier 1 (core) capital ratio of at least 8% and a total risk-basedcapital ratio of at least 12.0% and maintain these higher ratios for as long asthe Bank Order is in effect.  At December 31,2009, the Bank’s core and total risk-based capital ratios were 5.75% and9.97%.  Had the Bank been required tomeet these capital requirements at December 31, 2009, it would have neededadditional capital of approximately $16.5 million.

 

Management has developed andwill continue to refine capital and strategic plans which take intoconsideration available information in the development of future financialprojections, which includes, but is not limited to, twelve months from thebalance sheet date of December 31, 2009. The expected results of theseplans, forecasts and strategic initiatives, which are based on multiplescenarios and stress tested cases, provide for the enhancement and preservationof capital. Management’s plans to preserve and enhance its capital levels dependon various factors, some of which are outside the control of management. Thesefactors include improvement in the economy, the ability to raise capital, theability to reduce nonperforming assets, and the ability to maintain the Company’sliquidity.

 

The Company is continuing toaggressively pursue various available alternatives to improve its capitalratios, including operating strategies designed to increase profitability,through, among others, a reduction of nonperforming assets and reduction of operatingcosts, shrinking the balance sheet, and raising capital.  There can be no assurance that the economicconditions that caused the deterioration in loan quality, profits and capitalwill improve, and should the Bank’s capital and related ratios continue todeteriorate, the OTS could impose more severe directives on the Bank. Theprojected results of operations in 2010 and balance sheet shrinkage will not besufficient to comply with the Orders. Currently, the Company intends to raise capital in the third or fourthquarter to comply with the requirements of the Orders.

 

The Company’s ability toraise additional capital will depend on conditions in the capital markets atthat time, which are outside the Company’s control. Accordingly, the Companycannot be certain of its ability to raise additional capital on acceptableterms. The Company’s potential inability to raise capital and comply with theterms of the Order raises substantial doubt about its ability to continue as agoing concern.

 

**3.****                     ****RESTRICTIONSON CASH AND AMOUNTS DUE FROM BANKS**

 

Based on the reserverequirements of the Federal Reserve Bank, the Bank is required to maintainaverage cash balances on hand or with the Federal Reserve Bank. AtDecember 31, 2009 and 2008, these required reserves balances amounted to$636,000 and $575,000, respectively.

 

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**4.****                     ****INVESTMENTSECURITIES**

 

Investment securitiesconsisted of the following at December 31 (in thousands):

 
| ** **                              | ** ** | **2009**      | ** ** |
|-----------------------------------------|------------|---------------|------------|
| ** **                              | ** ** | ** **    | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                              | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| **Held To  Maturity**                   | ** ** | **Cost**      | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
|                                    |       |          |       |   |   |   |   |   |   |
| Municipal  securities                   |       | $             | 25,480     |   | $ | 247 |   | $ | (269 | ) | $ | 25,458 |   |
| U.S.  Government and Agency obligations |       | 110,051       |       | 21 |   | (3,021 | ) | 107,051 |   |
|                                    |       |          |       |   |   |   |   |   |   |
| Total                                   |       | $             | 135,531    |   | $ | 268 |   | $ | (3,290 | ) | $ | 132,509 |   |

 
| ** **                              | ** ** | **2008**      | ** ** |
|-----------------------------------------|------------|---------------|------------|
| ** **                              | ** ** | ** **    | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                              | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| **Held To  Maturity**                   | ** ** | **Cost**      | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
|                                    |       |          |       |   |   |   |   |   |   |
| Municipal  securities                   |       | $             | 19,565     |   | $ | 75 |   | $ | (599 | ) | $ | 19,041 |   |
| U.S.  Government and Agency obligations |       | 116,847       |       | 233 |   | (66 | ) | 117,014 |   |
|                                    |       |          |       |   |   |   |   |   |   |
| Total                                   |       | $             | 136,412    |   | $ | 308 |   | $ | (665 | ) | $ | 136,055 |   |

 

The following tablessummarize the gross unrealized losses and fair value of the Company’sinvestments with unrealized losses that are not deemed to beother-than-temporarily impaired (in thousands), aggregated by investmentcategory and length of time that individual securities have been in acontinuous unrealized loss position at December 31, 2009 and 2008:

 
| ** **                              | ** ** | **2009**                | ** ** |
|-----------------------------------------|------------|-------------------------|------------|
| ** **                              | ** ** | **Less than 12 Months** | ** ** | **12 Months or More** | ** ** | **Total** | ** ** |
| ** **                              | ** ** | **Fair**                | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| ** **                              | ** ** | **Value**               | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** |
|                                    |       |                    |       |   |   |   |   |   |   |   |   |   |   |
| Municipal  securities                   |       | $                       | 5,156      |   | $ | 92 |   | $ | 2,453 |   | $ | 177 |   | $ | 7,609 |   | $ | 269 |   |
| U.S.  Government and Agency obligations |       | 100,142                 |       | 2,908 |   | 2,888 |   | 113 |   | 103,030 |   | 3,021 |   |
|                                    |       |                    |       |   |   |   |   |   |   |   |   |   |   |
|                                    |       | $                       | 105,298    |   | $ | 3,000 |   | $ | 5,341 |   | $ | 290 |   | $ | 110,639 |   | $ | 3,290 |   |

 
| ** **                              | ** ** | **2008**                | ** ** |
|-----------------------------------------|------------|-------------------------|------------|
| ** **                              | ** ** | **Less than 12 Months** | ** ** | **12 Months or More** | ** ** | **Total** | ** ** |
| ** **                              | ** ** | **Fair**                | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| ** **                              | ** ** | **Value**               | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** |
|                                    |       |                    |       |   |   |   |   |   |   |   |   |   |   |
| Municipal  securities                   |       | $                       | 5,493      |   | $ | 171 |   | $ | 3,926 |   | $ | 428 |   | $ | 9,419 |   | $ | 599 |   |
| U.S.  Government and Agency obligations |       | 15,503                  |       | 66 |   | — |   | — |   | 15,503 |   | 66 |   |
|                                    |       |                    |       |   |   |   |   |   |   |   |   |   |   |
|                                    |       | $                       | 20,996     |   | $ | 237 |   | $ | 3,926 |   | $ | 428 |   | $ | 24,922 |   | $ | 665 |   |

 

On a quarterly basis,management conducts a formal review of securities for the presence ofOTTI.  Management assesses whether an OTTI is present when the fairvalue of a security is less than its amortized cost basis at the balance sheetdate.  For such securities, OTTI is considered to have occurred ifthe Company intends to sell the security, if it is more likely than not theCompany will be required to sell the security before recovery of its amortizedcost basis or if the present values of expected cash flows is not sufficient torecover the entire amortized cost.

 

The unrealized losses areprimarily a result of increases in market yields from the time ofpurchase.  In general, as market yields rise, the fair value ofsecurities will decrease; as market yields fall, the fair value of securitieswill 

 

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increase. Managementgenerally views changes in fair value caused by changes in interest rates astemporary; therefore, these securities have not been classified asother-than-temporarily impaired.  Additionally, the impairment isalso considered temporary because scheduled coupon payments have been made, itis anticipated that the entire principal balance will be collected asscheduled, and management neither intends to sell the securities and it is notmore likely than not that the Company will be required to sell the securitiesbefore the recovery of the remaining amortized cost amount.

 

The Company has pledgedinvestment securities held to maturity with carrying values of approximately$59.5  million and $54.5 million atDecember 31, 2009 and 2008, respectively, as collateral for certaindeposits in excess of $250,000.  Inaddition, the Company has pledged investment securities held to maturity withcarrying values of approximately $22.0 million at December 31, 2008 forborrowings outstanding at the FHLB and FRB. No securities were used as collateral for borrowings outstanding at December 31,2009.

 

The scheduled maturities ofdebt securities at December 31, 2009, by contractual maturity are shownbelow (in thousands). Expected maturities may differ from contractualmaturities because borrowers may have the right to call or prepay obligationswith or without call or prepayment penalties.

 
| ** **                        | ** ** | **2009**      | ** ** |
|-----------------------------------|------------|---------------|------------|
| ** **                        | ** ** | **Amortized** | ** ** | **Fair** | ** ** |
| ** **                        | ** ** | **Cost**      | ** ** | **Value** | ** ** |
|                              |       |          |       |   |   |
| Within  one year                  |       | $             | 200        |   | $ | 204 |   |
| Due  from one year to five years  |       | 2,100         |       | 2,075 |   |
| Due  from five years to ten years |       | 9,147         |       | 9,054 |   |
| Due  after ten years              |       | 124,084       |       | 121,176 |   |
|                              |       |          |       |   |   |
| Total                             |       | $             | 135,531    |   | $ | 132,509 |   |

 

As of December 31, 2009and 2008, investments with carrying values of approximately $127.6 million and$135.8 million, respectively, have call options held by the issuer, of whichapproximately $99.2 million and $124.8 million, respectively, are or werecallable within one year.

 

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**5.****                     ****LOANSRECEIVABLE**

 

Loans receivable consistedof the following at December 31 (in thousands):

 
| ** **                                      | ** ** | **2009**   | ** ** | **2008**   | ** ** |
|-------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Mortgage  loans:                                |       |       |       |       |       |
| One-  to four-family residences                 |       | $          | 235,990    |       | $          | 241,735 |   |
| Home  equity and second mortgage                |       | 27,022     |       | 31,712     |       |
| Commercial  real estate                         |       | 104,618    |       | 115,935    |       |
| Multifamily                                     |       | 27,987     |       | 24,147     |       |
| Land                                            |       | 41,405     |       | 50,510     |       |
| Construction                                    |       | 49,295     |       | 77,316     |       |
|                                            |       |       |       |       |       |
| Total  mortgage loans                           |       | 486,317    |       | 541,355    |       |
|                                            |       |       |       |       |       |
| Commercial  loans                               |       | 14,575     |       | 21,922     |       |
|                                            |       |       |       |       |       |
| Consumer  loans:                                |       |       |       |       |       |
| Automobile                                      |       | 6,810      |       | 8,631      |       |
| Other                                           |       | 11,052     |       | 12,291     |       |
|                                            |       |       |       |       |       |
| Total  consumer loans                           |       | 17,862     |       | 20,922     |       |
|                                            |       |       |       |       |       |
| Undisbursed  loan funds                         |       | (4,327     | )          | (11,750    | )          |
| Unearned  discounts and net deferred loan costs |       | 23         |       | 529        |       |
| Allowance  for loan losses                      |       | (32,908    | )          | (6,441     | )          |
|                                            |       |       |       |       |       |
| Loans  receivable—net                      |       | $          | 481,542    |       | $          | 566,537 |   |

 

Mortgage loans serviced forothers are not included in the accompanying consolidated statements offinancial condition.  The unpaid principalbalances of such loans at December 31, 2009 and 2008 were $11.8 millionand $28.5 million, respectively. Servicing loans for others generally consists of collecting mortgagepayments, maintaining escrow accounts, disbursing payments to investors, andforeclosure processing.   Servicingincome for the years ended December 31, 2009, 2008, and 2007 was $91,000,$117,000, and $110,000, respectively.

 

As of December 31, 2009and 2008, qualifying loans collateralized by first lien one- to four-family mortgageswith balances totaling approximately $97.4 million and $91.3 million,respectively, were pledged as collateral for FHLB advances.

 

In April 2008, based onthe FHLB rating criteria, the Bank was notified of the replacement of our FHLBblanket lien with a restricted custody collateral arrangement, whereby the FHLBhas custody and endorsement of the loans that collateralize our outstandingborrowings with the FHLB.  Qualifying loans (i) must not be 90 daysor more past due; (ii) must not have been in default within the mostrecent twelve-month period, unless such default has been cured in a manneracceptable to the FHLB; (iii) must relate to real property that is coveredby fire and hazard insurance in an amount at least sufficient to discharge themortgage loan in case of loss and as to which all real estate taxes arecurrent; (iv) must not have been classified as substandard, doubtful, orloss by the Bank’s regulatory authority or the Bank; and (v) must notsecure the indebtedness to any director, officer, employee, attorney, or agentof the Bank or of any FHLB.  The FHLB currently allows an aggregatecollateral or lendable value on the qualifying loans of approximately 75% ofthe outstanding balance of the loans pledged to the FHLB.

 

As of December 31, 2009and 2008, qualifying loans collateralized by commercial real estate withbalances of $46.1 million and $37.5 million, respectively, were pledged ascollateral for the Federal Reserve Bank discount window.  In addition, at December31, 2009, the loans may also be used to secure transaction settlements at theFederal Reserve Bank.   In September 2008, a subordination agreementwas secured with the FHLB based on its blanket lien of such loans.  Thisagreement provides the Bank the ability to pledge commercial real estate loansto the Federal Reserve Bank discount window and to secure transactionsettlements.  The collateral was held by the Bank through the FederalReserve Bank’s Borrower in Custody of Collateral Program until December 2009,when the

 

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Federal Reserve Banknotified the Bank that custody of the collateral must be transferred to theFederal Reserve Bank.

 

The Federal Reserve Bankwill not accept loans that: (i) are 30 days or more past due; (ii) areclassified as substandard, doubtful, or loss by the Bank’s regulatory authorityor the Bank; (iii) are illegal investments for the Bank; (iv) securethe indebtedness to any director, officer, employee, attorney, affiliate oragent of the Bank; or that (v) exhibit collateral and credit documentationdeficiencies.  The lendable value at December 31, 2009 was 57% of thefair market value of the loans as determined by the Federal Reserve Bank takinginto consideration the rate and duration of the loans pledged.

 

Impaired loans consisted ofthe following as of the dates indicated (in thousands):

 
| ** **                                               | ** ** | **December 31, 2009 (1)** | ** ** | **December 31, 2008 (1)** | ** ** |
|----------------------------------------------------------|------------|--------------------------------|------------|--------------------------------|------------|
| ** **                                               | ** ** | **Recorded  Investment**       | ** ** | **Valuation  Allowance**       | ** ** | **Carrying  Value** | ** ** | **Recorded  Investment** | ** ** | **Valuation  Allowance** | ** ** | **Carrying  Value** | ** ** |
| Impaired  loans without a valuation allowance            |       | $                              | 37,191     |                           | $          | — |   | $ | 37,191 |   | $ | 18,482 |   | $ | — |   | $ | 18,482 |   |
| Impaired  loans with a valuation allowance               |       | 24,095                         |       | 7,476                          |       | 16,619 |   | 8,830 |   | 2,916 |   | 5,914 |   |
| Total  impaired loans                                    |       | $                              | 61,286     |                           | $          | 7,476 |   | $ | 53,810 |   | $ | 27,312 |   | $ | 2,916 |   | $ | 24,396 |   |
|                                                     |       |                           |       |                           |       |   |   |   |   |   |   |   |   |
| Nonaccrual  loans                                        |       | $                              | 50,343     |                           | $          | 7,476 |   | $ | 42,867 |   | $ | 25,419 |   | $ | 2,916 |   | $ | 22,503 |   |
|                                                     |       |                           |       |                           |       |   |   |   |   |   |   |   |   |
| Total  loans past due 90 days or more and still accruing |       | $                              | —     |                           | $          | — |   | $ | — |   | $ | 8,961 |   | $ | — |   | $ | 8,961 |   |

 
| **Years Ended December 31**                              |   |   |   |   |   | **2009** |   |   |   |   |   | **2008** |   |
|---------------------------------------------------------------|--------|--------|--------|--------|--------|----------|--------|--------|--------|--------|--------|----------|--------|
| Average  investment in impaired loans                         |   |   |   |   |   | $        | 48,609 |   |   |   |   |     | $      | 26,676 |   |
|                                                          |   |   |   |   |   |     |   |   |   |   |   |     |   |
| Interest  income recognized on impaired loans                 |   |   |   |   |   | $        | 1,747  |   |   |   |   |     | $      | 498 |   |
|                                                          |   |   |   |   |   |     |   |   |   |   |   |     |   |
| Interest  income recognized on a cash basis on impaired loans |   |   |   |   |   | $        | 128    |   |   |   |   |     | $      | 64 |   |
|                                                          |   |   |   |   |   |     |   |   |   |   |   |     |   |
| Interest  based on original terms                             |   |   |   |   |   | $        | 4,355  |   |   |   |   |     | $      | 1,920 |   |

 

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(1)          Subsequent to the issuanceof the Company’s 2009 consolidated financial statements included in its AnnualReport on Form 10-K, filed on April 15, 2010, management identifiedan immaterial error in the disclosure of impaired loans in the tableabove.  Impaired loans of $20.5 million and $16.1 million were omittedfrom the previously presented disclosure as of December 31, 2009 and 2008,respectively.  These amounts primarily represent impaired non-homogeneousloans less than $500,000 and borrower relationships less than $1.0million.  The disclosed amounts of impaired loans without valuationallowance, impaired loans with a valuation allowance, average investment inimpaired loans, interest income recognized on impaired loans, and interestincome recognized on a cash basis on impaired loans previously presented havebeen restated to include these impaired loans.  The previously omittedloans did not impact the consolidated statements of financial condition,operations or cash flows for the years ended December 31, 2009 or 2008.

 

The following is a summaryof changes made to previously presented impaired loan disclosures (inthousands):

 
| ** **                                                    | ** ** | **December 31, 2009**    | ** ** | **December 31, 2008** | ** ** |
|---------------------------------------------------------------|------------|-------------------------------|------------|----------------------------|------------|
| ** **                                                    | ** ** | **As  Previously  Presented** | ** ** | **Adjustment**             | ** ** | **As  Restated** | ** ** | **As Previously  Presented** | ** ** | **Adjustment** | ** ** | **As Restated** | ** ** |
| Impaired  loans without a valuation allowance                 |       | $                             | 22,152     |                       | $          | 15,039 |   | $ | 37,191 |   | $ | 4,815 |   | $ | 13,667 |   | $ | 18,482 |   |
| Impaired  loans with a valuation allowance                    |       | 11,197                        |       | 5,422                      |       | 16,619 |   | 3,529 |   | 2,385 |   | 5,914 |   |
| Total  impaired loans                                         |       | $                             | 33,349     |                       | $          | 20,461 |   | $ | 53,810 |   | $ | 8,344 |   | $ | 16,052 |   | $ | 24,396 |   |
|                                                          |       |                          |       |                       |       |   |   |   |   |   |   |   |   |
| Average  investment in impaired loans                         |       | $                             | 29,171     |                       | $          | 19,438 |   | $ | 48,609 |   | $ | 11,165 |   | $ | 15,511 |   | $ | 26,676 |   |
|                                                          |       |                          |       |                       |       |   |   |   |   |   |   |   |   |
| Interest  income recognized on impaired loans                 |       | $                             | 1,001      |                       | $          | 746 |   | $ | 1,747 |   | $ | 56 |   | $ | 442 |   | $ | 498 |   |
|                                                          |       |                          |       |                       |       |   |   |   |   |   |   |   |   |
| Interest  income recognized on a cash basis on impaired loans |       | $                             | —     |                       | $          | 128 |   | $ | 128 |   | $ | — |   | $ | 64 |   | $ | 64 |   |

 

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Interest income recordedduring the years ended December 31, 2009, 2008, and 2007 for nonaccrualloans was $1.1 million, $415,000, and $458,000, respectively.  Under the original terms, these loans wouldhave reported approximately $3.7 million, $1.8 million, and $2.6 million, ofinterest income for the years ended December 31, 2009, 2008, and 2007,respectively.

 

**6.****                     ****ACCRUEDINTEREST RECEIVABLE**

 

Accrued interest receivableconsisted of the following at December 31 (in thousands):

 
| ** **             | ** ** | **2009** | ** ** | **2008** | ** ** |
|------------------------|------------|----------|------------|----------|------------|
|                   |       |     |       |     |       |
| Loans                  |       | $        | 2,562      |     | $          | 4,734 |   |
| Investment  securities |       | 1,667    |       | 1,967    |       |
|                   |       |     |       |     |       |
| Total                  |       | $        | 4,229      |     | $          | 6,701 |   |

 

**7.****                     ****ALLOWANCESFOR LOAN AND REAL ESTATE LOSSES**

 

A summary of the activity inthe allowances for loan and real estate losses is as follows for the yearsended December 31 (in thousands):

 
| ** **                       | ** ** | **2009**  | ** ** | **2008**         | ** ** | **2007**  | ** ** |
|----------------------------------|------------|-----------|------------|------------------|------------|-----------|------------|
| ** **                       | ** ** | **Loans** | ** ** | **Real  Estate** | ** ** | **Loans** | ** ** | **Real  Estate** | ** ** | **Loans** | ** ** | **Real  Estate** | ** ** |
|                             |       |      |       |             |       |      |       |   |   |   |   |   |   |
| Balance—beginning  of year  |       | $         | 6,441      |             | $          | —    |       | $ | 5,162 |   | $ | — |   | $ | 2,572 |   | $ | — |   |
|                             |       |      |       |             |       |      |       |   |   |   |   |   |   |
| Provisions  for estimated losses |       | 44,365    |       | 6,224            |       | 5,710     |       | 1,042 |   | 4,028 |   | 494 |   |
| Recoveries                       |       | 866       |       | —           |       | 483       |       | — |   | 181 |   | — |   |
| Losses  charged off              |       | (18,764   | )          | (681             | )          | (4,914    | )          | (1,042 | ) | (1,619 | ) | (494 | ) |
|                             |       |      |       |             |       |      |       |   |   |   |   |   |   |
| Balance—end  of year(1)     |       | $         | 32,908     |             | $          | 5,543     |       | $ | 6,441 |   | $ | — |   | $ | 5,162 |   | $ | — |   |

 

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(1)          The allowance for loanlosses at December 31, 2009, 2008, and 2007 is comprised of specificvaluation allowances of $7.5 million, $2.9 million and $2.9 million,respectively, and general valuation allowances of $25.4 million, $3.5 millionand $2.3 million, respectively.

 

**8.****                     ****OFFICEPROPERTIES AND EQUIPMENT**

 

Office properties andequipment consisted of the following at December 31 (in thousands):

 
| ** **                                | ** ** | **2009** | ** ** | **2008** | ** ** |
|-------------------------------------------|------------|----------|------------|----------|------------|
|                                      |       |     |       |     |       |
| Land  and land improvements               |       | $        | 5,937      |     | $          | 5,937 |   |
| Buildings  and improvements               |       | 21,547   |       | 21,406   |       |
| Furniture  and equipment                  |       | 7,240    |       | 7,073    |       |
| Automobiles                               |       | 472      |       | 484      |       |
| Construction  in progress                 |       | 143      |       | 107      |       |
|                                      |       |     |       |     |       |
| Total                                     |       | 35,339   |       | 35,007   |       |
|                                      |       |     |       |     |       |
| Accumulated  depreciation                 |       | (11,772  | )          | (10,313  | )          |
|                                      |       |     |       |     |       |
| Office  properties and equipment—net |       | $        | 23,567     |     | $          | 24,694 |   |

 

Depreciation expense for theyears ended December 31, 2009, 2008, and 2007, amounted to approximately$1.5 million, $1.5 million, and $1.4 million, respectively.

 

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Pursuant to the terms ofnoncancelable lease agreements in effect at December 31, 2009, pertainingto banking premises and equipment, future minimum rent commitments (inthousands) under various operating leases are as follows:

 
| **Years Ending December 31** | ** ** | ** ** | ** ** |
|-----------------------------------|------------|------------|------------|
|                              |       |       |       |
| 2010                              |       | $          | 198        |   |
| 2011                              |       | 180        |       |
| 2012                              |       | 180        |       |
| 2013                              |       | 172        |       |
| 2014                              |       | 160        |       |
| 2015  and thereafter              |       | 507        |       |
|                              |       |       |       |
| Total                             |       | $          | 1,397      |   |

 

The leases contain optionsto extend for periods from ten to twenty-five years.  The cost of such rentals is not includedabove.  Total rent expense for the yearsended December 31, 2009, 2008 and 2007 amounted to $254,000, $225,000, and$96,000, respectively.

 

The Bank also leases certainof its banking premises to third parties under operating lease agreements.  The following is a schedule by years ofminimum future rentals on noncancelable operating leases (in thousands):

 
| **Years Ending December 31** | ** ** | ** ** | ** ** |
|-----------------------------------|------------|------------|------------|
|                              |       |       |       |
| 2010                              |       | $          | 63         |   |
| 2011                              |       | 40         |       |
| 2012                              |       | 39         |       |
| 2013                              |       | 18         |       |
| 2014                              |       | 3          |       |
| 2015  and thereafter              |       | —     |       |
|                              |       |       |       |
| Total                             |       | $          | 163        |   |

 

The leases contain optionsto extend for periods from three to ten years. Such rentals are not included above. Total rental income for the years ended December 31, 2009, 2008 and2007 amounted to $74,000, $35,000, and $23,000, respectively.

 

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**9.****                     ****DEPOSITS**

 

Deposits are summarized asfollows at December 31 (in thousands):

 
| ** **                                                                                                        | ** ** | **2009**   | ** ** | **2008**   | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                                                                                                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Checking  accounts, including noninterest bearing deposits of $25,656 and $27,538 in  2009 and 2008, respectively | ** ** | $          | 166,707    | ** ** | $          | 163,468 | ** ** |
| Money  market accounts                                                                                            |       | 53,597     |       | 45,022     |       |
| Savings  accounts                                                                                                 |       | 24,983     |       | 23,019     |       |
| Certificates  of deposit                                                                                          |       | 379,337    |       | 386,494    |       |
|                                                                                                              |       |       |       |       |       |
| Total                                                                                                             |       | $          | 624,624    |       | $          | 618,003 |   |

 

Overdrafts of checkingaccounts of $379,000 and $483,000 at December 31, 2009 and 2008,respectively, have been reclassified for financial reporting and are reflectedin net loans receivable on the consolidated statements of financial condition.

 

The aggregate amount of timedeposits in denominations of $100,000 or more was approximately $133.7 millionand $123.3 million at December 31, 2009 and 2008, respectively.

 

At December 31, 2009,scheduled maturities of certificates of deposit are as follows (in thousands):

 
| **Year  Ending December 31** | ** ** | ** ** | ** ** |
|-----------------------------------|------------|------------|------------|
| ** **                        | ** ** | ** ** | ** ** |
| 2010                              |       | $          | 253,007    |   |
| 2011                              |       | 77,862     |       |
| 2012                              |       | 29,682     |       |
| 2013                              |       | 9,757      |       |
| 2014                              |       | 3,226      |       |
| 2015  and thereafter              |       | 5,803      |       |
|                              |       |       |       |
| Total                             |       | $          | 379,337    |   |

 

Interest expense on depositsconsisted of the following (in thousands):

 
| ** **                         | ** ** | **Year Ended December 31** | ** ** |
|------------------------------------|------------|-------------------------------------------|------------|
| ** **                         | ** ** | **2009**                                  | ** ** | **2008** | ** ** | **2007** | ** ** |
|                               |       |                                      |       |   |   |   |   |
| Interest bearing checking accounts |       | $                                         | 1,231      |   | $ | 1,730 |   | $ | 1,877 |   |
| Money market accounts              |       | 427                                       |       | 900 |   | 1,486 |   |
| Savings and certificate accounts   |       | 11,676                                    |       | 15,988 |   | 20,608 |   |
| Early withdrawal penalties         |       | (62                                       | )          | (69 | ) | (98 | ) |
|                               |       |                                      |       |   |   |   |   |
| Total                              |       | $                                         | 13,272     |   | $ | 18,549 |   | $ | 23,873 |   |

 

Eligible deposits of theBank are insured up to $250,000 by the Deposit Insurance Fund of the FDIC.

 

Full FDIC deposit insurancecoverage is provided through the Transaction Account Guarantee Program fornoninterest bearing transaction deposit accounts, negotiable order ofwithdrawal (“NOW”) accounts paying less than 0.5% interest per annum, andinterest on lawyers trust accounts held at participating FDICinstitutions.  This program was set toexpire June 30, 2010, but was recently extended to December 31,2010.  The extension applies to NOWaccounts with a maximum interest rate of .25% effective July 1, 2010.

 

**10.****              ****OTHERBORROWINGS**

 

**Federal Home Loan Bank. **The Bank is a member of theFederal Home Loan Bank System. As a member of this system, it is required tomaintain an investment in capital stock of the FHLB in an amount equal to thesum of 0.06% of total assets as of the previous December 31 and 4.10% ofoutstanding advances. No ready market exists for such stock and it has no quotedmarket value. The carrying value of the stock is its cost.

 

The Bank pledges ascollateral for FHLB advances certain qualifying one- to four-family mortgageloans and certain qualifying investment securities.  Pledged collateral is held in the custody ofthe FHLB.  Based on the Bank’s

 

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restricted status with theFHLB, the Bank may only borrow short-term advances with maturities up to thirtydays.

 

Advances atDecember 31, 2009 and 2008 consisted of the following (in thousands):

 
| ** **                           | ** ** | **2009**     | ** ** | **2008**   | ** ** |
|--------------------------------------|------------|--------------|------------|------------|------------|
| ** **                           | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** |
| **Amounts  Maturing in Year Ending** | ** ** | **Average**  | ** ** | ** ** | ** ** | **Average** | ** ** | ** ** | ** ** |
| **December 31**                 | ** ** | **Rate**     | ** ** | **Amount** | ** ** | **Rate** | ** ** | **Amount** | ** ** |
| ** **                           | ** ** | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| 2009                                 |       | —       | %          | $          | —     |   | 3.55 | % | $ | 46,636 |   |
| 2010                                 |       | 1.46         |       | 41,353     |       | 3.37 |   | 17,353 |   |
| 2011                                 |       | 3.14         |       | 11,514     |       | 3.24 |   | 11,514 |   |
| 2012                                 |       | 2.23         |       | 3,570      |       | 2.36 |   | 3,570 |   |
| 2013                                 |       | 0.66         |       | 2,168      |       | 0.89 |   | 2,168 |   |
| 2014                                 |       | 4.16         |       | 114        |       | 4.16 |   | 114 |   |
| Thereafter                           |       | 4.35         |       | 827        |       | 4.35 |   | 827 |   |
|                                 |       |         |       |       |       |   |   |   |   |
| Total                                |       | 1.85         | %          | $          | 59,546     |   | 3.36 | % | $ | 82,182 |   |

 

**FederalReserve Bank.**  At December 31,2008, the Bank had $10.0 million in overnight borrowings outstanding at a rateof 0.25% at the FRB.  At December 31,2009, the Bank did not have any outstanding borrowings with the FRB.

 

**11.****              ****INCOMETAXES**

 

The provisions (benefits)for income taxes are summarized as follows (in thousands):

 
| ** **                       | ** ** | **Year Ended December 31** | ** ** |
|----------------------------------|------------|---------------------------------|------------|
| ** **                       | ** ** | **2009**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
|                             |       |                            |       |   |   |   |   |
| Income  tax provision (benefit): |       |                            |       |   |   |   |   |
| Current:                         |       |                            |       |   |   |   |   |
| Federal                          |       | $                               | (1,441     | ) | $ | 251 |   | $ | 1,800 |   |
| State                            |       | 10                              |       | (17 | ) | 130 |   |
| Total  current                   |       | (1,431                          | )          | 234 |   | 1,930 |   |
|                             |       |                            |       |   |   |   |   |
| Deferred:                        |       |                            |       |   |   |   |   |
| Federal                          |       | (13,548                         | )          | (525 | ) | (1,328 | ) |
| State                            |       | (2,997                          | )          | (132 | ) | (257 | ) |
| Valuation  allowance             |       | 18,124                          |       | — |   | — |   |
| Total  deferred                  |       | 1,579                           |       | (657 | ) | (1,585 | ) |
|                             |       |                            |       |   |   |   |   |
| Total                            |       | $                               | 148        |   | $ | (423 | ) | $ | 345 |   |

 

The reasons for thedifferences between the statutory federal income tax rates and the effectivetax rates are summarized as follows (in thousands):

 
| ** **                           | ** ** | **Year Ended December 31** | ** ** |
|--------------------------------------|------------|---------------------------------|------------|
| ** **                           | ** ** | **2009**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                 |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Taxes  at statutory rate             |       | $                               | (15,419    | ) | 34.0 | % | $ | 709 |   | 34.0 | % | $ | 1,016 |   | 34.0 | % |
| Increase  (decrease) resulting from: |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| State  income tax—net           |       | (1,946                          | )          | 4.3 |   | (98 | ) | (4.7 | ) | (141 | ) | (4.7 | ) |
| Change  in valuation allowance       |       | 18,124                          |       | (40.0 | ) | — |   | — |   | — |   | — |   |
| Earnings  on life insurance policies |       | (277                            | )          | 0.6 |   | (667 | ) | (32.0 | ) | (259 | ) | (8.7 | ) |
| Nontaxable  investments              |       | (317                            | )          | 0.7 |   | (243 | ) | (11.7 | ) | (203 | ) | (6.8 | ) |
| Other—net                       |       | (17                             | )          | — |   | (124 | ) | (6.0 | ) | (68 | ) | (2.3 | ) |
|                                 |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Total                                |       | $                               | 148        |   | 0.3 | % | $ | (423 | ) | (20.3 | )% | $ | 345 |   | 11.5 | % |

 

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The Company’s net deferredtax asset account was comprised of the following at December 31 (inthousands):

 
| ** **                            | ** ** | **2009** | ** ** | **2008** | ** ** |
|---------------------------------------|------------|----------|------------|----------|------------|
|                                  |       |     |       |     |       |
| Deferred  tax assets:                 |       |     |       |     |       |
| Allowance  for loan losses            |       | $        | 11,054     |     | $          | 2,466 |   |
| Real  estate owned                    |       | 3,426    |       | 360      |       |
| Net  operating loss carryforward      |       | 4,432    |       | 12       |       |
| Other                                 |       | 190      |       | 2        |       |
|                                  |       |     |       |     |       |
| Total  deferred tax assets            |       | 19,102   |       | 2,840    |       |
| Valuation  allowance                  |       | (18,124  | )          | —   |       |
| Deferred  tax asset, net of allowance |       | 978      |       | 2,840    |       |
|                                  |       |     |       |     |       |
| Deferred  tax liabilities:            |       |     |       |     |       |
| Office  properties                    |       | (928     | )          | (919     | )          |
| Federal  Home Loan Bank stock         |       | (300     | )          | (559     | )          |
| Pension  plan contribution            |       | (94      | )          | (106     | )          |
| Prepaid  expenses                     |       | (130     | )          | (151     | )          |
|                                  |       |     |       |     |       |
| Total  deferred tax liabilities       |       | (1,452   | )          | (1,735   | )          |
|                                  |       |     |       |     |       |
| Net  deferred tax asset (liability)   |       | $        | (474       | )        | $          | 1,105 |   |

 

A deferred tax asset orliability is recognized for the tax consequences of temporary differences inthe recognition of revenue and expense, and unrealized gains and losses, forfinancial and tax reporting purposes. Deferred tax assets are reduced by avaluation allowance when, in the opinion of management, it is more likely thannot that some or all of the deferred tax assets will not be realized. TheCompany conducted an analysis to assess the need for a valuation allowance at December 31,2009. As part of this assessment, all available evidence, including bothpositive and negative, was considered to determine whether based on the weightof such evidence, a valuation allowance on the Company’s deferred tax assetswas needed. In accordance with ASC Topic 740-10, *Income Taxes*(ASC 740), a valuation allowance is deemed to be needed when, based on theweight of the available evidence, it is more likely than not (a likelihood ofmore than 50%) that some portion or all of a deferred tax asset will not berealized. The future realization of the deferred tax asset depends on theexistence of sufficient taxable income within the carryback and carryforwardperiods.

 

As part of its analysis, theCompany considered the following positive evidence:

 

·                  The Company hasa long history of earnings profitability.

·                  The Company isprojecting future taxable income sufficient to utilize all net operatingloss carryforwards prior to expiration.

·                  Futurereversals of certain deferred tax liabilities.

·                  The FederalReserve has indicated that the economy has exited the recession.

 

As part of its analysis, theCompany considered the following negative evidence:

 

·                  The Companyrecorded a large net loss in 2009.

·                  The Company didnot meet its financial goals in 2009.

·                  The Company maynot meet its projections concerning future taxable income.

 

Since December 31,2008, the Company’s deferred tax asset has increased significantly, primarilydue to additions to the allowance for loan losses and an increase in the netoperating loss carryover.  The 2009federal NOL is expected to be carried back to the 2007 and 2008 tax yearsresulting in a refund receivable of approximately $1.9 million.  At December 31, 2009, we determined thata valuation allowance relating to both the federal and state portion of ourdeferred tax asset was necessary. This determination for the state deferred taxasset was based largely on the negative evidence represented by the level ofstate tax exempt interest income which reduces state taxable income to a levelthat makes it unlikely the Company will realize its state deferred tax asset.Therefore, valuation allowances of $14.7 million and $3.4 million at December 31,2009 were recorded for a portion of the federal deferred tax asset and all ofthe state deferred tax asset, respectively.

 

Specifically exempted fromdeferred tax recognition requirements are bad debt reserves for tax purposes ofU.S. savings and loans in the institution’s base year, as defined. Base yearreserves totaled approximately $4.2 million.

 

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Consequently, a deferred taxliability of approximately $1.6 million related to such reserves was notprovided for in the consolidated statements of financial condition at December 31,2009 and December 31, 2008. Payment of dividends to shareholders out ofretained earnings deemed to have been made out of earnings previously set asideas bad debt reserves may create taxable income to the Bank. No provision hasbeen made for income tax on such a distribution as the Bank does not anticipatemaking such distributions.

 

The Company files income taxreturns in the U.S. federal jurisdiction and the state of Arkansas. The Companyis subject to U.S. federal and state income tax examinations by tax authoritiesfor tax years ended December 31, 2006 and forward.  The Company’s 2007 federal income tax returnwas subject to a limited scope examination by the Internal Revenue Serviceduring the first quarter of 2009.  As aresult of the examination, the Company was assessed approximately $45,000,including interest, for the 2007 tax year. The Company recognizes interest andpenalties on income taxes as a component of income tax expense.

 

**12.****              ****STOCKBASED COMPENSATION**

 

***Stock Option Plan***—The Stock Option Plan (“SOP”)provided for a committee of the Company’s Board of Directors to award incentivestock options, non-qualified or compensatory stock options and stockappreciation rights representing up to 1,030,750 shares of Company stock.One-fifth of the options granted vested immediately upon grant, with the balancevesting in equal amounts on the four subsequent anniversary dates of the grant.Options granted vest immediately in the event of retirement, disability, ordeath. Stock options granted expire in ten years unless grantee terminatesemployment, in which case the award expires five years after termination dateor ten years after grant date, whichever comes first.  The SOP expired during 2007, so no furtheroption grants will be made.  Compensationexpense attributable to stock options during the years ended December 31,2009, 2008 and 2007 totaled approximately $1,000, $4,000, and $10,000,respectively.

 

Under the SOP, options havebeen granted to directors and key employees to purchase common stock of theCompany. The exercise price in each case equals the fair market value of theCompany’s stock at the date of grant. Options granted are summarized asfollows:

 
| ** **        | ** ** | ** **                    | ** ** | **Options Outstanding********December 31, 2009** | ** ** | **Options Exercisable********December 31, 2009** | ** ** |
|-------------------|------------|-------------------------------|------------|-------------------------------------------------------|------------|-------------------------------------------------------|------------|
| **Year  Granted** | ** ** | **Range of  Exercise Prices** | ** ** | **Number of  Options  Outstanding**                   | ** ** | **Weighted  Average  Remaining  Contractual  Life**   | ** ** | **Weighted  Average  Exercise  Price Per  Share** | ** ** | **Number of  Options  Exercisable** | ** ** | **Weighted  Average  Exercise  Price Per  Share** | ** ** |
| 2000              |       | $9.13                         |       | 450                                                   |       | 0.7  years                                            |       | $ | 9.13 |   | 450 |   | $ | 9.13 |   |
| 2001              |       | 9.34 – 11.35             |       | 7,600                                                 |       | 1.5  years                                            |       | 10.66 |   | 7,600 |   | 10.66 |   |
| 2002              |       | 12.32                         |       | 1,200                                                 |       | 0.4  years                                            |       | 12.32 |   | 1,200 |   | 12.32 |   |
| 2003              |       | 12.93 – 16.11            |       | 1,712                                                 |       | 3.4  years                                            |       | 15.41 |   | 1,712 |   | 15.41 |   |
| 2004              |       | 19.25 – 21.50            |       | 2,520                                                 |       | 4.4  years                                            |       | 20.36 |   | 2,520 |   | 20.36 |   |
| 2005              |       | 24.81                         |       | 1,000                                                 |       | 5.9  years                                            |       | 24.81 |   | 1,000 |   | 24.81 |   |
| 2006              |       | 22.40 – 25.50            |       | 1,000                                                 |       | 4.5  years                                            |       | 24.57 |   | 900 |   | 24.47 |   |
|              |       |                          |       | 15,482                                                |       | 2.6  years                                            |       | $ | 14.66 |   | 15,382 |   | $ | 14.59 |   |

 

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A summary of the status ofthe Company’s SOP as of December 31, 2009, 2008, and 2007, and changesduring the years ending on those dates are presented below:

 
| ** **                               | ** ** | ** ** | ** ** | **Weighted** | ** ** |
|------------------------------------------|------------|------------|------------|--------------|------------|
| ** **                               | ** ** | ** ** | ** ** | **Average**  | ** ** |
| ** **                               | ** ** | ** ** | ** ** | **Exercise** | ** ** |
| ** **                               | ** ** | **Shares** | ** ** | **Price**    | ** ** |
| ** **                               | ** ** | ** ** | ** ** | ** **   | ** ** |
| Outstanding—January 1,  2007   |       | 179,359    |       | $            | 10.30      |   |
|                                     |       |       |       |         |       |
| Exercised                                |       | (154,817   | )          | 9.80         |       |
| Granted                                  |       | (1,200     | )          | 8.53         |       |
| Forfeited                                |       | (300       | )          | 25.50        |       |
|                                     |       |       |       |         |       |
| Outstanding—December 31,  2007 |       | 23,042     |       | $            | 13.59      |   |
|                                     |       |       |       |         |       |
| Exercised                                |       | (4,000     | )          | 11.63        |       |
| Expired                                  |       | (1,600     | )          | 9.31         |       |
| Forfeited                                |       | (200       | )          | 22.40        |       |
|                                     |       |       |       |         |       |
| Outstanding—December 31,  2008 |       | 17,242     |       | $            | 14.34      |   |
|                                     |       |       |       |         |       |
| Expired                                  |       | (1,760     | )          | $            | 11.48      |   |
|                                     |       |       |       |         |       |
| Outstanding—December 31,  2009 |       | 15,482     |       | $            | 14.66      |   |

 

***Management Recognition and Retention Plan—***The ManagementRecognition Plan (“MRR Plan”) provided for a committee of the Company’s Boardof Directors to award restricted stock to key officers as well as non-employeedirectors. The MRR Plan authorized the Company to grant up to 412,300 shares ofthe Company stock, of which 405,688 shares have been granted throughDecember 31, 2009. The MRR Plan expired during 2007, so no further awardswill be made.  Compensation expense hasbeen recognized over the vesting period based on the fair market value of theshares on the grant date. Shares granted will be deemed vested in the event ofdisability or death. Approximately $2,000 and $29,000 in compensation expensewas recognized during each of the years ended December 31, 2008 and2007.  On October 31, 2008, 1,600previously awarded yet unvested MRR Plan shares were canceled.  There were no expenses incurred related tothe MRR Plan during 2009.

 

**13.****              ****EMPLOYEEBENEFIT PLANS**

 

***401(k) Plan******—*** The Company hasestablished a 401(k) Plan (the “Plan”) whereby substantially all employeesparticipate in the Plan.  Employees maycontribute up to 75% of their salary subject to certain limits based on federaltax laws.  The Company makes matchingcontributions equal to 100% of the first 3% plus 50% of contributions between3% and 5% of an employee’s compensation contributed to the Plan.  Matching contributions vest immediately tothe employee upon enrollment in the Plan. During the years ended December 31, 2009, 2008 and 2007, 401(k) Planexpense was approximately $38,000, $303,000, and $309,000, respectively.  Effective February 16, 2009, the Companysuspended its matching contributions.

 

***Other Postretirement Benefits—***The Bank is a participant ina multi-employer retirement plan and therefore separate information is notavailable. The plan is noncontributory and covers substantially all employees.The plan provides a retirement benefit and a death benefit. Retirement benefitsare payable in monthly installments for life and must begin not later than thefirst day of the month coincident with or the next month following theseventieth birthday or the participant may elect a lump-sum distribution. Deathbenefits are paid in a lump-sum distribution, the amount of which depends onyears of service. Net pension expense was approximately $343,000, $518,000, and$761,000 for the years ended December 31, 2009, 2008, and 2007,respectively.

 

**14.****              ****PREFERREDSTOCK**

 

On March 6, 2009, aspart of the Troubled Asset Relief Program (“TARP”) Capital Purchase Program,the Company entered into a Securities Purchase Agreement (the “PurchaseAgreement”) with the United States Department of the Treasury (“Treasury”),pursuant to which the Company, for a purchase price of $16.5 million in cash, (i) sold16,500 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock,Series A (the “Series A Preferred Stock”) and (ii) issued awarrant (the “Warrant”) to purchase 321,847 shares of the Company’s commonstock, par value $1.00 per share (the “Common Stock”), at an exercise price of$7.69 per share.  The Series APreferred Stock qualifies as Tier 1 capital and is entitled to cumulativedividends. The preferred stock dividend reduces earnings available to commonshareholders and is computed at an annual rate of 5% per annum for the firstfive years, and 9% per annum thereafter. The Series A Preferred Stock isnon-voting, other than class voting

 

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rights on certain mattersthat could adversely affect the Series A Preferred Stock. The Series APreferred Stock may be redeemed by the Company with regulatory approval andwhen such preferred shares are redeemed, the Treasury shall liquidate theWarrant associated with such preferred shares. The Warrant has a 10-year term and was immediately exercisable upon itsissuance, with an exercise price, subject to anti-dilution adjustments, equalto $7.69 per share of the Common Stock.  Treasury has agreed not to exercise voting power with respect to anyshares of Common Stock issued upon exercise of the Warrant that it holds.

 

Upon receipt of theaggregate consideration from the Treasury on March 6, 2009, the Companyallocated the $16.5 million proceeds on a pro rata basis to the Series APreferred Stock and the Warrant based on relative fair values. In estimatingthe fair value of the Warrant, the Company utilized an option pricing modelwhich includes assumptions regarding the Company’s common stock prices, stockprice volatility, dividend yield, the risk free interest rate and the estimatedlife of the Warrant. The fair value of the Series A Preferred Stock wasdetermined using a discounted cash flow methodology and a discount rate of 12%.As a result, the Company assigned $358,000 of the aggregate proceeds to theWarrant and $16.1 million to the Series A Preferred Stock. The valueassigned to the Series A Preferred Stock will be accreted up to the $16.5million liquidation value of such preferred stock, with the cost of suchaccretion being reported as additional preferred stock dividends. This results ina total dividend with a constant effective yield of 5.50% over a five-yearperiod, which is the expected life of the Series A Preferred Stock. Inaddition, the Purchase Agreement (i) grants the holders of the Series APreferred Stock, the Warrant and the Warrant Common Stock certain registrationrights, (ii) subjects the Company to certain of the executive compensationlimitations included in the EESA (which are discussed below) and (iii) allowsthe Treasury to unilaterally amend any of the terms of the Purchase Agreementto the extent required to comply with any changes after March 6, 2009 inapplicable federal statutes. On April 2, 2009, the Company filed a “shelf”registration statement on Form S-3 with the Securities and ExchangeCommission (the “Commission”) for the purpose of registering the Warrant andthe Warrant Common Stock in order to permit the sale of such securities by theU.S. Treasury at any time after effectiveness of the registration statement. OnApril 28, 2009, the Company was notified by the Commission that the “shelf”registration statement was deemed effective.

 

Immediately prior to theexecution of the Purchase Agreement, the Company amended its compensation,bonus, incentive and other benefit plans, arrangements and agreements to theextent necessary to comply with the executive compensation and corporategovernance requirements of Section 111(b) of the EESA and applicableguidance or regulations issued by the Treasury on or prior to March 6,2009. The applicable executive compensation requirements apply to thecompensation of the Company’s chief executive officer, chief financial officerand three other most highly compensated executive officers (collectively, the “seniorexecutive officers”). In addition, in connection with the closing of theTreasury’s purchase of the Series A Preferred Stock each of the seniorexecutive officers was required to execute a waiver of any claim against theUnited States or the Company for any changes to his or her compensation orbenefits that are required in order to comply with the regulation issued by theTreasury as published in the Federal Register on October 20, 2008.

 

The Company’s ability torepurchase its shares is restricted. Consent of the Treasury generally isrequired for the Company to make any stock repurchase until the thirdanniversary of the investment by Treasury unless all of the Series APreferred Stock has been redeemed or transferred to a third party. Further,common, junior preferred or *pari passu* preferredshares may not be repurchased if the Company is in arrears on the Series APreferred Stock dividends. Under the terms of the Purchase Agreement, theCompany’s ability to declare or pay dividends on any of its shares isrestricted.  Specifically, the Companymay not declare dividend payments on common, junior preferred or *pari passu* preferred shares if it is in arrears on thedividends on the Series A Preferred Stock. In addition, the Company may not increase the dividends on its CommonStock above the amount of the last quarter cash dividend per share declaredprior to October 14, 2008, which was $0.16 per share, without the Treasury’sapproval until the third anniversary of the investment unless all of the Series APreferred Stock has been redeemed or transferred to a third party.

 

As discussed more fully inNote 23 to the consolidated financial statements, the Company and the Bank aresubject to a regulatory order which prohibits the Company and the Bank frompaying dividends on any of its stock, including the Series A PreferredStock, without prior written non-objection of the OTS.  As a result, the Company will not be payingits Series A Preferred Stock dividends beginning with the dividend paymentdue February 15, 2010.  However, theCompany will continue to accrue these dividends and at December 31, 2009dividends of approximately $105,000 were accrued in other liabilities on theconsolidated statement of financial condition related to dividend payment dueon February 15, 2010.

 

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**15.****    ****EARNINGS PER SHARE**

 
| ** **                                                                               | ** ** | **Year Ended December 31, 2009**          | ** ** |
|------------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                               | ** ** | **Income (Loss)  (In Thousands)  (Numerator)** | ** ** | **Shares  (Denominator)** | ** ** | **Per Share  Amount** | ** ** |
| Basic  EPS—Income (loss) available to common stockholders                           |       | $                                              | (46,226    | ) | 4,846,785 |   | $ | (9.54 | ) |
|                                                                                     |       |                                           |       |   |   |   |   |
| Effect  of dilutive securities                                                           |       | —                                         |       | — |   |   |   |
|                                                                                     |       |                                           |       |   |   |   |   |
| Diluted  EPS—Income (loss) available to common stockholders and assumed conversions |       | $                                              | (46,226    | ) | 4,846,785 |   | $ | (9.54 | ) |

 

The calculation of dilutedearnings per share excludes 15,482 options outstanding for the year ended December 31,2009, which were antidilutive. In addition, the calculation excludes theWarrant to purchase 321,847 shares of common stock outstanding for the yearended December 31, 2009, which was antidilutive.

 
| ** **                                                                        | ** ** | **Year Ended December 31, 2008**   | ** ** |
|-----------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                        | ** ** | **Income  (In Thousands)  (Numerator)** | ** ** | **Shares  (Denominator)** | ** ** | **Per Share  Amount** | ** ** |
| Basic  EPS—Income available to common stockholders                           |       | $                                       | 2,507      |   | 4,848,092 |   | $ | 0.52 |   |
|                                                                              |       |                                    |       |   |   |   |   |
| Effect  of dilutive securities—Stock options                                 |       | —                                  |       | 374 |   |   |   |
|                                                                              |       |                                    |       |   |   |   |   |
| Diluted  EPS—Income available to common stockholders and assumed conversions |       | $                                       | 2,507      |   | 4,848,466 |   | $ | 0.52 |   |

 

The incremental shares forthe assumed exercise of the outstanding options were determined by applicationof the treasury stock method. The calculation of diluted earnings per shareexcludes 14,192 options outstanding for the year ended December 31, 2008,which were antidilutive.

 
| ** **                                                                        | ** ** | **Year Ended December 31, 2007**   | ** ** |
|-----------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                        | ** ** | **Income  (In Thousands)  (Numerator)** | ** ** | **Shares  (Denominator)** | ** ** | **Per Share  Amount** | ** ** |
| Basic  EPS—Income available to common stockholders                           |       | $                                       | 2,643      |   | 4,865,127 |   | $ | 0.54 |   |
|                                                                              |       |                                    |       |   |   |   |   |
| Effect  of dilutive securities—Stock options                                 |       | —                                  |       | 15,734 |   |   |   |
|                                                                              |       |                                    |       |   |   |   |   |
| Diluted  EPS—Income available to common stockholders and assumed conversions |       | $                                       | 2,643      |   | 4,880,861 |   | $ | 0.54 |   |

 

The incremental shares forthe assumed exercise of the outstanding options were determined by applicationof the treasury stock method. The calculation of diluted earnings per shareexcludes 2,700 options outstanding for the year ended December 31, 2007,which were antidilutive.

 

**16.****   ****OFF-BALANCE SHEET ARRANGEMENTSAND COMMITMENTS**

 

The Bank is a party tofinancial instruments with off-balance sheet risk in the normal course ofbusiness to meet the financing needs of its customers. These financialinstruments include commitments to extend credit and standby letters of credit.Those instruments involve, to varying degrees, elements of credit risk in excessof the amount recognized in the consolidated statements of financial condition.

 

The Bank does not usefinancial instruments with off-balance sheet risk as part of itsasset/liability management program or for trading purposes. The Bank’s exposureto credit loss in the event of nonperformance by the other party to thefinancial instrument for commitments to extend credit and standby letters ofcredit is represented by the contractual amounts of those instruments. The Bankuses the same credit policies in making commitments and conditional obligationsas it does for on-balance sheet instruments.

 

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Commitments to extend creditare agreements to lend to a customer as long as there is no violation of anycondition established in the contract. Commitments generally have fixedexpiration dates or other termination clauses. The Bank evaluates each customer’screditworthiness on a case-by-case basis. The amount of collateral obtained, ifdeemed necessary by the Bank upon extension of credit, is based on management’scredit evaluation of the counterparty. Such collateral consists primarily ofresidential properties. Standby letters of credit are conditional commitmentsissued by the Bank to guarantee the performance of a customer to a third party.The credit risk involved in issuing letters of credit is essentially the sameas that involved in extending loan facilities to customers.

 

The funding period forconstruction loans is generally six to eighteen months and commitments tooriginate mortgage loans are generally outstanding for 60 days or less.

 

The Company, in the normalcourse of business, makes commitments to buy or sell assets or to incur or fundliabilities. Commitments include, but are not limited to:

 

·      theorigination, purchase or sale of loans;

·      the fulfillmentof commitments under letters of credit, extensions of credit on home equitylines of credit, construction loans, and under predetermined overdraftprotection limits; and

·      the commitmentto fund withdrawals of certificates of deposit at maturity.

 

At December 31, 2009,the Bank’s off-balance sheet arrangements principally included lendingcommitments, which are described below. At December 31, 2009, the Companyhad no interests in non-consolidated special purpose entities.

 

At December 31, 2009,commitments included:

 

·      total approvedloan origination commitments outstanding amounting to $2.1 million, includingapproximately $1.3 of loans committed to sell;

·      rate lockagreements with customers of $3.9 million, all of which have been locked withan investor;

·      funded mortgageloans committed to sell of $1.0 million;

·      unadvancedportion of construction loans of $4.3 million;

·      unused lines ofcredit of $15.2 million;

·      outstandingstandby letters of credit of $3.8 million;

·      totalpredetermined overdraft protection limits of $12.2 million; and

·      certificates ofdeposit scheduled to mature in one year or less totaling $253.0 million.

 

Total unfunded commitmentsto originate loans for sale and the related commitments to sell of $3.9 millionmeet the definition of a derivative financial instrument. The related asset andliability are considered immaterial at December 31, 2009.

 

Historically, a very smallpercentage of predetermined overdraft limits have been used. AtDecember 31, 2009, overdrafts of accounts with Bounce Protectionä representedusage of 3.11% of the limit.

 

Based on historicalexperience, management believes that a significant portion of maturing depositswill remain with the Bank. Management anticipates that the Bank will continueto have sufficient funds, through repayments, deposits and borrowings, to meetour current commitments.

 

**17.****   ****FAIR VALUE MEASUREMENTS**

 

ASC 820 provides a frameworkfor measuring fair value. ASC 820 defines fair value as the exchange price thatwould be received for an asset or paid to transfer a liability (an exit price)in the principal or most advantageous market for the asset or liability in anorderly transaction between market participants on the measurement date. ASC820 also establishes a fair value hierarchy which requires an entity tomaximize the use of observable inputs and minimize the use of unobservable inputswhen measuring fair value. The standard describes three levels of inputs thatmay be used to measure fair value:

 
| Level 1 | Unadjusted, quoted prices  in active markets for identical assets or liabilities at the measurement  date.                                                                                                                                                                                                                          |
|--------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|         |                                                                                                                                                                                                                                                                                                                                |
| Level 2 | Observable inputs other  than Level 1 prices, such as quoted prices for similar assets or liabilities;  quoted prices in markets that are not active; or other inputs that are  observable or can be corroborated by observable market data at the  measurement date for substantially the full term of the assets or  liabilities. |
|         |                                                                                                                                                                                                                                                                                                                                |
| Level 3 | Unobservable inputs that  reflect management’s best estimate of what market participants would use in  pricing the asset or liability at the measurement date.                                                                                                                                                                 |
|         |                                                                                                                                                                                                                                                                                                                                |

 

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The following is adescription of valuation methodologies used for significant assets measured atfair value on a non-recurring basis.

 

*Loans Receivable*

* *

Loans which meet certaincriteria are evaluated individually for impairment. A loan is consideredimpaired when, based upon current information and events, it is probable theBank will be unable to collect all amounts due, including principal andinterest, according to the contractual terms of the loanagreement.  Substantially all of the Bank’s impaired loans at December 31,2009 are secured by real estate.  These impaired loans areindividually assessed to determine that the carrying value of the loan is notin excess of the fair value of the collateral, less estimated selling costs.Fair value is estimated through current appraisals, real estate brokers orlisting prices.  Fair values may be adjusted by management to reflectcurrent economic and market conditions and, as such, are classified asLevel 3.  Impaired loans at December 31, 2009 were $53.8million, net of specific valuation allowances of $7.5 million at December 31,2009.

 

*REO, net*

 

REO represents real estateacquired as a result of foreclosure or by deed in lieu of foreclosure and iscarried at the lower of cost or fair value less estimated sellingcosts.  Fair value is estimated through current appraisals, realestate brokers or listing prices.  As these properties are activelymarketed, estimated fair values may be adjusted by management to reflectcurrent economic and market conditions and, as such, are classified as Level3.  REO at December 31, 2009 was $35.2 million. During theyear ended December 31, 2009, charge-offs to the allowance for loan lossesrelated to loans that were transferred to REO were $5.0 million ontransfers to REO of $28.9 million.  Writedowns related to REO that were charged to expense were $6.2 million for theyear ended December 31, 2009.

 

The following table providesthe level of valuation assumption used to determine the carrying value of theCompany’s assets measured at fair value on a non-recurring basis at December 31,2009:

 
| ** **      | ** ** | **Fair  Value** | ** ** | **Quoted  Prices in  Active Markets for  Identical Assets  (Level 1)** | ** ** | **Significant  Other Observable  Inputs  (Level 2)** | ** ** | **Significant  Unobservable  Inputs  (Level 3)** | ** ** |
|-----------------|------------|-----------------|------------|------------------------------------------------------------------------|------------|------------------------------------------------------|------------|--------------------------------------------------|------------|
| Impaired  loans |       | $               | 53,810     |                                                                   | $          | —                                               |       | $                                                | —     |   | $ | 53,810 |   |
| REO,  net (1)   |       | 36,285          |       | —                                                                 |       | —                                               |       | 36,285                                           |       |
|            |       | $               | 90,095     |                                                                   | $          | —                                               |       | $                                                | —     |   | $ | 90,095 |   |

 

----

(1)   The amounts listed reflectfair value measurements of the properties before deducting estimated costs tosell.

 

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**18.****   ****FAIR VALUE OF FINANCIALINSTRUMENTS**

 

The estimated fair valueamounts have been determined by the Company using available market informationand appropriate valuation methodologies. However, considerable judgment isrequired to interpret market data to develop the estimates of fair value. Accordingly,the estimates presented herein are not necessarily indicative of the amountsthe Company could realize in a current market exchange. The use of differentmarket assumptions and/or estimation methodologies may have a material effecton the estimated fair value amounts. The estimated fair values of financialinstruments are as follows (in thousands):

 
| ** **                                             | ** ** | **December 31, 2009** | ** ** | **December 31, 2008** | ** ** |
|--------------------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                                             | ** ** | **Carrying  Value**        | ** ** | **Estimated  Fair  Value** | ** ** | **Carrying  Value** | ** ** | **Estimated  Fair  Value** | ** ** |
| ASSETS:                                                |       |                       |       |                       |       |   |   |   |   |
| Cash  and cash equivalents                             |       | $                          | 22,149     |                       | $          | 22,149 |   | $ | 9,367 |   | $ | 9,367 |   |
| Investment  securities—held to maturity           |       | 135,531                    |       | 132,509                    |       | 136,412 |   | 136,055 |   |
| Federal  Home Loan Bank stock                          |       | 3,125                      |       | 3,125                      |       | 4,825 |   | 4,825 |   |
| Loans  receivable—net                             |       | 481,542                    |       | 483,127                    |       | 566,537 |   | 579,627 |   |
| Loans  held for sale                                   |       | 1,012                      |       | 1,012                      |       | 1,586 |   | 1,586 |   |
| Cash  surrender value of life insurance                |       | 21,226                     |       | 21,226                     |       | 20,412 |   | 20,412 |   |
| Accrued  interest receivable                           |       | 4,229                      |       | 4,229                      |       | 6,701 |   | 6,701 |   |
|                                                   |       |                       |       |                       |       |   |   |   |   |
| LIABILITIES:                                           |       |                       |       |                       |       |   |   |   |   |
| Deposits:                                              |       |                       |       |                       |       |   |   |   |   |
| Checking,  money market and savings accounts           |       | 245,287                    |       | 245,287                    |       | 231,509 |   | 231,509 |   |
| Certificates  of deposit                               |       | 379,337                    |       | 383,187                    |       | 386,494 |   | 390,638 |   |
| Other  borrowings                                      |       | 59,546                     |       | 60,203                     |       | 92,212 |   | 94,114 |   |
| Accrued  interest payable                              |       | 474                        |       | 474                        |       | 910 |   | 910 |   |
| Advance  payments by borrowers for taxes and insurance |       | 695                        |       | 695                        |       | 810 |   | 810 |   |
|                                                        |            |                            |            |                            |            |  |  |  |  |  |  |  |  |

 

For cash and cashequivalents, Federal Home Loan Bank stock, cash surrender value of lifeinsurance and accrued interest receivable, the carrying value is a reasonableestimate of fair value, primarily because of the short-term nature of theinstruments or, as to Federal Home Loan Bank stock, the ability to sell thestock back to the Federal Home Loan Bank at cost. The fair value of investmentsecurities is based on quoted market prices, dealer quotes and prices obtainedfrom independent pricing services. The fair value of variable rate loans isbased on repricing dates. Fixed rate loans were valued using discounted cashflows. The discount rates used to determine the present value of these loanswere based on interest rates currently being charged by the Bank on comparableloans as to credit risk and term.

 

The fair value of checkingaccounts, savings accounts and money market deposits is the amount payable ondemand at the reporting date. The fair value of fixed-maturity certificates ofdeposit and Federal Home Loan Bank advances is estimated using the ratescurrently offered for deposits of similar terms and advances of similarremaining maturities at the reporting date. For advance payments by borrowers,for taxes and insurance and for accrued interest payable the carrying value isa reasonable estimate of fair value, primarily because of the short-term natureof the instruments.

 

The fair value estimatespresented herein are based on pertinent information available to management asof December 31, 2009 and 2008. Although management is not aware of anyfactors that would significantly affect the estimated fair value amounts, suchamounts have not been comprehensively revalued for purposes of these financial statementssince the reporting date and, therefore, current estimates of fair value maydiffer significantly from the amounts presented herein.

 

**19.****   ****CONTINGENCIES**

 

The Company is a defendantin certain claims and legal actions arising in the ordinary course of business.In the opinion of management, after consultation with legal counsel, theultimate disposition of these matters is not expected to have a materialadverse effect on the consolidated financial statements of the Company.

 

**20.****   ****RETAINED EARNINGS—SUBSTANTIALLYRESTRICTED**

 

Upon conversion, the Companyestablished a special liquidation account for the benefit of eligible accountholders and the supplemental eligible account holders in an amount equal to thenet worth of the Bank as of the date of its latest statement of financialcondition contained in the final offering circular used in connection with theconversion. The liquidation account will be maintained for the benefit ofeligible account holders and supplemental eligible account holders who continueto maintain their accounts in the Bank after conversion. In the event of acomplete liquidation (and only in such event), each eligible and supplementaleligible account holder will be entitled to receive 

 

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a liquidation distributionfrom the liquidation account in an amount proportionate to the current adjustedqualifying balances for accounts then held.

 

The Company may not declareor pay cash dividends on its shares of common stock if the effect thereof wouldcause the Company’s stockholders’ equity to be reduced below applicableregulatory capital maintenance requirements for insured institutions or belowthe special liquidation account referred to above.

 

**21.****   ****REGULATORY MATTERS**

 

The Bank is subject tovarious regulatory capital requirements administered by the OTS. Failure tomeet minimum capital requirements can initiate certain mandatory—and possibleadditional discretionary—actions by regulators that, if undertaken, could havea direct and material effect on the Bank’s financial statements. Under capitaladequacy guidelines and the regulatory framework for prompt corrective action,the Bank must meet specific capital guidelines that involve quantitativemeasures of the Bank’s assets, liabilities, and certain off-balance sheet itemsas calculated under regulatory accounting practices. The Bank’s capital amountsand classification are also subject to qualitative judgments by the regulatorsabout components, risk weightings, and other factors.

 

Quantitative measuresestablished by regulation to ensure capital adequacy require the Bank tomaintain minimum amounts and ratios (set forth in the following table) of tangiblecapital (as defined) to tangible assets (as defined) and core capital (asdefined) to adjusted tangible assets (as defined), and of total risk-basedcapital (as defined) to risk-weighted assets (as defined).   Tier 1 (core) capital includes common stockholders’equity and qualifying preferred stock less certain other deductions.  Total capital includes tier 1 capital plusthe allowance for loan losses, subject to limitations.

 

As the following tableindicates, at December 31, 2009, the Bank was below the regulatory minimumfor total capital to risk weighted assets and above the regulatory adequacyminimums for tangible, core, and tier 1 risk-based capital.  The Bank has historically been categorized aswell-capitalized in periods prior to December 31, 2009.

 

As discussed in Note 23, on April 12,2010, the Company and the Bank each consented to a Cease and Desist Order(collectively, the “Orders”) issued by the OTS. The Orders became effective onApril 14, 2010. The Bank’s Order states that no later than December 31,2010, the Bank shall achieve and maintain a Tier 1 (Core) capital ratio of atleast 8% and a total risk-based capital ratio of at least 12%.  The Bank had previously agreed with the OTSto maintain a core capital ratio of atleast 5% and a total risk-based capital ratio of at least 10%.  These are the ratios that were in effect at December 31,2009 and such ratios were in excess of the ratios required under the capitaladequacy requirements.  The requirementto meet and maintain a specific capital level means that the Bank may not bedeemed to be well-capitalized for the purposes of prompt corrective action.

 

The Order also states thatby June 30, 2010, the Bank shall submit to the OTS a written capital planto achieve and maintain the foregoing capital levels.  At a minimum,the plan shall address: (i) the amount of additional capital that will benecessary to meet the foregoing capital levels under different, progressivelystressed economic environments; (ii) the requirements and restrictions imposedby the Order and the Bank’s most recent examination; (iii) the Bank’slevel of classified assets, allowance for loan and lease losses, earnings,asset concentrations, liquidity needs, and trends in this area;  (iv) current and projected trends in realestate market conditions; (v) the Bank’s capital preservation andenhancement strategies; and (vi) identify specific sources of additionalcapital and the timeframes and methods by which additional capital will beraised.

 

Under the regulatoryframework for prompt corrective action, the Bank’s capital status may precludethe Bank from access to borrowings from the Federal Reserve System through thediscount window. Also, as required by the framework, the Bank must submit tothe OTS a written capital plan as described above.  The Bank believes it can attain these ratiosby December 31, 2010 through improved operating results, shrinkage inasset size, potential branch sales, and raising capital in the third or fourthquarter of 2010.  Management’s plan is subjectto economic conditions and assumes no significant deterioration of our loanportfolio.

 

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The Bank’s actual capitalamounts (in thousands) and ratios are presented in the following table:

 
|                                      |   |       |   |                                         |   |                                               |   |      |   | **To be Categorized  as Adequately  Capitalized Under** |   |
|-------------------------------------------|--------|------------|--------|----------------------------------------------|--------|----------------------------------------------------|--------|-----------|--------|-----------------------------------------------------------------------------|--------|
|                                      |   | **Actual** |   | **For Capital  Adequacy Purposes** |   | **Prompt Corrective  Action Provisions** |   |
|                                      |   | **Amount** |   | **Ratio**                                    |   | **Amount**                                         |   | **Ratio** |   | **Amount**                                                                  |   | **Ratio** |   |
|                                      |   |       |   |                                         |   |                                               |   |      |   |                                                                        |   |   |   |
| As  of December 31, 2009:            |   |       |   |                                         |   |                                               |   |      |   |                                                                        |   |   |   |
|                                      |   |       |   |                                         |   |                                               |   |      |   |                                                                        |   |   |   |
| Tangible  Capital to Tangible Assets      |   | $          | 42,042 |                                         | 5.75   | %                                                  | $      | 10,965    |   | 1.50                                                                        | %      | N/A |   | N/A |   |
|                                      |   |       |   |                                         |   |                                               |   |      |   |                                                                        |   |   |   |
| Core  Capital to Adjusted Tangible Assets |   | 42,042     |   | 5.75                                         | %      | 36,550                                             |   | 5.00      | %      | $                                                                           | 36,550 |   | 5.00 | % |
|                                      |   |       |   |                                         |   |                                               |   |      |   |                                                                        |   |   |   |
| Total  Capital to Risk-Weighted Assets    |   | 48,344     |   | 9.97                                         | %      | 48,512                                             |   | 10.00     | %      | 48,512                                                                      |   | 10.00 | % |
|                                      |   |       |   |                                         |   |                                               |   |      |   |                                                                        |   |   |   |
| Tier  I Capital to Risk-Weighted Assets   |   | 42,042     |   | 8.67                                         | %      | N/A                                                |   | N/A       |   | 19,405                                                                      |   | 4.00 | % |
|                                           |        |            |        |                                              |        |                                                    |        |           |        |                                                                             |        |  |  |  |  |  |

 
|                                      |   | ** ** |   | ** **                                   |   | ** **                                         |   | ** ** |   | **To be Categorized  as Well  Capitalized Under** |   |
|-------------------------------------------|--------|------------|--------|----------------------------------------------|--------|----------------------------------------------------|--------|------------|--------|-----------------------------------------------------------------------|--------|
|                                      |   | **Actual** |   | **For Capital  Adequacy Purposes** |   | **Prompt Corrective  Action Provisions** |   |
|                                      |   | **Amount** |   | **Ratio**                                    |   | **Amount**                                         |   | **Ratio**  |   | **Amount**                                                            |   | **Ratio** |   |
|                                      |   |       |   |                                         |   |                                               |   |       |   |                                                                  |   |   |   |
| As of December 31,  2008:            |   |       |   |                                         |   |                                               |   |       |   |                                                                  |   |   |   |
|                                      |   |       |   |                                         |   |                                               |   |       |   |                                                                  |   |   |   |
| Tangible  Capital to Tangible Assets      |   | $          | 70,703 |                                         | 8.89   | %                                                  | $      | 11,925     |   | 1.50                                                                  | %      | N/A |   | N/A |   |
|                                      |   |       |   |                                         |   |                                               |   |       |   |                                                                  |   |   |   |
| Core  Capital to Adjusted Tangible Assets |   | 70,703     |   | 8.89                                         | %      | 31,799                                             |   | 4.00       | %      | $                                                                     | 39,748 |   | 5.00 | % |
|                                      |   |       |   |                                         |   |                                               |   |       |   |                                                                  |   |   |   |
| Total  Capital to Risk-Weighted Assets    |   | 74,144     |   | 13.35                                        | %      | 44,436                                             |   | 8.00       | %      | 55,545                                                                |   | 10.00 | % |
|                                      |   |       |   |                                         |   |                                               |   |       |   |                                                                  |   |   |   |
| Tier  I Capital to Risk-Weighted Assets   |   | 70,703     |   | 12.73                                        | %      | N/A                                                |   | N/A        |   | 33,327                                                                |   | 6.00 | % |
|                                           |        |            |        |                                              |        |                                                    |        |            |        |                                                                       |        |  |  |  |  |  |

 

**DividendRestrictions.**  Theprincipal source of the Company’s revenues is dividends from the Bank.  The Company’s ability to pay dividends to ourshareholders depends to a large extent upon the dividends we receive from theBank.  On November 19, 2009, the OTSissued written directives to the Company and the Bank which require the Companyand the Bank to obtain prior written non-objection of the OTS in order to makeor declare any dividends or payments on their outstanding securities.

 

**22.****   ****RELATED PARTY TRANSACTIONS**

 

In the normal course ofbusiness, the Bank has made loans to its directors, officers, and their relatedbusiness interests. In the opinion of management, related party loans are madeon substantially the same terms, including interest rates and collateral, asthose prevailing at the time for comparable transactions with unrelated personsand do not involve more than the normal risk of collectibility. The aggregatedollar amount of loans outstanding to directors, officers, and their relatedbusiness interests was approximately $1.1 million at both December 31,2009 and 2008.

 

Deposits from relatedparties held by the Bank at December 31, 2009 and 2008 amounted to $4.2million and $5.2 million, respectively.

 

**23.****   ****SUBSEQUENT EVENT**

 

On April 12, 2010, theCompany and the Bank each consented to the terms of Cease and Desist Ordersissued by the OTS (the “Bank Order” and the “Company Order” and, together, the “Orders”).  The Orders impose certain operationsrestrictions on the Company and, to a greater extent, the Bank, includinglending and dividend restrictions.  TheOrders also require the Company the Bank to take certain actions, including thesubmission to the OTS of capital plans and business plans to, among otherthings, preserve and enhance the capital of the Company and the Bank andstrengthen and improve the consolidated Company’s operations, earnings andprofitability.  The Bank Orderspecifically requires the Bank to achieve and maintain, by December 31,2010, a tier 1 (core) capital ratio of at least 8% and a total risk-basedcapital ratio of at least 12.0%.

 

Any material failure by theCompany and the Bank to comply with the provisions of the Orders could resultin further enforcement actions by the OTS. While the Company and the Bankintend to take such actions as may be necessary to comply with the requirementsof the Orders, there can be no assurance that the Company or the Bank 

 

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will be able to comply fullywith the Orders, or that efforts to comply with the Orders will not haveadverse effects on the operations and financial condition of the Company or theBank.

 

**25.****   ****PARENT COMPANY ONLY FINANCIALINFORMATION**

 

The following condensedstatements of financial condition, as of December 31, 2009 and 2008, andcondensed statements of income and of cash flows for each of the three years inthe period ended December 31, 2009, for First Federal Bancshares ofArkansas, Inc. should be read in conjunction with the consolidatedfinancial statements and the notes herein.

 

**FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.**

**(Parent Company Only)**

 

**CONDENSED STATEMENTS OF FINANCIAL CONDITION**

**DECEMBER 31, 2009 AND 2008**

**(In thousands)**

 
| ** **                                    | ** ** | **2009** | ** ** | **2008** | ** ** |
|-----------------------------------------------|------------|----------|------------|----------|------------|
| **ASSETS**                                    |       |     |       |     |       |
| Cash  and cash equivalents (deposits in Bank) |       | $        | 99         |     | $          | 97 |   |
| Loan  to Bank subsidiary                      |       | 1,216    |       | 1,565    |       |
| Investment  in Bank                           |       | 42,182   |       | 70,877   |       |
| Other  assets                                 |       | 475      |       | 673      |       |
|                                          |       |     |       |     |       |
| TOTAL                                         |       | $        | 43,972     |     | $          | 73,212 |   |
|                                          |       |     |       |     |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY** |       |     |       |     |       |
|                                          |       |     |       |     |       |
| Accrued  expenses and other liabilities       |       | $        | 672        |     | $          | 95 |   |
| Stockholders’  equity                    |       | 43,300   |       | 73,117   |       |
|                                          |       |     |       |     |       |
| TOTAL                                         |       | $        | 43,972     |     | $          | 73,212 |   |

 

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**FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.**

**(Parent Company Only)**

 

**CONDENSED STATEMENTS OF OPERATIONS**

**YEARS ENDED DECEMBER 31, 2009, 2008, AND 2007**

**(In thousands)**

 
| ** **                                                                                       | ** ** | **2009**   | ** ** | **2008**   | ** ** | **2007**   | ** ** |
|--------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                                                                                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| INCOME:                                                                                          |       |       |       |       |       |       |       |
| Dividends  from the Bank                                                                         |       | $          | —     |       | $          | 5,000      |       | $ | 5,000 |   |
| Interest  income—loan to the Bank                                                           |       | 1          |       | 39         |       | 50         |       |
|                                                                                             |       |       |       |       |       |       |       |
| Total  income                                                                                    |       | 1          |       | 5,039      |       | 5,050      |       |
|                                                                                             |       |       |       |       |       |       |       |
| EXPENSES:                                                                                        |       |       |       |       |       |       |       |
| Management  fees                                                                                 |       | 66         |       | 66         |       | 66         |       |
| Other  operating expenses                                                                        |       | 425        |       | 263        |       | 290        |       |
|                                                                                             |       |       |       |       |       |       |       |
| Total  expenses                                                                                  |       | 491        |       | 329        |       | 356        |       |
|                                                                                             |       |       |       |       |       |       |       |
| INCOME  BEFORE INCOME TAXBENEFIT AND  EQUITY IN UNDISTRIBUTED EARNINGS (LOSS) OF BANK SUBSIDIARY |       | (490       | )          | 4,710      |       | 4,694      |       |
|                                                                                             |       |       |       |       |       |       |       |
| INCOME  TAX BENEFIT                                                                              |       | 187        |       | 111        |       | 118        |       |
|                                                                                             |       |       |       |       |       |       |       |
| INCOME  BEFORE EQUITY IN UNDISTRIBUTEDEARNINGS (LOSS) OF BANK SUBSIDIARY                         |       | (303       | )          | 4,821      |       | 4,812      |       |
|                                                                                             |       |       |       |       |       |       |       |
| EQUITY  IN UNDISTRIBUTED EARNINGS (LOSS)OF BANK SUBSIDIARY                                       |       | (45,195    | )          | (2,314     | )          | (2,169     | )          |
|                                                                                             |       |       |       |       |       |       |       |
| NET  INCOME (LOSS)                                                                               |       | $          | (45,498    | )          | $          | 2,507      |       | $ | 2,643 |   |

 

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**FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.**

**(Parent Company Only)**

 

**CONDENSED STATEMENTS OF CASH FLOWS**

**YEARS ENDED DECEMBER 31, 2009, 2008, AND 2007**

**(In thousands)**

 
| ** **                                                                        | ** ** | **2009**   | ** ** | **2008**   | ** ** | **2007**   | ** ** |
|-----------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                                                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| OPERATING  ACTIVITIES:                                                            |       |       |       |       |       |       |       |
| Net  income (loss)                                                                |       | $          | (45,498    | )          | $          | 2,507      |       | $ | 2,643 |   |
| Adjustments  to reconcile net income to net cash providedby operating activities: |       |       |       |       |       |       |       |
| Equity  in undistributed net loss (earnings) of Bank                              |       | 45,195     |       | 2,314      |       | 2,169      |       |
| Stock  compensation expense                                                       |       | 1          |       | 5          |       | 39         |       |
| Changes  in operating assets and liabilities:                                     |       |       |       |       |       |       |       |
| Accrued  interest receivable                                                      |       | —     |       | 3          |       | 4          |       |
| Other  assets                                                                     |       | 198        |       | (386       | )          | 307        |       |
| Accrued  expenses and other liabilities                                           |       | 472        |       | (58        | )          | (156       | )          |
|                                                                              |       |       |       |       |       |       |       |
| Net  cash provided by operating activities                                        |       | 368        |       | 4,385      |       | 5,006      |       |
|                                                                              |       |       |       |       |       |       |       |
| INVESTING  ACTIVITIES—                                                       |       |       |       |       |       |       |       |
| Investment  in Bank                                                               |       | (16,500    | )          | —     |       | —     |       |
| Loan  to Bank, net of repayments                                                  |       | 349        |       | (1,329     | )          | 141        |       |
|                                                                              |       |       |       |       |       |       |       |
| Net  cash provided by (used in) investing activities                              |       | (16,151    | )          | (1,329     | )          | 141        |       |
|                                                                              |       |       |       |       |       |       |       |
| FINANCING  ACTIVITIES:                                                            |       |       |       |       |       |       |       |
| Purchase  of preferred stock                                                      |       | 16,500     |       | —     |       | —     |       |
| Purchase  of treasury stock                                                       |       | —     |       | —     |       | (2,312     | )          |
| Dividends  paid, preferred shares                                                 |       | (570       | )          | —     |       | —     |       |
| Dividends  paid, common shares                                                    |       | (145       | )          | (3,102     | )          | (3,111     | )          |
| Stock  options exercised                                                          |       | —     |       | 46         |       | 350        |       |
|                                                                              |       |       |       |       |       |       |       |
| Net  cash used in financing activities                                            |       | 15,785     |       | (3,056     | )          | (5,073     | )          |
|                                                                              |       |       |       |       |       |       |       |
| NET  INCREASE (DECREASE) IN CASH AND CASHEQUIVALENTS                              |       | 2          |       | —     |       | 74         |       |
|                                                                              |       |       |       |       |       |       |       |
| CASH  AND CASH EQUIVALENTS:                                                       |       |       |       |       |       |       |       |
| Beginning  of period                                                              |       | 97         |       | 97         |       | 23         |       |
|                                                                              |       |       |       |       |       |       |       |
| End  of period                                                                    |       | $          | 99         |       | $          | 97         |       | $ | 97 |   |

 

******

 

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**SELECTED QUARTERLY OPERATING RESULTS (UNAUDITED)**

**(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)**

 
| **YEAR ENDED DECEMBER 31, 2009**                     | ** ** | **Fourth  Quarter** | ** ** | **Third  Quarter** | ** ** | **Second  Quarter** | ** ** | **First  Quarter** | ** ** |
|------------------------------------------------------|------------|---------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|
| Interest income                                      |       | $                   | 9,036      |               | $          | 8,692               |       | $                  | 9,193      |   | $ | 9,122 |   |
| Interest expense                                     |       | 3,218               |       | 3,551              |       | 4,060               |       | 4,426              |       |
| Net interest income                                  |       | 5,818               |       | 5,141              |       | 5,133               |       | 4,696              |       |
| Provision for loan losses                            |       | 8,203               |       | 30,196             |       | 2,445               |       | 3,521              |       |
| Net interest income after provision for  loan losses |       | (2,385              | )          | (25,055            | )          | 2,688               |       | 1,175              |       |
| Noninterest income                                   |       | 2,062               |       | 2,109              |       | 2,039               |       | 1,907              |       |
| Noninterest expense                                  |       | 7,590               |       | 9,895              |       | 6,556               |       | 5,849              |       |
| Income (loss) before income taxes                    |       | (7,913              | )          | (32,841            | )          | (1,829              | )          | (2,767             | )          |
| Income tax provision (benefit)                       |       | 11,918              |       | (9,614             | )          | (892                | )          | (1,264             | )          |
| Net income (loss)                                    |       | (19,831             | )          | (23,227            | )          | (937                | )          | (1,503             | )          |
| Preferred stock dividend and discount  accretion     |       | 222                 |       | 222                |       | 222                 |       | 62                 |       |
| Net income (loss) available to common  shareholders  |       | $                   | (20,053    | )                  | $          | (23,449             | )          | $                  | (1,159     | ) | $ | (1,565 | ) |
|                                                 |       |                |       |               |       |                |       |               |       |
| Earnings per share(1):                               |       |                |       |               |       |                |       |               |       |
| Basic                                                |       | $                   | (4.14      | )                  | $          | (4.84               | )          | $                  | (0.24      | ) | $ | (0.32 | ) |
| Diluted                                              |       | $                   | (4.14      | )                  | $          | (4.84               | )          | $                  | (0.24      | ) | $ | (0.32 | ) |
|                                                 |       |                |       |               |       |                |       |               |       |
| Selected Ratios (Annualized):                        |       |                |       |               |       |                |       |               |       |
| Net interest margin                                  |       | 3.49                | %          | 2.94               | %          | 2.86                | %          | 2.65               | %          |
| Return on average assets                             |       | (10.56              | )          | (11.99             | )          | (0.47               | )          | (0.76              | )          |
| Return on average equity                             |       | (123.95             | )          | (106.70            | )          | (4.24               | )          | (7.70              | )          |

 
| **YEAR ENDED DECEMBER 31, 2008** | ** ** | **Fourth  Quarter** | ** ** | **Third  Quarter** | ** ** | **Second  Quarter** | ** ** | **First  Quarter** | ** ** |
|------------------------------------------------------|------------|---------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|
| Interest income                                      |       | $                   | 10,493     |               | $          | 10,451              |       | $                  | 11,467     |   | $ | 11,536 |   |
| Interest expense                                     |       | 4,818               |       | 5,155              |       | 5,658               |       | 6,471              |       |
| Net interest income                                  |       | 5,675               |       | 5,296              |       | 5,809               |       | 5,065              |       |
| Provision for loan losses                            |       | 1,600               |       | 1,611              |       | 971                 |       | 1,528              |       |
| Net interest income after provision for  loan losses |       | 4,075               |       | 3,685              |       | 4,838               |       | 3,537              |       |
| Noninterest income                                   |       | 1,952               |       | 2,213              |       | 2,048               |       | 3,204              |       |
| Noninterest expense                                  |       | 5,983               |       | 5,766              |       | 5,648               |       | 6,071              |       |
| Income before income taxes                           |       | 44                  |       | 132                |       | 1,238               |       | 670                |       |
| Income tax provision                                 |       | (149                | )          | (86                | )          | 229                 |       | (417               | )          |
| Net income                                           |       | $                   | 193        |               | $          | 218                 |       | $                  | 1,009      |   | $ | 1,087 |   |
|                                                 |       |                |       |               |       |                |       |               |       |
| Earnings per share(1):                               |       |                |       |               |       |                |       |               |       |
| Basic                                                |       | $                   | 0.04       |               | $          | 0.05                |       | $                  | 0.21       |   | $ | 0.22 |   |
| Diluted                                              |       | $                   | 0.04       |               | $          | 0.05                |       | $                  | 0.21       |   | $ | 0.22 |   |
|                                                 |       |                |       |               |       |                |       |               |       |
| Selected Ratios (Annualized):                        |       |                |       |               |       |                |       |               |       |
| Net interest margin                                  |       | 3.19                | %          | 2.92               | %          | 3.15                | %          | 2.78               | %          |
| Return on average assets                             |       | 0.10                |       | 0.11               |       | 0.49                |       | 0.54               |       |
| Return on average equity                             |       | 1.05                |       | 1.17               |       | 5.43                |       | 5.86               |       |

 

----

(1)  Basic and diluted shares outstandingare summarized below.

 
| ** **                        | ** ** | **Fourth  Quarter** | ** ** | **Third  Quarter** | ** ** | **Second  Quarter** | ** ** | **First  Quarter** | ** ** |
|-----------------------------------|------------|---------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|
| YEAR ENDED DECEMBER 31, 2009      |       |                |       |               |       |                |       |               |       |
| Basic weighted - average shares   |       | 4,846,785           |       | 4,846,785          |       | 4,846,785           |       | 4,846,785          |       |
| Effect of dilutive securities     |       | —              |       | —             |       | —              |       | —             |       |
| Diluted weighted - average shares |       | 4,846,785           |       | 4,846,785          |       | 4,846,785           |       | 4,846,785          |       |
|                              |       |                |       |               |       |                |       |               |       |
| YEAR ENDED DECEMBER 31, 2008      |       |                |       |               |       |                |       |               |       |
| Basic weighted - average shares   |       | 4,847,307           |       | 4,848,385          |       | 4,848,385           |       | 4,848,297          |       |
| Effect of dilutive securities     |       | —              |       | —             |       | 1,091               |       | 2,338              |       |
| Diluted weighted - average shares |       | 4,847,307           |       | 4,848,385          |       | 4,849,476           |       | 4,850,635          |       |

 

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**Item 9A.  Controls andProcedures.**

 

Our management evaluated,with the participation of our Chief Executive Officer and Chief FinancialOfficer, the effectiveness of the design and operation of our disclosurecontrols and procedures (as defined in Rules 13a-15(e) and 15d-15(e) underthe Securities Exchange Act of 1934) as of the end of the period covered bythis report.  Based on such evaluation,our Chief Executive Officer and Chief Financial Officer have concluded that ourdisclosure controls and procedures are operating effectively.

 

Nochange in the Company’s internal control over financial reporting (as definedin Rules 13a-15(f) and 15d-15(f) under the Exchange Act)occurred during the fiscal quarter ended December 31, 2009 that hasmaterially affected, or is reasonably likely to materially affect, the Company’sinternal control over financial reporting.

 

**MANAGEMENT REPORTON INTERNAL CONTROL**

 

The management of FirstFederal Bancshares of Arkansas, Inc. and its subsidiary, First FederalBank, (collectively referred to as the “Company”) is responsible for thepreparation, integrity, and fair presentation of its published financialstatements and all other information presented in this annual report.  The financial statements have been preparedin accordance with accounting principles generally accepted in the UnitedStates of America (“GAAP”) and, as such, include amounts based on informedjudgments and estimates made by management.

 

Management is responsiblefor establishing and maintaining adequate internal control over financialreporting for financial presentations in conformity with GAAP. Pursuant to the rules andregulations of the Securities and Exchange Commission, internal control overfinancial reporting is a process designed by, or under the supervision of, theCompany’s principal executive and principal financial officers, or personsperforming similar functions, and effected by the Company’s board of directors,management and other personnel, to provide reasonable assurance regarding thereliability of financial reporting and the preparation of financial statementsfor external purposes in accordance with GAAP and includes those policies andprocedures that:

 

Pertain to the maintenanceof records that in reasonable detail accurately and fairly reflect thetransactions and dispositions of the assets of the Company;

 

Provide reasonable assurancethat transactions are recorded as necessary to permit preparation of financialstatements in accordance with GAAP, and that receipts and expenditures of theCompany are being made only in accordance with authorizations of management anddirectors of the Company; and

 

Provide reasonable assuranceregarding prevention or timely detection of unauthorized acquisition, use ordisposition of the Company’s assets that could have a material effect on thefinancial statements.

 

Management has evaluated theeffectiveness of its internal control over financial reporting for financialpresentations in conformity with GAAP as of December 31, 2009 based on thecontrol criteria established in a report entitled *Internal Control—Integrated Framework*, issued by theCommittee of Sponsoring Organizations of the Treadway Commission. Based on suchevaluation, we have concluded that the Company’s internal control overfinancial reporting is effective as of December 31, 2009.

 

The independent registeredpublic accounting firm of Deloitte & Touche LLP, as auditors of theCompany’s consolidated financial statements, has issued an attestation reporton the Company’s internal control over financial reporting.

 
| Larry J. Brandt         | Sherri R. Billings            |
|-------------------------|-------------------------------|
| President and           | Executive Vice President  and |
| Chief Executive Officer | Chief Financial Officer       |

 

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**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

Tothe Board of Directors and Stockholders of

FirstFederal Bancshares of Arkansas, Inc.

Harrison,AR

 

We have audited the internalcontrol over financial reporting of First Federal Bancshares of Arkansas, Inc.and subsidiaries (the “Company”) as of December 31, 2009, based oncriteria established in *Internal Control —Integrated Framework*issued by the Committee of SponsoringOrganizations of the Treadway Commission. The Company’s management isresponsible for maintaining effective internal control over financial reportingand for its assessment of the effectiveness of internal control over financialreporting, included in the accompanying Management Report on Internal Control.Our responsibility is to express an opinion on the Company’s internal controlover financial reporting based on our audit.

 

We conducted our audit inaccordance with the standards of the Public Company Accounting Oversight Board(United States). Those standards require that we plan and perform the audit toobtain reasonable assurance about whether effective internal control overfinancial reporting was maintained in all material respects. Our audit includedobtaining an understanding of internal control over financial reporting,assessing the risk that a material weakness exists, testing and evaluating thedesign and operating effectiveness of internal control based on the assessedrisk, and performing such other procedures as we considered necessary in thecircumstances.  We believe that our auditprovides a reasonable basis for our opinion.

 

A company’s internal controlover financial reporting is a process designed by, or under the supervision of,the company’s principal executive and principal financial officers, or personsperforming similar functions, and effected by the company’s board of directors,management, and other personnel to provide reasonable assurance regarding thereliability of financial reporting and the preparation of financial statementsfor external purposes in accordance with generally accepted accountingprinciples. A company’s internal control over financial reporting includesthose policies and procedures that (1) pertain to the maintenance ofrecords that, in reasonable detail, accurately and fairly reflect thetransactions and dispositions of the assets of the company; (2) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the company arebeing made only in accordance with authorizations of management and directorsof the company; and (3) provide reasonable assurance regarding preventionor timely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

 

Because of the inherentlimitations of internal control over financial reporting, including thepossibility of collusion or improper management override of controls, materialmisstatements due to error or fraud may not be prevented or detected on atimely basis. Also, projections of any evaluation of the effectiveness of theinternal control over financial reporting to future periods are subject to therisk that the controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

 

In our opinion, the Companymaintained, in all material respects, effective internal control over financialreporting as of December 31, 2009, based on the criteria established in *Internal Control — Integrated Framework*issuedby the Committee of Sponsoring Organizations of the Treadway Commission.

 

We have also audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the consolidated financial statements as of and for the yearended December 31, 2009 of the Company and our report dated April 15,2010 (July 23, 2010 as to the restatement described in Note 5) expressedan unqualified opinion on those financial statements and included anexplanatory paragraph regarding the Company’s ability to continue as a goingconcern.

 

/s/Deloitte & Touche LLP

 

LittleRock, AR

April 15,2010

 

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** **

**PART IV.**

 

**Item 15. Exhibits and Financial Statement Schedules.**

 

**(a)  Documents Filed as Part of thisReport**

 

(1) Financial statements have been included in Item 8.

 

(2) All schedules for which provision is made in the applicableaccounting regulation of the SEC are omitted because of the absence ofconditions under which they are required or because the required information isincluded in the financial statements and related notes thereto.

 

**(b) Exhibit Index.**

 
| 2.1*        | Plan  of Conversion                                                                                                                                                                                                           |
|-------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1*        | Articles  of Incorporation of First Federal Bancshares of Arkansas, Inc.                                                                                                                                                 |
| 3.2**       | Amended  and Restated Bylaws of First Federal Bancshares of Arkansas, Inc.                                                                                                                                               |
| 3.3***      | Statement  of Designations for the Preferred Stock                                                                                                                                                                            |
| 4.0****     | Stock  Certificate of First Federal Bancshares of Arkansas, Inc.                                                                                                                                                         |
| 4.1***      | Form of  Certificate for the Preferred Stock                                                                                                                                                                             |
| 4.2***      | Warrant  for Purchase of Shares of Common Stock                                                                                                                                                                               |
| 10.1*****   | Employment  Agreement between the Company, the Bank and Larry J. Brandt as amended and  restated                                                                                                                              |
| 10.2*****   | Employment  Agreement between the Company, the Bank and Tommy W. Richardson as amended  and restated                                                                                                                          |
| 10.3*****   | Employment  Agreement between the Company, the Bank and Sherri R. Billings as amended and  restated                                                                                                                           |
| 10.4***     | Letter  Agreement, dated March 6, 2009, between First Federal Bancshares of  Arkansas, Inc. and the U.S. Department of the Treasury                                                                                 |
| 10.5***     | ARRA  Letter Agreement, dated March 6, 2009, between First Federal Bancshares  of Arkansas, Inc. and the U.S. Department of the Treasury                                                                            |
| 10.6***     | Form of  Amendment to the Amended and Restated Employment Agreements among First  Federal Bancshares of Arkansas, Inc., First Federal Bank and each of  Larry J. Brandt, Tommy W. Richardson and Sherri R. Billings |
| 10.7******  | Stipulation  and Consent to Issuance of Order to Cease and Desist for Company                                                                                                                                                 |
| 10.8******  | Company  Cease and Desist Order                                                                                                                                                                                               |
| 10.9******  | Stipulation  and Consent to Issuance of Order to Cease and Desist for Bank                                                                                                                                                    |
| 10.10****** | Bank  Cease and Desist Order                                                                                                                                                                                                  |
| 21.0        | Subsidiaries  of the Registrant - Reference is made to “Item 1 Business - Subsidiaries” for  the required information                                                                                               |
| 23.0        | Consent of  Deloitte & Touche LLP                                                                                                                                                                                    |
| 31.1        | Certification  of Chief Executive Officer pursuant to Rule 13a-14(a) of Exchange  Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of  2002                                                   |
| 31.2        | Certification  of Chief Financial Officer pursuant to Rule 13a-14(a) of Exchange  Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of  2002                                                   |
| 32.1        | Section 906  Certification of the CEO                                                                                                                                                                                    |
| 32.2        | Section 906  Certification of the CFO                                                                                                                                                                                    |
| 99.1******  | Certification  of Chief Executive Officer pursuant to TARP CPP                                                                                                                                                                |

 

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| 99.2****** | Certification  of Chief Financial Officer pursuant to TARP CPP |
|------------|----------------------------------------------------------------|

 

----

| (*)      | Incorporated  herein by reference from the Company’s Registration Statement on  Form S-1 (File No. 333-612) filed with the SEC.           |
|----------|----------------------------------------------------------------------------------------------------------------------------------------------------------|
| (**)     | Incorporated  herein by reference from the Company’s Annual Report on Form 10-K for  the year ended December 31, 2007 filed with the SEC. |
| (***)    | Incorporated  herein by reference from the Company’s Form 8-K filed with the SEC on  March 6, 2009.                                       |
| (****)   | Incorporated  herein by reference from the Company’s Registration Statement on  Form 8-A filed with the SEC.                                   |
| (*****)  | Incorporated  herein by reference from the Company’s Form 8-K filed with the SEC on  December 20, 2007.                                   |
| (******) | Incorporated  herein by reference from the Company’s Form 10-K filed with the SEC on  April 15, 2010.                                     |

 

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** **

**SIGNATURES**

 

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the Registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.

 

 
|   | FIRST FEDERAL BANCSHARES  OF ARKANSAS, INC. |
|--------|--------------------------------------------------|
|   |                                             |   |
|   |                                             |   |
|   | By:                                              | /s/ Larry J. Brandt |
|   |                                             | Larry J. Brandt |
|   |                                             | President and Chief  Executive Officer |
|   |                                             |   |
|   |                                             | July 23, 2010 |

 

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the Registrant and inthe capacities and on the dates indicated.

 

 
| /s/ Larry J. Brandt                    |   | July 23,  2010 |
|----------------------------------------|--------|---------------------|
| Larry J. Brandt                        |   |                |
| President and Chief  Executive Officer |   |                |
|                                   |   |                |
|                                   |   |                |
| /s/ John P. Hammerschmidt              |   | July 23,  2010 |
| John P. Hammerschmidt                  |   |                |
| Chairman                               |   |                |
|                                   |   |                |
|                                   |   |                |
| /s/ Jeff Brandt                        |   | July 23,  2010 |
| Jeff Brandt                            |   |                |
| Director                               |   |                |
|                                   |   |                |
|                                   |   |                |
| /s/ Kenneth C. Savells                 |   | July 23,  2010 |
| Kenneth C. Savells                     |   |                |
| Director                               |   |                |
|                                   |   |                |
|                                   |   |                |
| /s/ Frank Conner                       |   | July 23,  2010 |
| Frank Conner                           |   |                |
| Director                               |   |                |
|                                   |   |                |
|                                   |   |                |
| /s/ Sherri R. Billings                 |   | July 23,  2010 |
| Sherri R. Billings                     |   |                |
| Executive Vice President  and Chief    |   |                |
| Financial and Accounting  Officer      |   |                |

 

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