UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549





Form 10-Q





R
            
            Quarterly
      report pursuant to Section 13 or 15(d) of the Securities Exchange Act
      of 1934For
      the quarterly period ended September 30, 2008OR*
            
            Transition
      report pursuant to Section 13 or 15(d) of the Securities Exchange Act
      of 1934











Commission
File Number 000-51507





WATERSTONE
FINANCIAL, INC.





(Exact
name of registrant as specified in its charter)








Federal
            20-3598485(State
      or other jurisdiction of
              incorporation
      or organization)
            (IRS
      Employer Identification No.)








11200
W. Plank Ct.


Wauwatosa,
WI  53226


(414) 761-1000


(Address,
including Zip Code, and telephone number,


including
area code, of registrant’s principal executive offices)





Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.





Yes
            R
            
            No
            *





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





Large
      accelerated filer
            *
            
            Accelerated
      filer
            R
            
            Non-accelerated
      filer
            *
            
            Smaller
      Reporting Company
            *





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





Yes
            *
            
            No
            R





The number of shares outstanding of the
issuer’s common stock, $0.01 par value per share, was 31,250,897 at October 31,
2008.











WATERSTONE FINANCIAL, INC.





10-Q
INDEX


























Page
      No.PARTI.FINANCIAL
      INFORMATIONItem l. Financial
      StatementsConsolidated Statements of
      Financial Condition as ofSeptember 30, 2008 (unaudited) and December
      31, 2007
            3Consolidated Statements of
      Operations for the threeand ninemonths endedSeptember 30, 2008 and 2007
      (unaudited)
            4Consolidated Statements of
      Changes in Shareholders’ Equity for theninemonths endedSeptember30, 2008 and 2007
      (unaudited)
            5Consolidated Statements of Cash
      Flows for theninemonths endedSeptember30, 2008 and 2007
      (unaudited)
            6-7Notes to Consolidated Financial
      Statements
            8-18Item 2. Management’s Discussion
      and Analysis of Financial Condition and Results of
      Operations
            19-42Item 3. Quantitative and
      Qualitative Disclosures about Market Risk
            43Item 4. Controls and
      Procedures
            44PART II.
      OTHER INFORMATION
            45Item 1. Legal
      Proceedings
            45Item 1A. Risk
      Factors
            45Item 6.
      Exhibits
            46Signatures
            46CertificationCertificationCertificationCertification





- 2
-
 Table of Contents


PART
I — FINANCIAL INFORMATION


Item 1. Financial
Statements





WATERSTONE
FINANCIAL, INC AND SUBSIDIARIES


CONSOLIDATED STATEMENTS OF FINANCIAL
CONDITION





(Unaudited)September,
      30
            
            
            December,
      312008
            
            
            2007Assets
            
            (In
      Thousands, except share data)Cash
            
            $
            41,152
            
            
            
            5,492Federal
      funds sold
            
            
            10,954
            
            
            
            11,833Interest-earning
      deposits in other financial institutionsand
      other short term investments
            
            
            —
            
            
            
            559Cash
      and cash equivalents
            
            
            52,106
            
            
            
            17,884Securities
      available for sale (at fair value)
            
            
            184,243
            
            
            
            172,137Securities
      held to maturity (at amortized cost)fair
      value of $8,606 in 2008 and $7,174 in 2007
            
            
            9,938
            
            
            
            7,646Loans
      held for sale
            
            
            8,635
            
            
            
            23,108Loans
      receivable
            
            
            1,555,466
            
            
            
            1,402,048Less:
      Allowance for loan losses
            
            
            26,210
            
            
            
            12,839Loans
      receivable, net
            
            
            1,529,256
            
            
            
            1,389,209Office
      properties and equipment, net
            
            
            30,932
            
            
            
            32,018Federal
      Home Loan Bank stock, at cost
            
            
            21,653
            
            
            
            19,289Cash
      surrender value of life insurance
            
            
            32,163
            
            
            
            25,649Real
      estate owned
            
            
            20,304
            
            
            
            8,543Prepaid
      expenses and other assets
            
            
            8,631
            
            
            
            14,719Total
      assets
            
            $
            1,897,861
            
            
            
            1,710,202Liabilities
      and Shareholders’ EquityLiabilities:Demand
      deposits
            
            $
            52,357
            
            
            
            53,210Money
      market and savings deposits
            
            
            110,548
            
            
            
            115,135Time
      deposits
            
            
            1,012,781
            
            
            
            826,190Total
      deposits
            
            
            1,175,686
            
            
            
            994,535Short
      term borrowings
            
            
            25,050
            
            
            
            53,484Long
      term borrowings
            
            
            487,000
            
            
            
            422,000Advance
      payments by borrowers for taxes
            
            
            24,562
            
            
            
            607Other
      liabilities
            
            
            16,170
            
            
            
            37,757Total
      liabilities
            
            
            1,728,468
            
            
            
            1,508,383Shareholders’
      equity:Preferred
      stock (par value $.01 per share)Authorized
      20,000,000 shares, no shares issued
            
            
            —
            
            
            
            —Common
      stock (par value $.01 per share)Authorized
      - 200,000,000 shares in 2008 and 2007Issued
      - 33,975,250 shares in 2008 and in 2007Outstanding
      - 31,250,897 shares in 2008 and in 2007
            
            
            340
            
            
            
            340Additional
      paid-in capital
            
            
            107,643
            
            
            
            106,306Accumulated
      other comprehensive income (loss) net of taxes
            
            
            (4,245
            )
            
            
            44Retained
      earnings
            
            
            116,253
            
            
            
            146,367Unearned
      ESOP shares
            
            
            (5,337
            )
            
            
            (5,977
            )Treasury
      shares (2,724,353 shares), at cost
            
            
            (45,261
            )
            
            
            (45,261
            )Total
      shareholders’ equity
            
            
            169,393
            
            
            
            201,819Total
      liabilities and shareholders’ equity
            
            $
            1,897,861
            
            
            
            1,710,202








See
Accompanying Notes to Consolidated Financial Statements.


- 3
-
 Table of Contents


WATERSTONE FINANCIAL, INC
AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF OPERATIONS


(Unaudited)








Nine
      months ended
              September
      30,
            
            
            Three
      months ended
              September
      30,2008
            
            
            2007
            
            
            2008
            
            
            2007(In
      thousands, except per share data)Interest
      income:Loans
            
            $
            69,584
            
            
            
            65,077
            
            
            $
            25,166
            
            
            
            21,769Mortgage-related
      securities
            
            
            5,661
            
            
            
            4,075
            
            
            
            1,921
            
            
            
            1,533Debt
      securities, federal funds sold andshort-term
      investments
            
            
            2,667
            
            
            
            3,178
            
            
            
            1,000
            
            
            
            1,118Total
      interest income
            
            
            77,912
            
            
            
            72,330
            
            
            
            28,087
            
            
            
            24,420Interest
      expense:Deposits
            
            
            31,803
            
            
            
            33,641
            
            
            
            10,384
            
            
            
            11,475Borrowings
            
            
            15,534
            
            
            
            12,427
            
            
            
            5,372
            
            
            
            4,438Total
      interest expense
            
            
            47,337
            
            
            
            46,068
            
            
            
            15,756
            
            
            
            15,913Net
      interest income
            
            
            30,575
            
            
            
            26,262
            
            
            
            12,331
            
            
            
            8,507Provision
      for loan losses
            
            
            34,578
            
            
            
            8,852
            
            
            
            23,301
            
            
            
            2,826Net
      interest income (loss) after provision for loan losses
            
            
            (4,003
            )
            
            
            17,410
            
            
            
            (10,970
            )
            
            
            5,681Noninterest
      income:Service
      charges on loans and deposits
            
            
            1,359
            
            
            
            1,479
            
            
            
            383
            
            
            
            426Increase
      in cash surrender value of life insurance
            
            
            1,208
            
            
            
            988
            
            
            
            626
            
            
            
            540Mortgage
      banking income
            
            
            3,333
            
            
            
            2,138
            
            
            
            1,354
            
            
            
            745Loss
      on impairment of securities
            
            
            (1,997
            )
            
            
            -
            
            
            
            (1,997
            )
            
            
            -Other
            
            
            673
            
            
            
            573
            
            
            
            231
            
            
            
            152Total
      noninterest income
            
            
            4,576
            
            
            
            5,178
            
            
            
            597
            
            
            
            1,863Noninterest
      expenses:Compensation,
      payroll taxes, and other employee benefits
            
            
            12,787
            
            
            
            11,778
            
            
            
            4,493
            
            
            
            3,859Occupancy,
      office furniture and equipment
            
            
            3,606
            
            
            
            3,779
            
            
            
            1,187
            
            
            
            1,285Advertising
            
            
            953
            
            
            
            870
            
            
            
            421
            
            
            
            315Data
      processing
            
            
            1,055
            
            
            
            1,148
            
            
            
            358
            
            
            
            494Communications
            
            
            524
            
            
            
            554
            
            
            
            180
            
            
            
            171Professional
      fees
            
            
            697
            
            
            
            911
            
            
            
            184
            
            
            
            273Real
      estate owned
            
            
            2,758
            
            
            
            199
            
            
            
            1,518
            
            
            
            192Other
            
            
            2,511
            
            
            
            1,735
            
            
            
            895
            
            
            
            589Total
      noninterest expenses
            
            
            24,891
            
            
            
            20,974
            
            
            
            9,236
            
            
            
            7,178Income
      (loss) before income taxes
            
            
            (24,318
            )
            
            
            1,614
            
            
            
            (19,609
            )
            
            
            366Income
      taxes (benefit)
            
            
            5,796
            
            
            
            363
            
            
            
            8,578
            
            
            
            (55
            )Net
      income (loss)
            
            
            (30,114
            )
            
            
            1,251
            
            
            
            (28,187
            )
            
            
            421Earnings
      (loss) per share:Basic
            
            
            (0.99
            )
            
            
            0.04
            
            
            
            (0.92
            )
            
            
            0.01Diluted
            
            
            (0.99
            )
            
            
            0.04
            
            
            
            (0.92
            )
            
            
            0.01Weighted
      average shares outstanding:Basic
            
            
            30,545,245
            
            
            
            31,912,040
            
            
            
            30,564,179
            
            
            
            30,797,083Diluted
            
            
            30,545,245
            
            
            
            31,920,231
            
            
            
            30,564,179
            
            
            
            30,804,538








See
Accompanying Notes to Consolidated Financial Statements.





- 4
-
 Table of Contents


WATERSONE FINANCIAL, INC AND
SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY


(Unaudited)





AccumulatedAdditional
            
            
            Other
            
            
            
            
            
            UnearnedCommon
      Stock
            
            
            Paid-In
            
            
            Comprehensive
            
            
            Retained
            
            
            ESOP
            
            
            TreasuryShares
            
            
            Amount
            
            
            Capital
            
            
            Income
      (Loss)
            
            
            Earnings
            
            
            Shares
            
            
            Shares
            
            
            Equity(In
      Thousands)Balances
      at December 31, 2006
            
            
            33,724
            
            
            $
            337
            
            
            
            104,182
            
            
            
            (1,225
            )
            
            
            144,809
            
            
            
            (6,831
            )
            
            
            —
            
            
            
            241,272Comprehensive
      income:Net
      income
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            1,251
            
            
            
            —
            
            
            
            —
            
            
            
            1,251Other
      comprehensive income (loss):Net
      unrealized holding gains onavailable
      for sale securities arising during the period, net of taxes of
      $203
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            378
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            378Total
      comprehensive loss
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1,629ESOP
      shares committed to be released to Plan participants
            
            
            —
            
            
            
            —
            
            
            
            326
            
            
            
            —
            
            
            
            —
            
            
            
            640
            
            
            
            —
            
            
            
            966Stock
      based compensation
            
            
            251
            
            
            
            3
            
            
            
            1,296
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1,299Purchase
      of treasury stock
            
            
            (2,556
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (42,875
            )
            
            
            (42,875
            )Balances
      at September 30, 2007
            
            
            31,419
            
            
            $
            340
            
            
            
            105,804
            
            
            
            (847
            )
            
            
            146,060
            
            
            
            (6,191
            )
            
            
            (42,875
            )
            
            
            202,291Balances
      at December 31, 2007
            
            
            31,251
            
            
            $
            340
            
            
            
            106,306
            
            
            
            44
            
            
            
            146,367
            
            
            
            (5,977
            )
            
            
            (45,261
            )
            
            
            201,819Comprehensive
      loss:Net
      loss
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (30,114
            )
            
            
            —
            
            
            
            —
            
            
            
            (30,114
            )Other
      comprehensive income (loss):Net
      unrealized holding loss onavailable
      for sale securities arising during the period, net of taxes of
      $1,610
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (5,587
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (5,587
            )Reclassification
      of adjustment for net losses onavailable
      for sale securities realized during the period, net of taxes of
      $699
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1,298
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1,298Total
      comprehensive loss
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (34,403
            )ESOP
      shares committed to be released to Plan participants
            
            
            —
            
            
            
            —
            
            
            
            26
            
            
            
            —
            
            
            
            —
            
            
            
            640
            
            
            
            —
            
            
            
            666Stock
      based compensation
            
            
            —
            
            
            
            —
            
            
            
            1,311
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            1,311Balances
      at September 30, 2008
            
            
            31,251
            
            
            $
            340
            
            
            
            107,643
            
            
            
            (4,245
            )
            
            
            116,253
            
            
            
            (5,337
            )
            
            
            (45,261
            )
            
            
            169,393





See
Accompanying Notes to Consolidated Financial Statements.


- 5
-
 Table of Contents


WATERSONE FINANCIAL, INC AND
SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(Unaudited)





Nine
      months ended September 30,2008
            
            
            2007(In
      Thousands)Operating
      activities:Net
      income (loss)
            
            $
            (30,114
            )
            
            
            1,251Adjustments
      to reconcile net income (loss) to netcash
      provided by operating activities:Provision
      for loan losses
            
            
            34,578
            
            
            
            8,852Depreciation
            
            
            1,847
            
            
            
            1,960Deferred
      income taxes
            
            
            9,731
            
            
            
            (1,957
            )Stock
      based compensation
            
            
            1,311
            
            
            
            1,299Net
      amortization of premium on debt and mortgage-related
      securities
            
            
            (255
            )
            
            
            (125
            )Amortization
      of unearned ESOP shares
            
            
            666
            
            
            
            966Gain
      on sale of loans held for sale
            
            
            (2,083
            )
            
            
            (1,069
            )Loans
      originated for sale
            
            
            (212,628
            )
            
            
            (160,916
            )Proceeds
      on sales of loans originated for sale
            
            
            229,183
            
            
            
            156,910Increase
      in accrued interest receivable
            
            
            (975
            )
            
            
            (875
            )Increase
      in cash surrender value of bank owned life insurance
            
            
            (1,208
            )
            
            
            (988
            )Increase
      in accrued interest on deposits and borrowings
            
            
            1,233
            
            
            
            139Increase
      (decrease) in other liabilities
            
            
            (1,136
            )
            
            
            513Loss
      on impairment of securities
            
            
            1,997
            
            
            
            —Loss
      (gain) on sale of real estate owned and other assets
            
            
            1,141
            
            
            
            (13
            )Other
            
            
            116
            
            
            
            (132
            )Net
      cash provided by operating activities
            
            
            33,404
            
            
            
            5,815Investing
      activities:Net
      increase in loans receivable
            
            
            (196,897
            )
            
            
            (21,118
            )Purchases
      of:Debt
      securities
            
            
            (12,761
            )
            
            
            (28,958
            )Mortgage-related
      securities
            
            
            (25,524
            )
            
            
            (44,212
            )Structured
      notes, held to maturity
            
            
            (4,289
            )
            
            
            (7,646
            )Premises
      and equipment, net
            
            
            (1,049
            )
            
            
            (1,781
            )Bank
      owned life insurance
            
            
            (5,306
            )
            
            
            (306
            )FHLB
      stock
            
            
            (2,363
            )
            
            
            (337
            )Proceeds
      from:Principal
      repayments on mortgage-related securities
            
            
            15,313
            
            
            
            13,796Maturities
      of debt securities
            
            
            984
            
            
            
            5,510Calls
      on structured notes
            
            
            1,998
            
            
            
            —Sales
      of real estate owned and other assets
            
            
            9,218
            
            
            
            1,425Net
      cash used in investing activities
            
            
            (220,676
            )
            
            
            (83,627
            )





See
Accompanying Notes to Consolidated Financial Statements.


- 6
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 Table of Contents


WATERSTONE
FINANCIAL, INC AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(Unaudited)








Nine
      months ended September 30,2008
            
            
            2007(In
      Thousands)Financing
      activities:Net
      increase (decrease) in deposits
            
            
            181,151
            
            
            
            (13,190
            )Net
      change in short-term borrowings
            
            
            (28,434
            )
            
            
            (16,531
            )Proceeds
      from long-term borrowings
            
            
            65,000
            
            
            
            92,900Net
      increase in advance payments by borrowers for taxes
            
            
            3,777
            
            
            
            6,347Purchase
      of treasury stock
            
            
            —
            
            
            
            (42,875
            )Net
      cash provided by financing activities
            
            
            221,494
            
            
            
            26,651Increase
      (decrease) in cash and cash equivalents
            
            
            34,222
            
            
            
            (51,161
            )Cash
      and cash equivalents at beginning of period
            
            
            17,884
            
            
            
            73,807Cash
      and cash equivalents at end of period
            
            $
            52,106
            
            
            
            22,646Supplemental
      information:Cash
      paid or credited during the period for:Income
      tax payments
            
            
            1,291
            
            
            
            3,187Interest
      payments
            
            
            46,104
            
            
            
            45,930Noncash
      investing activities:Loans
      receivable transferred to foreclosed properties
            
            
            22,272
            
            
            
            8,347Noncash
      financing activities:Long-term
      FHLB advances reclassified to short-term
            
            
            —
            
            
            
            22,729



























































See
Accompanying Notes to Consolidated Financial Statements.


- 7
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 Table of Contents


WATERSTONE FINANCIAL, INC AND
SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





Note
1 — Basis of Presentation





The
consolidated financial statements include the accounts of Waterstone Financial,
Inc. (the “Company”) and the Company’s subsidiaries.  At a special
meeting of shareholders held on July 18, 2008, the shareholders of Wauwatosa
Holdings, Inc. approved an amendment to the Company’s charter changing its name
to Waterstone Financial, Inc. The charter amendment was effective August 1,
2008.





The
accompanying unaudited consolidated financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information, Rule 10-01 of Regulation S-X and the instructions to Form
10-Q. The financial statements do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, the accompanying unaudited
consolidated financial statements contain all adjustments (consisting of normal
recurring accruals) necessary to present fairly the financial position, results
of operations, changes in shareholders’ equity, and cash flows of the Company
for the periods presented.





The
accompanying unaudited consolidated financial statements and related notes
should be read in conjunction with the Company’s December 31, 2007 Annual Report
on Form 10-K. Operating results for the nine months ended September 30, 2008,
are not necessarily indicative of the results that may be expected for the year
ending December 31, 2008.





The
preparation of the unaudited consolidated financial statements requires
management of the Company to make a number of estimates and assumptions relating
to the reported amount of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the consolidated financial
statements and the reported amounts of revenues and expenses during the
period.  Significant items subject to such estimates and assumptions
include the allowance for loan losses and deferred income
taxes.  Actual results could differ from those estimates.








Note
2 — Reclassifications





Certain
items in the prior period consolidated financial statements have been
reclassified to conform with the September 30, 2008
presentation.


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 Table of Contents


Note
3 — Securities





Securities
Available for Sale





The
amortized cost and fair values of the Company’s investment in securities
available for sale follow:







September
      30, 2008(In
      Thousands)Gross
            
            
            GrossAmortized
            
            
            unrealized
            
            
            unrealizedcost
            
            
            gains
            
            
            losses
            
            
            Fair
      valueMortgage-backed
      securities
            
            $
            40,402
            
            
            
            192
            
            
            
            (224
            )
            
            
            40,370Collateralized
      mortgage obligations
            
            
            98,474
            
            
            
            1,019
            
            
            
            (4,648
            )
            
            
            94,845Mortgage-related
      securities
            
            
            138,876
            
            
            
            1,211
            
            
            
            (4,872
            )
            
            
            135,215Government
      sponsored entity bonds
            
            
            13,005
            
            
            
            208
            
            
            
            —
            
            
            
            13,213Municipal
      securities
            
            
            32,655
            
            
            
            88
            
            
            
            (2,800
            )
            
            
            29,943Corporate
      notes
            
            
            988
            
            
            
            —
            
            
            
            (16
            )
            
            
            972Other
      debt securities
            
            
            5,250
            
            
            
            —
            
            
            
            (350
            )
            
            
            4,900Debt
      securities
            
            
            51,898
            
            
            
            296
            
            
            
            (3,166
            )
            
            
            49,028$
            190,774
            
            
            
            1,507
            
            
            
            (8,038
            )
            
            
            184,243















December
      31, 2007(In
      Thousands)Gross
            
            
            GrossAmortized
            
            
            unrealized
            
            
            unrealizedcost
            
            
            gains
            
            
            losses
            
            
            Fair
      valueMortgage-backed
      securities
            
            $
            20,128
            
            
            
            154
            
            
            
            (68
            )
            
            
            20,214Collateralized
      mortgage obligations
            
            
            110,419
            
            
            
            1,050
            
            
            
            (1,073
            )
            
            
            110,396Mortgage-related
      securities
            
            
            130,547
            
            
            
            1,204
            
            
            
            (1,141
            )
            
            
            130,610Government
      sponsored entity bonds
            
            
            13,996
            
            
            
            187
            
            
            
            (1
            )
            
            
            14,182Municipal
      securities
            
            
            27,277
            
            
            
            209
            
            
            
            (391
            )
            
            
            27,095Other
      debt securities
            
            
            250
            
            
            
            —
            
            
            
            —
            
            
            
            250Debt
      securities
            
            
            41,523
            
            
            
            396
            
            
            
            (392
            )
            
            
            41,527$
            172,070
            
            
            
            1,600
            
            
            
            (1,533
            )
            
            
            172,137







At
September 30, 2008, $12.2 million of the Company’s government sponsored entity
bonds and $79.8 million of the Company’s municipal securities and mortgage
related securities were pledged as collateral to secure repurchase agreement
obligations of the Company.




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The
amortized cost and fair values of investment securities by contractual maturity
at September 30, 2008, are shown below. Actual maturities may differ from
contractual maturities because issuers have the right to call or prepay
obligations with or without call or prepayment penalties.







Amortized
            
            
            FairCost
            
            
            Value(In
      Thousands)Debt
      securitiesDue
      within one year
            
            $
            10,988
            
            
            
            11,051Due
      after one year through five years
            
            
            5,684
            
            
            
            5,828Due
      after five years through ten years
            
            
            4,497
            
            
            
            4,429Due
      after ten years
            
            
            30,729
            
            
            
            27,720Mortgage-related
      securities
            
            
            138,876
            
            
            
            135,215$
            190,774
            
            
            
            184,243








Gross
unrealized losses on securities available for sale and the fair value of the
related securities, aggregated by investment category and length of time that
individual securities have been in a continuous unrealized loss position, were
as follows:








September
      30, 2008Less
      than 12 months
            
            
            12
      months or longer
            
            
            TotalFair
            
            
            Unrealized
            
            
            Fair
            
            
            Unrealized
            
            
            Fair
            
            
            Unrealizedvalue
            
            
            loss
            
            
            value
            
            
            loss
            
            
            value
            
            
            loss(In
      Thousands)Mortgage
      backed securites
            
            $
            22,522
            
            
            
            (204
            )
            
            
            1,795
            
            
            
            (20
            )
            
            
            24,317
            
            
            
            (224
            )Collateralized
      mortgage obligations
            
            
            36,507
            
            
            
            (4,316
            )
            
            
            12,023
            
            
            
            (332
            )
            
            
            48,530
            
            
            
            (4,648
            )Municipal
      securities
            
            
            14,706
            
            
            
            (1,247
            )
            
            
            9,196
            
            
            
            (1,553
            )
            
            
            23,902
            
            
            
            (2,800
            )Corporate
      notes
            
            
            973
            
            
            
            (16
            )
            
            
            —
            
            
            
            —
            
            
            
            973
            
            
            
            (16
            )Other
      securities
            
            
            4,900
            
            
            
            (350
            )
            
            
            —
            
            
            
            —
            
            
            
            4,900
            
            
            
            (350
            )$
            79,608
            
            
            
            (6,133
            )
            
            
            23,014
            
            
            
            (1,905
            )
            
            
            102,622
            
            
            
            (8,038
            )










In
September 2008, the Company held one available for sale security with a book
value that exceeded market value that was determined to be other than
temporarily impaired.  The security is a collateralized mortgage
obligation that had a book value of $6.6 million and an estimated fair market
value of $4.6 million.  As a result of the Company’s analysis,
an  impairment loss of $2.0 million has been recognized as of
September 30, 2008 with respect to this security.




Exclusive
of the aforementioned security that was determined to be other than temporarily
impaired, there is one mortgage backed security, seven collateralized mortgage
obligation securities and thirteen municipal securities at September 30, 2008
which have been in an unrealized loss position for twelve months or
longer.  Because the decline in fair value of all aforementioned
securities is not attributable to credit deterioration, and because the Company
has the ability and intent to hold these securities until a market price
recovery or maturity, these investments are not considered other than
temporarily impaired.




Securities
Held to Maturity




As of
September 30, 2008, the Company held three securities that have been designated
as held to maturity.  The securities have a total amortized cost of
$9.9 million and an estimated fair value of $8.6 million.  Each
security is callable quarterly, all of which are callable beginning in the first
quarter of 2009 and two of which have a final maturity in 2022.  The
remaining security has a final maturity in 2023.




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 Table of Contents


Note
4 — Loans Receivable





Loans
receivable are summarized as follows:









September
      30,
            
            
            December
      31,2008
            
            
            2007(In
      Thousands)Mortgage
      loans:Residential
      real estate:One-
      to four-family
            
            $
            784,798
            
            
            
            672,362Over
      four-family residential
            
            
            512,796
            
            
            
            477,766Commercial
      real estate
            
            
            54,862
            
            
            
            51,983Construction
      and land
            
            
            143,231
            
            
            
            156,289Home
      equity
            
            
            88,116
            
            
            
            85,954Consumer
      loans
            
            
            356
            
            
            
            286Commercial
      business loans
            
            
            40,575
            
            
            
            28,222Gross
      loans receivable
            
            
            1,624,734
            
            
            
            1,472,862Less:Undisbursed
      loan proceeds
            
            
            66,711
            
            
            
            67,549Unearned
      loan fees
            
            
            2,557
            
            
            
            3,265Total
      loans receivable, net
            
            $
            1,555,466
            
            
            
            1,402,048










Real
estate collateralizing the Company’s first mortgage loans is primarily located
in the Company’s general lending area of metropolitan
Milwaukee.  Residential real estate collateralizing $149.2 million or
9.4% of total mortgage loans is located outside of the state of
Wisconsin.





Non-accrual
loans totaled $92.6 million at September 30, 2008 and $80.4 million at December
31, 2007.





The
following table presents data on impaired loans at September 30, 2008 and
December 31, 2007.








September
      30,
            
            
            December
      31,2008
            
            
            2007(In
      Thousands)Impaired
      loans for which an allowance has been provided
            
            $
            49,883
            
            
            
            27,896Impaired
      loans for which no allowance has been provided
            
            
            47,328
            
            
            
            54,632Total
      loans determined to be impaired
            
            $
            97,211
            
            
            
            82,528Allowance
      for loan losses related to all impaired loans
            
            $
            9,461
            
            
            
            5,783





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A summary
of the activity in the allowance for loan loss is as follows:








For
      the Nine Months EndedSeptember
      30,2008
            
            
            2007(Dollars
      in Thousands)Balance
      at beginning of period
            
            $
            12,839
            
            
            
            7,195Provision
      for loan losses
            
            
            34,578
            
            
            
            8,852Charge-offs
            
            
            (21,504
            )
            
            
            (4,598
            )Recoveries
            
            
            297
            
            
            
            33Balance
      at end of period
            
            $
            26,210
            
            
            
            11,482Allowance
      for loan losses to loans receivable
            
            
            1.69
            %
            
            
            0.83
            %Net
      charge-offs to average loans outstanding (annualized)
            
            
            1.89
            %
            
            
            0.44
            %Allowance
      for loan losses to non-performing loans
            
            
            28.30
            %
            
            
            16.65
            %Non-performing
      loans to loans receivable
            
            
            5.95
            %
            
            
            4.99
            %

















Note
5 — Deposits





A summary of the contractual maturities of
certificate accounts at September 30, 2008 is as follows:














(In
      Thousands)Within
      one year
            
            $
            798,491One
      to two years
            
            
            170,739Two
      to three years
            
            
            21,990Three
      to four years
            
            
            17,140Four
      through five years
            
            
            4,421$
            1,012,781







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Note
6 — Borrowings




Borrowings
consist of the following:









September
      30, 2008
            
            
            December
      31, 2007Weighted
            
            
            
            
            
            WeightedAverage
            
            
            
            
            
            AverageBalance
            
            
            Rate
            
            
            Balance
            
            
            Rate(Dollars
      in Thousands)Federal
      funds maturing2008
            
            $
            -
            
            
            
            0.00
            %
            
            
            5,705
            
            
            
            4.75
            %Federal
      Home Loan Bank Chicago (FHLBC) advances maturing:2008
            
            
            25,050
            
            
            
            4.74
            %
            
            
            47,779
            
            
            
            4.24
            %2009
            
            
            4,100
            
            
            
            4.23
            %
            
            
            4,100
            
            
            
            4.23
            %2010
            
            
            48,900
            
            
            
            4.80
            %
            
            
            48,900
            
            
            
            4.80
            %2016
            
            
            220,000
            
            
            
            4.34
            %
            
            
            220,000
            
            
            
            4.34
            %2017
            
            
            65,000
            
            
            
            3.19
            %
            
            
            65,000
            
            
            
            3.19
            %2018
            
            
            65,000
            
            
            
            2.97
            %
            
            
            —
            
            
            
            —Repurchase
      agreements maturing:2017
            
            
            84,000
            
            
            
            3.97
            %
            
            
            84,000
            
            
            
            3.97
            %$
            512,050
            
            
            
            4.02
            %
            
            
            475,484
            
            
            
            4.16
            %







The $220
million in advances due in 2016 consist of eight callable
advances.  The call features are as follows: $70 million at a weighted
average rate of 4.44% callable quarterly until maturity, two $25 million
advances at a weighted average rate of 4.64% callable in July 2008 and in August
2008 and quarterly thereafter, and two $50 million advances at a weighted
average rate of 4.13% callable in January 2009 and in March 2009 and quarterly
thereafter.




The $65
million in advances due in 2017 consist of three callable
advances.  The call features are as follows: two $25 million advances
at a weighted average rate of 3.12% callable quarterly until maturity and a $15
million advance at a rate of 3.46% callable quarterly until
maturity.




The $65
million in advances due in 2018 consist of three callable
advances.  The call features are as follows: two $25 million advances
at a weighted average rate of 3.04% callable beginning in May 2010 and quarterly
thereafter and a $15 million advance at a rate of 2.73% callable quarterly until
maturity.




The $84
million in repurchase agreements include quarterly call options beginning in
2009.  The repurchase agreements are collateralized by securities
available for sale with an estimated fair value of $92.0 million at September
30, 2008.




The
Company selects loans that meet underwriting criteria established by the FHLBC
as collateral for outstanding advances.  The Company’s FHLBC
borrowings are limited to 75% of the carrying value of qualifying, unencumbered
one- to four-family mortgage loans.  In addition, these advances are
collateralized by FHLBC stock of $21.7 million at September 30, 2008 and $19.3
million at December 31, 2007.






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Note
7 – Income Taxes




The
income tax provisions differ from that computed at the Federal statutory
corporate tax rate for the nine month periods ended September 30, 2008 and 2007
as follows:









(Dollars
      in thousands)Income
      (loss) before income taxes
            
            $
            (24,318
            )
            
            
            1,614Tax
      at federal statutory rate
            
            $
            (8,511
            )
            
            
            565Effect
      of:State
      income taxes, net of Federal income tax benefit
            
            
            (1,170
            )
            
            
            46Cash
      surrender value of life insurance
            
            
            (423
            )
            
            
            (346
            )Non-deductible
      ESOP and stock options expense
            
            
            103
            
            
            
            180Tax-exempt
      interest income
            
            
            (287
            )
            
            
            (179
            )Valuation
      allowance for deferred tax assets
            
            
            16,100
            
            
            
            —Other
            
            
            (16
            )
            
            
            97Income
      tax provision
            
            $
            5,796
            
            
            
            363Effective
      tax rate
            
            
            (23.8
            %)
            
            
            22.5
            %







During
the third quarter of 2008, the Company recorded income tax expense related to
net deferred tax asset valuation allowances of $16.1 million, $1.2
million.  The expense was recorded in accordance with Statement
of Financial Accounting Standards No. 109, “Accounting for Income Taxes”, which
requires the need to assess whether a valuation allowance is necessary when
there are cumulative losses.  To the extent that tax rules could
potentially limit the ultimate realization of the deferred tax assets (generally
through a carryback to prior year’s taxable income and future taxable income,
including tax planning strategies), a valuation allowance against the deferred
tax asset should be recorded.  The benefit may still be realized in
the future, depending on anumber of factors including future taxable
income.






Note
8 – Financial Instruments with Off-Balance Sheet Risk







Off-balance
sheet financial instruments or obligations whose contract amounts represent
credit and/or interest rate risk are as follows:









September
      30,
            
            
            December
      31,2008
            
            
            2007(In
      Thousands)Financial
      instruments whose contract amounts representpotential
      credit risk:Commitments
      to extend credit under first mortgage loans
            
            $
            19,946
            
            
            
            16,674Unused
      portion of home equity lines of credit
            
            
            31,922
            
            
            
            31,492Unused
      portion of construction loans
            
            
            24,212
            
            
            
            27,336Unused
      portion of business lines of credit
            
            
            10,578
            
            
            
            8,721Standby
      letters of credit
            
            
            1,866
            
            
            
            2,337







In
connection with its mortgage banking activities, the Company enters into forward
loan sale commitments.  Forward commitments to sell mortgage loans
represent commitments obtained by the Company from a secondary market agency to
purchase mortgages from the Company at specified interest rates and within
specified periods of time.  Commitments to sell loans are made to
mitigate interest rate risk on commitments to originate loans and loans held for
sale.  As of September 30, 2008 and December 31, 2007, the Company had
$8.6 million and $23.1 million, respectively in forward loan sale
commitments.  A forward sale commitment is a derivative instrument
under Statement of Financial Accounting Standards No. 133 (“SFAS
No. 133”), “Accounting for Derivative Instruments and Hedging
Activities,”(as amended), which must be recognized at fair value on the
consolidated balance sheet in other assets and other liabilities with changes in
its value recorded in income from mortgage banking operations.  In
determining the fair value of its derivative loan commitments for economic
purposes, the Company considers the value that would be generated when the loan
arising from exercise of the loan commitment is sold in the secondary mortgage
market. That value includes the price that the loan is expected to be sold for
in the secondary mortgage market.








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 Table of Contents


Note
9 – Earnings (loss) per share





Basic
earnings (loss) per share is computed by dividing net income (loss) by the
weighted average number of common shares outstanding for the
period.  Diluted earnings is computed by dividing net income (loss) by
the weighted average number of common shares outstanding adjusted for the
dilutive effect of all potential common shares.  Unvested restricted
stock is considered outstanding for dilutive earnings (loss) per share
only.  Unvested restriced stock and stock options at September 30,
2008 are antidilutive and are excluded from the earnings (loss) per share
calculation.




Presented
below are the calculations for basic and diluted earnings (loss) per
share:







Nine
      Months Ended
            
            
            Three
      Months EndedSeptember
      30,
            
            
            September
      30,2008
            
            
            2007
            
            
            2008
            
            
            2007(In
      Thousands, except per share data)Net
      income (loss)
            
            $
            (30,114
            )
            
            
            1,251
            
            
            
            (28,187
            )
            
            
            421Weighted
      average shares outstanding
            
            
            30,545
            
            
            
            31,912
            
            
            
            30,564
            
            
            
            30,797Effect
      of dilutive potential common shares
            
            
            -
            
            
            
            8
            
            
            
            -
            
            
            
            8Diluted
      weighted average shares outstanding
            
            
            30,545
            
            
            
            31,920
            
            
            
            30,564
            
            
            
            30,805Basic
      earnings (loss) per share
            
            $
            (0.99
            )
            
            
            0.04
            
            
            $
            (0.92
            )
            
            
            0.01Diluted
      earnings (loss) per share
            
            $
            (0.99
            )
            
            
            0.04
            
            
            $
            (0.92
            )
            
            
            0.01





- 15
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 Table of Contents





Note
10 – Fair Value Measurements





Effective
January 1, 2008, the Company adopted FASB Statement No. 157, Fair Value Measurements (SFAS 157).SFAS No. 157 establishes a single authoritative definition of value, sets
out a framework for measuring fair value, and provides a hierarchical disclosure
framework for assets and liabilities measured at fair value.  The
adoption of SFAS 157 did not have any impact on our financial position or
results of operations.  Presented below is information about assets
recorded on our consolidated statement of financial position at fair value on a
recurring basis and assets recorded in our consolidated statement of financial
position on a nonrecurring basis.





Assets
and Liabilities Recorded at Fair Value on a Recurring Basis





The
following table presents information about our assets recorded in our
consolidated statement of financial position at their fair value on a recurring
basis as of September 30, 2008, and indicates the fair value hierarchy of the
valuation techniques utilized to determine such fair value.  In
general, fair values determined by Level 1 inputs use quoted prices in active
markets for identical assets or liabilities that we have the ability to
access.  Fair values determined by Level 2 inputs use inputs other
than quoted prices included in Level 1 inputs that are observable for the asset
or liability, either directly or indirectly.  Level 2 inputs include
quoted prices for similar assets and liabilities in active markets, quoted
prices for identical or similar assets or liabilities in markets where there are
few transactions and inputs other than quoted prices that are observable for the
asset or liability, such as interest rates and yield curves that are observable
at commonly quoted intervals.  Level 3 inputs are unobservable inputs
for the asset or liability and include situations where there is little, if any,
market activity for the asset or liability.








Assets
              Measured
      at
              Fair
      Value at
              September
      30, 2008
            
            
            Quoted
      Prices in
              Active
      Markets
              for
      Identical
              Assets
              (Level
      1)
            
            
            Significant
              Other
              Observable
              Inputs
              (Level
      2)
            
            
            Significant
              Unobservable
              Inputs
              (Level
      3)(In
      Thousands)Available
      for sale securities
            
            $
            184,243
            
            
            
            -
            
            
            
            179,626
            
            
            
            4,617








The
following summarizes the valuation techniques for assets recorded in our
consolidated statements of financial condition at their fair value on a
recurring basis:





Available for sale securities –The fair value of available-for-sale securities is determined by a third
party valuation source using observable market data utilizing a matrix or
multi-dimensional relational pricing model.  Standard inputs to these
models include observable market data such as benchmark yields, reported trades,
broker quotes, issuer spreads, benchmark securities and bid/offer market
data.  For securities with an early redemption feature, an option
adjusted spread model is utilized to adjust the issuer
spread.  Prepayment models are used for mortgage related securities
with prepayment features.





- 16
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 Table of Contents


The table
below presents a reconciliation for all assets measured at fair value on a
recurring basis using significant unobservable inputs (Level 3) during
2008.






Available-for-sale
      securties(In
      Thousands)Balance
      December 31, 2007
            
            $
            7,073Unrealized
      holding losses arising during the period:Included
      in other comprehensive income
            
            
            282Other
      than temporary impairment included in net loss
            
            
            (1,997
            )Principal
      repayments
            
            
            (741
            )Balance
      September 30, 2008
            
            $
            4,617








Level 3
available-for-sale securities include a single corporate collateralized mortgage
obligation.  The market for this security was not active as of
September 30, 2008.  As such, following the guidance set forth in FASB
Staff Position 157-3 Determining the Fair Value of a
Financial Asset When the Market for That Asset Is Not Active, the Company
valued this security based on the present value of estimated future cash
flows





Assets
Recorded at Fair Value on a Non-recurring Basis





Loans –On a non-recurring
basis, loans determined to be impaired are analyzed to determine whether a
collateral shortfall exists, and if such a shortfall exists, are recorded in our
consolidated statements of financial condition at fair value.  Fair
value is determined based on third party appraisals.  At September 30,
2008, loans determined to be impaired with an outstanding balance of $49.9
million were carried net of specific reserves of $9.5 million for a fair value
of $40.4 million.  Impaired loans are considered to be Level 2 in the
fair value hierarchy of valuation techniques.





Loans held for sale - On a
non-recurring basis, loans held-for-sale are recorded in our consolidated
statements of financial condition at the lower of cost or fair
value.  Fair value is generally determined by estimating a gross
premium or discount, which is derived from pricing currently observable in the
market.  At September 30, 2008, loans held-for-sale totaled $8.6
million.  Loans held-for-sale are considered to be Level 2 in the fair
value hierarchy of valuation techniques.





Real estate owned –On a
non-recurring basis, real estate owned, is recorded in our consolidated
statements of financial condition at the lower of cost or fair
value.  Fair value is determined based on third party appraisals
obtained at the time the Company takes title to the property and, if less than
the carrying value of the loan, the carrying value of the loan is adjusted to
the fair value.At
September 30, 2008, real estate owned totaled $20.3 million.  Real
estate owned is considered to be Level 2 in the fair value hierarchy of
valuation techniques.








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Note
11 – Recent Accounting Developments





In
December 2007, the FASB issued SFAS No. 141 (revised December 2007),
Business Combinations,
which replaces FASB Statement No. 141, “Business Combinations.” This
statement requires an acquirer to recognize identifiable assets acquired,
liabilities assumed, and any noncontrolling interest in the acquiree at the
acquisition date, measured at their full fair values at that date, with limited
exceptions. Assets and liabilities assumed that arise from contractual
contingencies as of the acquisition date must also be measured at their
acquisition-date full fair values. SFAS 141R requires the acquirer to
recognize goodwill as of the acquisition date, and in the case of a bargain
purchase business combination, the acquirer shall recognize a gain.
Acquisition-related costs are to be expensed in the periods in which the costs
are incurred


and the
services are received. Additional presentation and disclosure requirements have
also been established to enable financial statement users to evaluate and
understand the nature and financial effects of business combinations.
SFAS 141R is to be applied prospectively for acquisition dates on or after
the beginning of the first annual reporting period beginning on or after
December 15, 2008. The Company will adopt SFAS 141R when required in
2009 and is in the process of assessing the impact on its results of operations,
financial position, and liquidity.





In
December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements. SFAS 160 requires noncontrolling
interests to be treated as a separate component of equity, rather than a
liability or other item outside of equity. This statement also requires the
amount of consolidated net income attributable to the parent and the
noncontrolling interest to be clearly identified and presented on the face of
the income statement. Changes in a parent’s ownership interest, as long as the
parent retains a controlling financial interest, must be accounted for as equity
transactions, and should a parent cease to have a controlling financial
interest, SFAS 160 requires the parent to recognize a gain or loss in net
income. Expanded disclosures in the consolidated financial statements are
required by this statement and must clearly identify and distinguish between the
interest of the parent’s owners and the interests of the noncontrolling owners
of a subsidiary. SFAS 160 is to be applied prospectively for fiscal years
beginning on or after December 15, 2008, with the exception of presentation
and disclosure requirements, which shall be applied retrospectively for all
periods presented. The Company will adopt SFAS 160 when required in 2009
and is in the process of assessing the impact on its results of operations,
financial position, and liquidity.





In
March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities, an amendment of FASB Statement No. 133.SFAS 161 applies to all derivative instruments and related hedged items
accounted for under SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. SFAS 161 requires entities to provide
greater transparency about (a) how and why an entity uses derivative
instruments, (b) how derivative instruments and related hedged items are
accounted for under SFAS 133 and its related interpretations, and (c) how
derivative instruments and related hedged items affect an entity’s financial
position, results of operations and cash flows. To meet those objectives, SFAS
161 requires (1) qualitative disclosures about objectives for using
derivatives by primary underlying risk exposure (e.g., interest rate, credit or
foreign exchange rate) and by purpose or strategy (fair value hedge, cash flow
hedge, net investment hedge, and non-hedges), (2) information about the
volume of derivative activity in a flexible format that the preparer believes is
the most relevant and practicable, (3) tabular disclosures about balance
sheet location and gross fair value amounts of derivative instruments, income
statement and other comprehensive income location of gain and loss amounts on
derivative instruments by type of contract, and (4) disclosures about
credit-risk related contingent features in derivative agreements. SFAS 161 is
effective for financial statements issued for fiscal years and interim periods
beginning after November 15, 2008. The Company will adopt SFAS 161
when required in 2009 and is in the process of assessing the impact on its
results of operations, financial position, and liquidity.





In
October 2008, the FASB issued FASB Staff Position 157-3 Determining the Fair Value of a
Financial Asset When the Market for That Asset Is Not Active(FSP
157-3).FSP
157-3 clarifies the application of SFAS 157 Fair Value of a Financial
Asset, in a market that is not active.  FSP 157-3 was effective
upon issuance.  The Company’s adoption of FSP 157-3 had no impact on
its results of operations, financial position, and liquidity.





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Item 2.  Management’s Discussion and
Analysis of Financial Condition and Results of
Operations





Cautionary Statements
Regarding Forward-Looking Information





This
report contains or incorporates by reference various forward-looking statements
concerning the Company’s prospects that are based on the current expectations
and beliefs of management.  Forward-looking statements may also be
made by the Company from time to time in other reports and documents as well as
in oral presentations.  When used in written documents or oral
statements, the words “anticipate,” “believe,” “estimate,” “expect,” “objective”
and similar expressions and verbs in the future tense, are intended to identify
forward-looking statements.  The statements contained herein and such
future statements involve or may involve certain assumptions, risks and
uncertainties, many of which are beyond the Company’s control, that could cause
the Company’s actual results and performance to differ materially from what is
expected.  In addition to the assumptions and other factors referenced
specifically in connection with such statements, the following factors could
impact the business and financial prospects of the Company:





·
            inflation
      and changes in the interest rate environment that reduce our margins or
      reduce the fair value of financial
instruments;


·
            legislative
      or regulatory changes that adversely affect our
  business;


·
            our
      ability to enter new markets successfully and take advantage of growth
      opportunities;


·
            general
      economic conditions, either nationally or in our market areas, that are
      worse than expected;


·
            significantly
      increased competition among depository and other financial
      institutions;


·
            adverse
      changes in the securities markets;


·
            adverse
      changes in the real estate markets;


·
            changes
      in accounting policies and practices, as may be adopted by the bank
      regulatory agencies and the Financial Accounting Standards Board;
      and


·
            changes
      in consumer spending, borrowing and savings
  habits.





See also
the factors referred to in reports filed by the Company with the Securities and
Exchange Commission (particularly those under the caption “Risk Factors” in Item
1A of the Company’s 2007 Annual Report on Form 10-K).





Overview





On August
1, 2008, the Company changed its name to Waterstone Financial,
Inc.  Our name change is part of our ongoing efforts to reflect our
larger market area, which includes communities outside of Wauwatosa,
Wisconsin.




Generally,
our results of operations depend on our net interest income and the provision
for loan losses.  Net interest income is the difference between the
interest income we earn on loans receivable, investment securities and cash and
cash equivalents and the interest we pay on deposits and other
borrowings.  The Company’s banking subsidiary, WaterStone Bank SSB
(“WaterStone Bank”), formerly Wauwatosa Savings Bank, is primarily a mortgage
lender with such loans comprising 97.5% of total loans receivable on September
30, 2008.  Further, 79.9% of loans receivable are residential mortgage
loans with over four-family loans comprising 31.6% of all loans on September 30,
2008.  WaterStone Bank funds loan production primarily with retail
deposits and Federal Home Loan Bank advances.  On September 30, 2008,
deposits comprised 68.0% of total liabilities.  Time deposits, also
known as certificates of deposit, accounted for 86.1% of total deposits at
September 30, 2008.  Federal Home Loan Bank advances outstanding on
September 30, 2008 totaled $428.1 million, or 24.8% of total
liabilities.




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During
the nine months ended September 30, 2008, our results of operations were
adversely affected by deterioration in asset quality resulting in increases in
non-accrual loans and real estate owned and a corresponding increase in both the
provision for loan losses and loan charge-offs.  We have sought to
address the impact of deteriorating real estate market by increasing our
provisions for loan losses over the past six quarters.  The continued
downturn in the local real estate market prompted the Company to obtain updated
appraisals and reevaluate the assumptions used to determine the fair value of
collateral related to loans receivable to ensure that the allowance for loan
losses continued to be an accurate reflection of management’s best estimate of
the amount needed to provide for the probable loss on impaired loans and other
inherent losses in the loan portfolio.  During this process, the
Company obtained updated valuations on over five hundred
properties.  The scope of the review was sharply focused on the
nonperforming portfolio, but also included a large number of properties that
related to loans that were in good standing.  As a result of that
reevaluation, the Company determined that a provision for loan losses of $23.3
million was necessary during the quarter in order to bring the allowance for
loan losses to an appropriate level.  As discussed below, during the
nine months ended September 30, 2008, the Company significantly increased its
provision for loan losses to $34.6 million from $8.9 million for the nine months
ended September 30, 2007.  Additional information regarding loan
quality and its impact on our financial condition and results of operations can
be found in the Asset Quality discussion beginning on page
35.  As a direct result of the increase in provision for loan
loss during the nine months ended September 30, 2008, the Company recorded
income tax expense related to net deferred tax asset valuation allowances of
$16.1 million.  The details of this valuation allowance and its affect
on current and future income tax expense is discussed in more detail
below.  Our results of operations are also affected by noninterest
income and noninterest expense.  Noninterest income consists primarily
of service charges and mortgage banking fee income but was negatively impacted
in the quarter ended September 30, 2008 by a $2.0 million loss on impairment of
securities.  Noninterest expense consists primarily of compensation
and employee benefits, occupancy expenses and real estate owned
expense.  In 2009 we expect our non-interest expense to be affected by
higher deposit insurance premium assessment from the FDIC.  Our
results of operations also may be affected significantly by general and local
economic and competitive conditions, governmental policies and actions of
regulatory authorities.




The
following discussion and analysis is presented to assist the reader in the
understanding and evaluation of the Company’s financial condition and results of
operations. It is intended to complement the unaudited consolidated financial
statements, footnotes, and supplemental financial data appearing elsewhere in
this Form 10-Q and should be read in conjunction therewith. The detailed
discussion focuses on the results of operations for the nine and three month
periods ended September 30, 2008 and 2007 and the financial condition as of
September 30, 2008 compared to the financial condition as of December 31,
2007.




Critical
Accounting Policies





Critical
accounting policies are those that involve significant judgments and assumptions
by management and that have, or could have, a material impact on our income or
the carrying value of our assets.




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Allowance for
Loan Losses.WaterStone Bank
establishes valuation allowances on loans considered impaired. A loan is
considered impaired when, based on current information and events, it is
probable that WaterStone Bank will not be able to collect all amounts due
according to the contractual terms of the loan agreement. A valuation allowance
is established for an amount equal to the impairment when the carrying amount of
the loan exceeds the net realizable value of the underlying
collateral.  WaterStone Bank also establishes valuation allowances
based on an evaluation of the various risk components that are inherent in the
credit portfolio. The risk components that are evaluated include past loan loss
experience; the level of nonperforming and classified assets; current economic
conditions; volume, growth, and composition of the loan portfolio; adverse
situations that may affect the borrower’s ability to repay; the estimated value
of any underlying collateral; regulatory guidance; and other relevant factors.
The allowance is increased by provisions charged to earnings and recoveries of
previously charged-off loans and reduced by charge-offs. The adequacy of the
allowance for loan losses is reviewed and approved at least quarterly by the
WaterStone Bank board of directors. The allowance reflects management’s best
estimate of the amount needed to provide for the probable loss on impaired loans
and other inherent losses in the loan portfolio, and is based on a risk model
developed and implemented by management and approved by the WaterStone Bank
board of directors.




Actual
results could differ from this estimate and future additions to the allowance
may be necessary based on unforeseen changes in loan quality and economic
conditions.  In addition, state and federal regulators periodically
review the WaterStone Bank allowance for loan losses. Such regulators have the
authority to require WaterStone Bank to recognize additions to the allowance at
the time of their examination.




Income
Taxes.The Company and its subsidiaries file a consolidated
federal income tax return. The provision for income taxes is based upon income
in the consolidated financial statements, rather than amounts reported on the
income tax return.  Consequently, our federal income tax returns do
not include the financial results of our mutual holding company
parent.  Deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases.  Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled.  The effect on deferred tax assets and liabilities of a
change in tax rates is recognized as income or expense in the period that
includes the enactment date.





During
the third quarter of 2008, the Company recorded income tax expense related to
net deferred tax asset valuation allowances of $16.1 million.  The
expense was recorded in accordance with Statement of Financial Accounting
Standards No. 109, “Accounting for Income Taxes” which requires the need to
assess whether a valuation allowance is necessary when there are cumulative
losses.  To the extent that tax rules could potentially limit the
ultimate realization of the deferred tax assets (generally through a carryback
to prior year’s taxable income and future taxable income, inclduing tax planning
strategies), a valuation allowance against the deferred tax asset should be
recorded.  The benefit may still be realized in the future, depending
on a number of factors including future taxable income.




Positions
taken in the Company’s tax returns may be subject to challenge by the taxing
authorities upon examination.  Uncertain tax positions are initially
recognized in the financial statements when it is more likely than not the
position will be sustained upon examination by the tax
authorities.  Such tax positions are both initially and subsequently
measured as the largest amount of tax benefit that is more likely than
not to be realized upon settlement with the tax authority, assuming full
knowledge of the position and all relevant facts.  Interest and
penalties on income tax uncertainties are classified as income tax expense in
the income statement.




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Comparison
of Operating Results for the Nine Months Ended September 30, 2008 and
2007





General
- Net loss for the nine months ended September 30, 2008 totaled $30.1 million,
or $0.99 for both basic and diluted earnings per share compared to net income of
$1.3 million, or $0.04 for both basic and diluted earnings per share for the
nine months ended September 30, 2007.  The nine months ended September
30, 2008 generated an annualized loss on average assets of 2.21% and an
annualized loss on average equity of 20.02%, compared to a return on average
assets of 0.10% and a return on average equity of 0.75% for the comparable
period in 2007.  The net loss was due to a $25.7 million increase in
provisions for loan losses.  During the third quarter, the Company
received updated appraisals on a number of properties that collateralize
nonperforming loans.  The decline in value noted in the appraisals, in
addition to the continued downturn in the local real estate market, prompted the
Company to obtain updated appraisals and reevaluate the assumptions used to
determine the fair value of collateral related to additional nonperforming
loans.  This reevaluation contributed to the Company recording a
provision for loan losses of $23.3 million during the third
quarter.  The impact of the increase in provision for loan losses was
compounded by a $5.4 million increase in income tax expense, a $3.9 million
increase in noninterest expense which includes a $2.6 million increase
in real estate owned expense and a $602,000 decrease in noninterest
income which includes a $2.0 million loss on impairment of
securities.  These were partially offset by a $4.3 million increase in
net interest income.  Loan charge-off activity and specific loan
reserves are discussed in additional detail in the Asset Quality section
beginning on page
35.  The net interest margin for the nine months ended
September 30, 2008 was 2.35% compared to 2.22% for the nine months ended
September 30, 2007.





During
the third quarter of 2008, the Company recorded income tax expense related to
net deferred tax asset valuation allowances of $16.1 million.  The
expense was recorded in accordance with Statement of Financial Accounting
Standards No. 109, “Accounting for Income Taxes” which requires the need to
assess whether a valuation allowance is necessary when there are cumulative
losses.  To the extent that tax rules could potentially limit the
ultimate realization of the deferred tax assets (generally through a carryback
to prior year’s taxable income and future taxable income, inclduing tax planning
strategies), a valuation allowance against the deferred tax asset should be
recorded.  The benefit may still be realized in the future, depending
on a number of factors including future taxable income.





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Total
Interest Income - Total interest income increased $5.6 million, or 7.7%,
to $77.9 million during the nine months ended September 30, 2008 compared to
$72.3 million for the nine months ended September 30, 2007.  Interest
income on loans increased $4.5 million, or 6.9%, to $69.6 million for the nine
months ended September 30, 2008 compared to $65.1 million for the comparable
period of 2007.  The increase resulted primarily from an increase of
$108.3 million, or 7.8%, in the average loan balance to $1.49 billion during the
nine-month period ended September 30, 2008 from $1.39 billion during the
comparable period in 2007.  The increase in average balance was
partially offset by a 5 basis point decrease in the average yield on loans to
6.23% for the nine-month period ended September 30, 2008 from 6.28% for the
comparable period in 2007.  In addition to the increase in interest
income due to loan growth, $1.4 million of the overall increase compared to the
prior year related to income recognized on a loan that had previously been
recorded on the cost recovery method.  The loan was originated to
facilitate the sale of Company owned real estate during 2000 and the $1.4
million represented interest income that was collected but not recognized during
the facilitation period.  The loan was paid in full during the third
quarter, which resulted in full recognition of interest collected in prior
periods. Unrecognized interest income on non-accrual loans totaled $2.9 million
during the nine months ended September 30, 2008.  This had the effect
of reducing the average yield on loans during the same period by 26 basis
points.  Unrecognized interest income on non-accrual loans totaled
$1.4 million during the nine months ended September 30, 2007 effectively
reducing the average yield on loans for that period by 13 basis
points.





Interest
income from mortgage-related securities increased $1.6 million, or 38.9%, to
$5.7 million for the nine months ended September 30, 2008 compared to $4.1
million for the comparable quarter in 2007.  This was primarily due to
the increase of $33.4 million, or 31.9%, in the average balance to $137.9
million for the nine months ended September 30, 2008 from $104.6 million during
the comparable period in 2007.  The increase in interest income
reflects an increase in the average balance of mortgage-related securities as
well as a 28 basis point increase in the average yield on mortgage-related
securities to 5.49% for the nine months ended September 30, 2008 from 5.21% for
the comparable period in 2007.  Finally, interest income from debt
securities, federal funds sold and short-term investments decreased $511,000, or
16.1%, to $2.7 million for the nine months ended September 30, 2008 compared to
$3.2 million for the comparable period in 2007.  This was due to a 137
basis point decrease in the average yield on other earning assets to 3.24% for
the nine months ended September 30, 2008 from 4.61% for the comparable period in
2007, partially offset by an increase of $17.7 million, or 19.2%, in the average
balance of other earning assets to $110.0 million during the nine months ended
September 30, 2008 from $92.2 million during the comparable period in
2007.  The decrease in average yield on other earning assets resulted
primarily from a drop in the federal funds rate of 275 basis points between
September 30, 2007 and September 30, 2008 and from a decline in dividends
received on the Company’s FHLBC stock.  The FHLBC stock yielded a
return of 2.89% during the nine months ended September 30, 2007, however, no
dividend was declared during the nine months ended September 30,
2008.  On October 10, 2007, the FHLBC entered into a consensual cease
and desist order with its regulator, the Federal Housing Finance Board. Under
the terms of the order, dividend declarations are subject to the prior written
approval of the Federal Housing Finance Board.  The FHLBC has not
declared a dividend since it entered into the cease and desist
order.  At the request of the FHLBC, on July 24, 2008, the Finance
Board amended the cease and desist order to allow the FHLBC to redeem
incremental purchases of capital stock tied to increased levels of borrowing
through advances after repayment of those new advances.


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Total
Interest Expense-Total interest expense increased by $1.3 million, or 2.8%, to $47.3
million during the nine months ended September 30, 2008 from $46.1 million
during the nine months ended September 30, 2007.  This increase was
the result of an increase of $196.8 million, or 14.0%, in average interest
bearing deposits and borrowings outstanding partially offset by a 43 basis point
drop in the cost of funding to 3.94% for the nine months ended September 30,
2008 from 4.37% for the comparable period ended September 30, 2007.





Interest
expense on deposits decreased $1.8 million, or 5.5%, to $31.8 million during the
nine months ended September 30, 2008 from $33.6 million during the comparable
period in 2007.  This was due to a decrease in the cost of total
average deposits of 51 basis points to 3.88% for the nine months ended September
30, 2008 compared to 4.39% for the comparable period during 2007.  The
decrease in interest expense attributable to the decrease in the cost of
deposits was partially offset by an increase of $71.9 million, or 7.0%, in the
average balance of other interest bearing deposits to $1.10 billion during the
nine months ended September 30, 2008 from $1.02 billion during the comparable
period in 2007.  The decrease in the cost of deposits reflects the
lower shorter term interest rate environment resulting from the Federal
Reserve’s reduction of short term interest rates which are typically used by
financial institutions in determining the market rate for deposit
products.





Interest
expense on borrowings increased $3.1 million, or 25.0%, to $15.5 million during
the nine months ended September 30, 2008 from $12.4 million during the
comparable period in 2007.  The increase resulted primarily from an
increase in average borrowings outstanding of $125.1 million, or 34.1%, to
$492.0 million during the nine months ended September 30, 2008 from $366.9
million during the comparable period in 2007.  The increase in average
borrowings was partially offset by a 27 basis point decrease in the average cost
of borrowings to 4.14% during the nine months ended September 30, 2008 from
4.41% during the comparable period in 2007.  The increased use of
borrowings as a source of funding during nine months ended September 30, 2008
reflected our assessment that such sources of funds provided favorable rates and
terms compared to alternate retail funding sources.  The reduction in
short term interest rates by the Federal Reserve allows banks such as WaterStone
Bank to borrow funds at lower rates, helping to reduce our cost of
borrowing.





Net
Interest Income - Net interest income increased by $4.3 million or 16.4%,
to $30.6 million during the nine months ended September 30, 2008 as compared to
$26.3 million during the comparable period in 2007.  Net interest
income continues to be positively affected by the steeper yield curve in 2008,
as compared to 2007.  The increase resulted primarily from a 29 basis
point increase in our interest rate spread to 2.04% for the nine month period
ended September 30, 2008 from 1.75% for the comparable period in
2007.  The 29 basis point increase in the interest rate spread
resulted from a 43 basis point decrease in the cost of interest bearing
liabilities, which was partially offset by a 14 basis point decrease in the
yield on interest earning assets.  The increase in net interest income
resulting from an increase in our net interest rate spread was partially offset
by a decrease in net average earning assets of $37.4 million, or 21.8%, to
$134.5 million for the nine months ended September 30, 2008 from $171.9 million
from the comparable period in 2007.  The decrease in net average
earning assets was primarily attributable to an increase in loans transferred to
real estate owned and an increase in the allowance for loan
losses.  The average balance of real estate owned totaled $13.7
million for the nine months ended September 30, 2008 compared to $1.5 million
for the nine months ended September 30, 2007.  The average balance of
the allowance for loan losses totaled $16.8 million for the nine months ended
September 30, 2008 compared to $8.2 million for the nine months ended September
30, 2007.





Provision
for Loan Losses - Provision for loan losses increased $25.7 million to
$34.6 million during the nine months ended September 30, 2008, from $8.9 million
during the comparable period during 2008.  The increased provision for
the nine months ended September 30, 2007 was primarily the result of $21.2
million of net loan charge-offs combined with continued weakness in local real
estate markets.  The increase in charge-offs reflects management’s
reevaluation of assumptions used to determine the fair value of collateral
supporting non performing loans.  In addition, compared to prior periods,
the Company has observed an increased likelihood of the borrower being
unable to resolve the ongoing default in the terms of the loan prior to
completion of a sheriff’s sale.  As such, charge-offs are generally being
recognized earlier in the foreclosure process than they have been in prior
periods.  See Asset Quality section beginning on page
35 for an analysis of charge-offs, nonperforming assets, specific
reserves and additional provisions.


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Noninterest
Income - Total noninterest income decreased $602,000, or 11.6%, to $4.6
million during the nine months ended September 30, 2008 from $5.2 million during
the comparable period in 2007.  The decrease resulted from $2.0
million in other than temporary impairment loss recognized on a collateralized
mortgage obligation, partially offset by a $1.2 million increase in mortgage
banking income generated by our Waterstone Mortgage Corporation
subsidiary.





Noninterest
Expense - Total noninterest expense increased $3.9 million, or 18.7%, to
$24.9 million during the nine months ended September 30, 2008 from $21.0 million
during the comparable period in 2007.  The increase was primarily the
result of the increase in real estate owned expense, a direct follow-on to the
increase in the provision for loan losses and the increase in real estate
owned.





Real
estate owned expense totaled $2.8 million for the nine months ended September
30, 2008 compared to $199,000 during the nine months ended September 30,
2007.  Real estate owned expense includes the net gain or loss
recognized upon the sale of a foreclosed property, as well as the operating and
carrying costs related to the properties.  During the nine months
ended September 30, 2008, operational expenses totaled $1.8 million and net
losses on sales of real estate totaled $915,000.  The increase in
expense compared to the prior period results from an increase in the number and
total cost basis of foreclosed properties.  The average balance of
real estate owned totaled $13.7 million for the nine months ended September 30,
2008 compared to $1.5 million for the nine months ended September 30,
2007.





Compensation,
payroll taxes and other employee benefit expense increased $1.0 million, or
8.6%, to $12.8 million during the nine months ended September 30, 2008 from
$11.8 million during the comparable period in 2007.  This increase
resulted primarily from an increase in salary expense, partially offset by a
reduction in expense related to the ESOP.  Salary expense increased
$1.4 million, or 17.0%, to $9.3 million during the nine months ended September
30, 2008 compared to $7.9 million during the comparable period in 2007 primarily
as a result of an increase in loan origination activity.  Expense
related to the Company’s ESOP decreased $300,000, or 31.1%, to $666,000 during
the nine months ended September 30, 2008 compared to $966,000 during the
comparable period in 2007.  This decrease reflects the decrease in the
Company’s average share price during the nine months ended September 30, 2008
compared to the comparable period in 2007.





Income
Taxes– Income tax expense
was $5.8 million, or (23.8%) of the pretax loss of $24.3 million for the nine
months ended September 30, 2008.  This compares to income tax expense
of $363,000, or 22.5% of the pretax income of $1.6 million for the nine months
ended September 30, 2007.  The unlikely relationship between pretax
loss and income tax expense for the nine months ended September 30, 2008 is the
result income tax expense related todeferred tax asset valuation
allowances of $16.1 million recorded during the third
quarter.  Statement of Financial Accounting Standards No. 109,
“Accounting for Income Taxes” requires that to the extent that tax rules
could potentially limit the ultimate realization of the deferred tax assets
(generally through a carryback to prior year’s taxable income and future taxable
income, including tax planning strategies), a valuation allowance against the
deferred tax asset should be recorded.  The benfit may still be
realized in the future, depending on a number of factors including future
taxable income.




Net
Loss-As a
result of the foregoing factors, net loss for the nine months ended September
30, 2008 was $30.1 million as compared to net income of $1.3 million during the
comparable period in 2007.







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Comparison
of Operating Results for the Three Months Ended September 30, 2008 and
2007





General
- Net loss for the three months ended September 30, 2008 totaled $28.2 million,
or $0.92 for both basic and diluted earnings per share compared to net income of
$421,000, or $0.01 for both basic and diluted earnings per share for the three
months ended September 30, 2007.  The quarter ended September 30, 2008
generated an annualized loss on average assets of 5.89% and an annualized loss
on average equity of 56.14%, compared to annualized return of 0.10% and 0.82%,
respectively, for the comparable period in 2007.  The net loss was due
to a $20.5 million increase in our provision for loan losses.  During
the third quarter, the Company received updated appraisals on properties that
collateralize non performing loans.  The decline in value noted in the
appraisals, in addition to the continued downturn in the real estate market
prompted the Company to obtain updated appraisals and reevaluate the assumptions
used to determine the fair value of collateral related to additional
nonperforming loans.  As a result of that reevaluation, the Company
recorded a provision for loan losses of $23.3 million during the
quarter.  The increase in the provision for loan losses was compounded
by a $1.3 million decrease in noninterest income, a $2.1 million increase in
noninterest expense and $8.6 million increase in income tax, partially offset by
a $3.8 million increase in net interest income.  Loan charge-off
activity and specific loan reserves are discussed in additional detail in the
Asset Quality section beginning on page
35.  The net interest margin for the three months ended
September 30, 2008 was 2.69% compared to 2.12% for the three months ended
September 30, 2007.





During
the third quarter of 2008, the Company recorded income tax expense related to
net deferred tax asset valuation allowances of $16.1 million.  The
expense was recorded in accordance with Statement of Financial Accounting
Standards No. 109, “Accounting for Income Taxes” which requires the need to
assess whether a valuation allowance is necessary when there are cumulative
losses.  To the extent that tax rules could potentially limit the
ultimate realization of the deferred tax assets (generally through a carryback
to prior year’s taxable income and future taxable income, inclduing tax planning
strategies), a valuation allowance against the deferred tax asset should be
recorded.  The benefit may still be realized in the future, depending
on a number of factors including future taxable income.





Total
Interest Income - Total interest income increased $3.7 million, or 15.0%,
to $28.1 million during the three months ended September 30, 2008 compared to
$24.4 million for the three months ended September 30, 2007.  Interest
income on loans increased $3.4 million, or 15.6%, to $25.2 million for the three
months ended September 30, 2008 compared to $21.8 million for the comparable
period of 2007.  The increase resulted primarily from an increase of
$170.5 million, or 12.3%, in the average loan balance to $1.55 billion during
the three-month period ended September 30, 2008 from $1.38 billion during the
comparable period in 2007.  The increase in average balance was
compounded by a 19 basis point increase in the average yield on loans to 6.43%
for the three-month period ended September 30, 2008 from 6.24% for the
comparable period in 2007.  In addition to the increase in interest income
due to loan growth, $1.4 million of the overall increase compared to the prior
year related to income recognized on a loan that had previously been recorded on
the cost recovery method.  The loan was originated to facilitate the
sale of Company owned real estate during 2000 and the $1.4 million represented
interest income that was collected but not recognized during the facilitation
period.  The loan was paid in full during the third quarter, which
resulted in full recognition of interest collected in prior periods.





In
addition, interest income from mortgage-related securities increased $388,000,
or 25.3%, to $1.9 million for the quarter ended September 30, 2008 compared to
$1.5 million for the comparable quarter in 2007.  This was primarily
due to an increase of $20.4 million, or 17.4%, in the average balance to $137.9
million for the three months ended September 30, 2008 from $117.5 million during
the comparable period in 2007.  The increase in average balance was
compounded by a 35 basis point increase in the average yield on mortgage-related
securities to 5.53% for the quarter ended September 30, 2008 from 5.18% for the
comparable period in 2007.  Finally, interest income from debt
securities, federal funds sold and short-term investments decreased $118,000, or
10.6%, to $1.0 million for the three months ended September 30, 2008 compared to
$1.1 million for the comparable period in 2007.  This was due to a 161
basis point decrease in the average yield on other earning assets to 3.12% for
the three-month period ended September 30, 2008 from 4.73% for the comparable
period in 2007, partially offset by an increase of $33.2 million, or 35.4%, in
the average balance of other earning assets to $127.1 million during the
three-month period ended September 30, 2008 from $93.8 million during the
comparable period in 2007.  The decrease in average yield on other
earning assets resulted primarily from a drop in the federal funds rate of 275
basis points between September 30, 2007 and September 30, 2008 and from a
decline in dividends declared on the Company’s FHLBC stock.  The FHLBC
stock yielded a return of 2.77% during the three months ended September 30,
2007, however, no dividend was declared during the three months ended September
30, 2008.  On October 10, 2007, the FHLBC entered into a cease and
desist order with its regulator, the Federal Housing Finance Board. Under the
terms of the order, dividend declarations are subject to the prior written
approval of the Federal Housing Finance Board.  The FHLBC has not
declared a dividend since it entered into the cease and desist
order.


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Total
Interest Expense-Total interest expense decreased by $157,000, or 1.0%, to $15.8 million
during the three months ended September 30, 2008 from $15.9 million during the
three months ended September 30, 2007.





Interest
expense on deposits decreased $1.1 million, or 9.5%, to $10.4 million during the
three months ended September 30, 2008 from $11.5 million during the comparable
period in 2007.  This was due to a decrease in the cost of total
average deposits of 86 basis points to 3.57% for the three months ended
September 30, 2008 compared to 4.43% for the comparable period during
2007.  The decrease in interest expense attributable to the decrease
in the cost of deposits was partially offset by an increase of $126.9 million,
or 12.4%, in the average balance of other interest bearing deposits to $1.15
billion during the three months ended September 30, 2008 from $1.03 billion
during the comparable period in 2007.  The decrease in the cost of
deposits reflects the lower interest rate environment occasioned by the Federal
Reserve’s reduction of short term interest rates which are the basis for
determining the market rate for deposit interest rates.





Interest
expense on borrowings increased $934,000, or 21.0%, to $5.4 million during the
three months ended September 30, 2008 from $4.4 million during the comparable
period in 2007.  The increase resulted primarily from an increase in
average borrowings outstanding of $125.6 million, or 32.3%, to $514.3 million
during the three-month period ended September 30, 2008 from $388.7 million
during the comparable period in 2007.  The increase in average
borrowings was partially offset by a 35 basis point decrease in the average cost
of borrowings to 4.07% during the three-month period ended September 30, 2008
from 4.42% during the three months ended September 30, 2007.





Net
Interest Income - Net interest income increased by $3.8 million or 45.0%,
to $12.3 million during the three months ended September 30, 2008 as compared to
$8.5 million during the same period in 2007.  The increase resulted
primarily from a 74 basis point increase in our net interest rate spread to
2.44% for the three month period ended September 30, 2008 from 1.70% for the
comparable period in 2007. The 74 basis point increase in the net interest rate
spread resulted from a 69 basis point decrease in the cost of interest bearing
liabilities, which was compounded by a 5 basis point increase in the yield on
interest earning assets.  The increase in net interest income
resulting from an increase in our net interest rate spread was partially offset
by a decrease in net average earning assets of $27.9 million, or 18.4%, to
$124.3 million for the three-month period ended September 30, 2008 from $152.2
million from the comparable period in 2007.  The decrease in net
average earning assets was primarily attributable to an increase in loans
transferred to real estate owned and an increase in the allowance for loan
losses.  The average balance of real estate owned totaled $19.6
million for the three months ended September 30, 2008 compared to $3.0 million
for the three months ended September 30, 2007.  The average balance of
the allowance for loan losses totaled $22.5 million for the three months ended
September 30, 2008 compared to $9.9 million for the three months ended September
30, 2007.





Provision
for Loan Losses - Provision for loan losses increased $20.5 million to
$23.3 million during the three months ended September 30, 2008, from $2.8
million during the comparable period during 2007.  The increased
provision for the three months ended September 30, 2008 was the result of $16.7
million of net loan charge-offs combined with continued weakness in local real
estate markets.  The increase in charge-offs is supported by a
reevaluation of assumptions used to determine the fair value of collateral
supporting non performing loans.  In addition, compared to prior periods,
the Company has observed an increased likelihood of the borrower being unable to
resolve the ongoing default in the terms of the loan prior to completion of a
sheriff's sale.  As such, charge-offs are generally being recognized
earlier in the foreclosure process then have been in prior
periods.    See Asset Quality section beginning on page
35 for an analysis of charge-offs, nonperforming assets specific reserves
and additional provisions.


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Noninterest
Income - Total noninterest income decreased $1.3 million, or 68.0%, to
$597,000 during the three months ended September 30, 2008 from $1.9 million
during the comparable period in 2007.  The decrease resulted from $2.0
million in other than temporary impairment loss recognized on a collateralized
mortgage obligation, partially offset by a $609,000 increase in mortgage banking
income generated by our Waterstone Mortgage Corporation subsidiary.





Noninterest
Expense - Total noninterest expense increased $2.1 million, or 28.7%, to
$9.2 million during the three months ended September 30, 2008 from $7.2 million
during the comparable period in 2007.  The increase was primarily the
result of increase in real estate owned expense, a direct follow-on to the
increase in the provision for loan losses and the increase in real estate
owned.





Real
estate owned expense totaled $1.5 million for the three months ended September
30, 2008 compared to $192,000 during the comparable period in
2007.  Real estate owned expense includes the net gain or loss
recognized upon the sale of a foreclosed property, as well as the operating and
carrying costs related to the properties.  During the quarter ended
September 30, 2008, operational expenses totaled $755,000 and net losses on
sales of real estate totaled $763,000.  The increase in expense
compared to the prior period results from an increase in the number and total
cost basis of foreclosed properties.  The average balance of real
estate owned totaled $19.6 million for the three months ended September 30, 2008
compared to $3.0 million for the three months ended September 30,
2007.





Compensation,
payroll taxes and other employee benefit expense increased $634,000, or 16.4%,
to $4.5 million during the three months ended September 30, 2008 from $3.9
million during the comparable period in 2007.  This increase resulted
primarily from an increase in salary expense, partially offset by a reduction in
expense related to the ESOP plan.  Salary expense increased $655,000,
or 24.4%, to $3.4 during the three months ended September 30, 2008 compared to
$2.7 million during the comparable period in 2007 primarily as a result of an
increase in loan origination activity.  Expense related to the
Company’s ESOP plan decreased $105,000, or 34.7%, to $198,000 during the three
months ended September 30, 2008 compared to $303,000 during the comparable
period in 2007.  This decrease directly reflects the decrease in the
Company’s average share price during the three months ended September 30, 2008
compared to the comparable period in 2007.





Income
Taxes – Income tax expense was $8.6 million, or (43.7%) of the pretax
loss of $19.6 million for the three months ended September 30,
2008.  This compares to income tax benefit of $55,000, or (15.0%) of
the pretax loss of $366,000 for the three months ended September 30,
2007.  The unlikely 2008 relationship between pretax loss and income
tax expense for the three months ended September 30, 2008 is the result of
income tax expense related to net deferred tax asset valuation allowances of
$16.1 million.  Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes" requires that to the extent that tax rules could
potentially limit the ultimate realization of the deferred tax assets (generally
through a carryback to prior year's taxable income and future taxable income,
including tax planning strategies), a valuation allowance against the deferred
tax asset should be recorded.  The benefit may be realized in the future,
depending on a number of factors including future taxable income.




Net
Loss-As a
result of the foregoing factors, net loss for the three months ended September
30, 2008 was $28.2 million compared to net income of $421,000 during the
comparable period in 2007.







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Comparison
of Financial Condition at September 30, 2008 and December 31, 2007





Total
Assets - Total assets increased by $187.7 million, or 11.0%, to $1.90
billion at September 30, 2008 from $1.71 billion at December 31, 2007. The
increase in total assets is reflected in increases in loans receivable of $153.4
million, cash and cash equivalents of $34.2 million securities available for
sale and held to maturity of $14.4 million and an increase in real estate owned
of $11.8 million.  These increases were partially offset by an
increase in the allowance for loan losses of $13.4 million and a $6.1 million
decrease in prepaid expenses and other assets.





Cash and
Cash Equivalents–Cash and cash equivalents increased by $34.2 million to $52.1 million at
September 30, 2008 from $17.9 million at December 31, 2007.





Securities
Available for Sale– Securities available for sale increased by $12.1
million, or 7.0%, to $184.2 million at September 30, 2008 from $172.1 million at
December 31, 2007.  The Company invested an additional $10.0 million
in its Nevada investment subsidiary during the nine months ended September 30,
2008.  The investment subsidiary used the proceeds of the capital
infusion to purchase additional mortgage-related securities.  In
addition, the Company purchased a $5 million trust preferred security during the
current year.  This increase was partially offset by an impairment
loss recognized during the third quarter.  In September 2008, the
Company held one available for sale security with a book value that exceeded
market value that was determined to be other than temporarily
impaired.  The security is a collateralized mortgage obligation that
had a book value of $6.6 million and an estimated fair market value of $4.6
million based on the present value of estimated future cash flows.  As
a result of the Company’s analysis, an $2.0 million impairment loss has been
recognized as of September 30, 2008 with respect to this security.





Securities
Held to Maturity – Securities held to maturity increased by $2.3 million,
or 30.0%, to $9.9 million at September 30, 2008 from $7.6 million at December
31, 2007.  These higher yielding structured corporate notes accrue
interest based on the range of a constant maturity treasury yield spread and
therefore have a higher potential for market value volatility.  As the
Company has the intent and ability to hold these securities until maturity, they
have been classified as held-to-maturity rather than as
available-for-sale.  The securities have a total estimated fair value
of $8.6 million as of September 30, 2008.





Loans
Held for Sale–Loans held for sale decreased by $14.5 million, or 62.6%, to $8.6 million
at September 30, 2008, from $23.1 million at December 31,
2007.  Fluctuations in the balance of loans held for sale result
primarily from the timing of loan closings and sales to third
parties.


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Loans
Receivable - Loans receivable increased $153.4 million, or 10.9%, to
$1.56 billion at September 30, 2008 from $1.40 billion at December 31,
2007.  The 2008 total increase in loans receivable was primarily
attributable to a $112.4 million increase in one- to four-family loans, a $35.0
million increase in over four-family loans and a $12.4 million increase in
commercial business.  During the nine-month period ended September 30,
2008, $22.3 million in loans were transferred to real estate owned.





The
following table shows loan origination, principal repayment and sales activity
during the periods indicated.







As
      of or for the
            
            
            As
      of or for theNine
      Months Ended
            
            
            Year
      EndedSeptember
      30, 2008
            
            
            December
      31, 2007(In
      Thousands)Total
      gross loans receivable and held for sale at beginning of
      period
            
            $
            1,495,970
            
            
            
            1,450,170Real
      estate loans originated for investment:ResidentialOne-
      to four-family
            
            
            174,973
            
            
            
            65,851Over
      four-family
            
            
            107,833
            
            
            
            64,857Construction
      and land
            
            
            46,677
            
            
            
            33,705Commercial
      real estate
            
            
            13,414
            
            
            
            13,494Home
      equity
            
            
            15,490
            
            
            
            15,886Total
      real estate loans originated for investment
            
            
            358,387
            
            
            
            193,793Consumer
      loans originated for investment
            
            
            179
            
            
            
            157Commerical
      business loans originated for investment
            
            
            17,906
            
            
            
            25,229Total
      loans originated for investment
            
            
            376,472
            
            
            
            219,179Principal
      repayments
            
            
            (181,122
            )
            
            
            (171,482
            )Transfers
      to real estate owned
            
            
            (22,272
            )
            
            
            (13,455
            )Loan
      principal charge off
            
            
            (21,207
            )
            
            
            (6,163
            )Net
      activity in loans held for investment
            
            
            151,871
            
            
            
            28,079Loans
      originated for sale
            
            
            217,518
            
            
            
            242,120Loans
      sold
            
            
            (231,990
            )
            
            
            (224,399
            )Net
      activity in loans held for sale
            
            
            (14,472
            )
            
            
            17,721Total
      gross loans receivable and held for sale at end of period
            
            $
            1,633,369
            
            
            
            1,495,970








Cash
Surrender Value of Life Insurance – Cash surrender value of life
insurance increased $6.5 million, or 25.4%, to $32.2 million at September 30,
2008 from $25.6 million at December 31, 2007.  A new $5 million bank
owned life insurance contract was entered into during the nine months ended
September 30, 2008.





Prepaid expenses and other
assets


Prepaid
expenses and other assets decreased by $6.1 million, or 41.4%, to $8.6 million
at September 30, 2008 from $14.7 million at December 31, 2007.  The
decrease in prepaid expenses and other assets results from a decrease in net
deferred tax assets of $7.4 million as a result of the aforementioned
establishment of valuation allowances during the quarter ended September 30,
2008.





Deposits
– Total deposits increased $181.2 million, or 18.2%, to $1.18 billion at
September 30, 2008 from $994.5 million at December 31, 2007.  Total
time deposits increased $186.6 million, or 22.6%, to $1.0 billion from $826.2
million at December 31, 2007.  The increase in time deposits resulted
from a promotion for time deposits in both the local retail and non-local
wholesale markets.  Time deposits originated through local retail
outlets increased $91.2 million, or 10.1%, to $903.0 million at September 30,
2008 from $811.9 million at December 31, 2007.  Time deposits
originated through the wholesale market increased $95.4 million, to $109.8
million at September 30, 2008 from $14.3 million at December 31,
2007.  Total money market and savings deposits decreased $4.6 million,
or 4.0%, to $110.5 million at September 30, 2008 from $115.1 million at December
31, 2007.  Total demand deposits decreased $853,000, or 1.6%, to $52.4
million at June 30, 2008 from $53.2 million at December 31, 2007.





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Borrowings
– Total borrowings increased $36.6 million, or 7.7%, to $512.1 million at
September 30, 2008 from $475.5 million at December 31, 2007.  The
overall increase in borrowings at September 30, 2008 was a result of an increase
of $42.3 million in FHLBC advances, partially offset by a decrease of $5.7
million in federal funds borrowed.





Advance
Payments by Borrowers for Taxes - Advance payments by borrowers for taxes
and insurance increased $24.0 million to $24.6 million at September 30, 2008
from $607,000 at December 31, 2007.  The increase was the result of
payments received from borrowers for their real estate taxes and is seasonally
normal, as balances increase during the course of the calendar year until real
estate tax obligations are paid out in the fourth quarter.





Other
Liabilities - Other liabilities decreased $21.6 million, or 57.2%, to
$16.2 million at September 30, 2008 from $37.8 million at December 31,
2007.  The decrease, which is seasonally normal, was primarily due to
a decrease in amounts due to mortgage holders related to advance payments by
borrowers for taxes.  The Company receives payments from borrowers for
their real estate taxes during the course of the calendar year until real estate
tax obligations are paid out in the fourth quarter.  These amounts
remain classified as other liabilities until paid.  The balance of
these outstanding checks was $30,000 at September 30, 2008 and $17.4 million at
December 31, 2007.





Shareholders’
Equity – Shareholders’ equity decreased $32.4 million, or 16.1%, to
$169.4 million at September 30, 2008 from $201.8 million at December 31,
2007.  The decrease was primarily a result of net loss of $30.1
million recognized during the nine months ended September 30,
2008.  In addition, accumulated other comprehensive loss, net of taxes
increased by $4.3 million.  Accumulated other comprehensive loss is
the estimated unrealized loss attributable to the decline in market value of
available-for-sale investment securities.  Volatility in both the
mortgage-backed securities market and the municipal bond market has resulted in
large declines in the estimated market value of these
securities.  These decreases in shareholders’ equity were partially
offset by an increase of $2.0 million due to the net impact of employee benefits
including ESOP, incentive stock options and restricted stock
awards.


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Average
Balance Sheets, Interest and Yields/Costs




The
following tables set forth average balance sheets, average yields and costs, and
certain other information for the periods indicated.  No
tax-equivalent yield adjustments were made, as the effect thereof was not
material.  Non-accrual loans were included in the computation of
average balances.  The yields set forth below include the effect of
deferred fees, discounts and premiums that are amortized or accreted to interest
income or expense.









Nine
      Months Ended September 30,2008
            
            
            2007Average
      Balance
            
            
            Interest
      and Dividends
            
            
            
            
            
            Yield/Cost
            
            
            Average
      Balance
            
            
            Interest
      and Dividends
            
            
            
            
            
            Yield/Cost(Dollars
      in Thousands)Interest-earning
      assets:Loans
      receivable, net
            
            $
            1,492,917
            
            
            
            69,584
            
            
            
            (1
            )
            
            
            6.23
            %
            
            $
            1,384,608
            
            
            
            65,077
            
            
            
            (1
            )
            
            
            6.28
            %Mortgage
      related securities(2)
            
            
            137,942
            
            
            
            5,661
            
            
            
            
            
            
            
            5.49
            
            
            
            104,557
            
            
            
            4,075
            
            
            
            
            
            
            
            5.21Debt
      securities (2),
      federal funds sold and short-term investments
            
            
            109,965
            
            
            
            2,667
            
            
            
            
            
            
            
            3.24
            
            
            
            92,227
            
            
            
            3,178
            
            
            
            
            
            
            
            4.61Total
      interest-earning assets
            
            
            1,740,824
            
            
            
            77,912
            
            
            
            
            
            
            
            5.98
            
            
            
            1,581,392
            
            
            
            72,330
            
            
            
            
            
            
            
            6.12Noninterest-earning
      assets
            
            
            79,949
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            67,895Total
      assets
            
            $
            1,820,773
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            $
            1,649,287Interest-bearing
      liabilities:Demand
      and money market accounts
            
            $
            144,037
            
            
            
            1,790
            
            
            
            
            
            
            
            1.66
            
            
            $
            141,644
            
            
            
            3,378
            
            
            
            
            
            
            
            3.19Savings
      accounts
            
            
            25,552
            
            
            
            184
            
            
            
            
            
            
            
            0.96
            
            
            
            19,424
            
            
            
            60
            
            
            
            
            
            
            
            0.41Certificates
      of deposit
            
            
            925,755
            
            
            
            29,797
            
            
            
            
            
            
            
            4.30
            
            
            
            862,352
            
            
            
            30,171
            
            
            
            
            
            
            
            4.68Total
      interest-bearing deposits
            
            
            1,095,344
            
            
            
            31,771
            
            
            
            
            
            
            
            3.88
            
            
            
            1,023,420
            
            
            
            33,609
            
            
            
            
            
            
            
            4.39Borrowings
            
            
            491,986
            
            
            
            15,233
            
            
            
            
            
            
            
            4.14
            
            
            
            366,907
            
            
            
            12,107
            
            
            
            
            
            
            
            4.41Other
      interest-bearing liabilities
            
            
            19,003
            
            
            
            333
            
            
            
            
            
            
            
            2.35
            
            
            
            19,193
            
            
            
            352
            
            
            
            
            
            
            
            2.45Total
      interest-bearing liabilities
            
            
            1,606,333
            
            
            
            47,337
            
            
            
            
            
            
            
            3.94
            
            
            
            1,409,520
            
            
            
            46,068
            
            
            
            
            
            
            
            4.37Noninterest-bearing
      liabilities
            
            
            13,555
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            17,678Total
      liabilities
            
            
            1,619,888
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1,427,198Equity
            
            
            200,883
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            222,089Total
      liabilities and equity
            
            $
            1,820,771
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            $
            1,649,287Net
      interest income
            
            
            
            
            
            
            30,575
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            26,262Net
      interest rate spread (3)
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            2.04
            %
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1.75
            %Net
      interest-earning assets (4)
            
            $
            134,491
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            $
            171,872Net
      interest margin (5)
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            2.35
            %
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            2.22
            %Average
      interest-earning assets to average interest-bearing
      liabilities
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            108.37
            %
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            112.19
            %







__________




(1)  Includes
      net deferred loan fee amortization income of $1,306,000 and $1,683,000 for
      the nine months ended September 30, 2008 and 2007,
      respectively.


(2)  Average
      balance of mortgage related and debt securities is based on amortized
      historical cost.


(3)  Net
      interest rate spread represents the difference between the yield on
      average interest-earning assets and the cost
of


average
interest-bearing liabilities.


(4)  Net
      interest-earning assets represent total interest-earning assets less total
      interest-bearing liabilities.


(5)  Net
      interest margin represents net interest income divided by average total
      interest-earning assets.








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Three
      Months Ended September 30,2008
            
            
            2007Average
      Balance
            
            
            Interest
      and Dividends
            
            
            
            
            
            Yield/Cost
            
            
            Average
      Balance
            
            
            Interest
      and Dividends
            
            
            
            
            
            Yield/Cost(Dollars
      in Thousands)Interest-earning
      assets:Loans
      receivable, net
            
            $
            1,553,779
            
            
            
            25,166
            
            
            
            (1
            )
            
            
            6.43
            %
            
            $
            1,383,271
            
            
            
            21,769
            
            
            
            (1
            )
            
            
            6.24
            %Mortgage
      related securities(2)
            
            
            137,890
            
            
            
            1,921
            
            
            
            
            
            
            
            5.53
            
            
            
            117,489
            
            
            
            1,533
            
            
            
            
            
            
            
            5.18Debt
      securities (2),
      federal funds sold and short-term investments
            
            
            127,061
            
            
            
            1,000
            
            
            
            
            
            
            
            3.12
            
            
            
            93,827
            
            
            
            1,118
            
            
            
            
            
            
            
            4.73Total
      interest-earning assets
            
            
            1,818,730
            
            
            
            28,087
            
            
            
            
            
            
            
            6.13
            
            
            
            1,594,587
            
            
            
            24,420
            
            
            
            
            
            
            
            6.08Noninterest-earning
      assets
            
            
            84,216
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            67,889Total
      assets
            
            $
            1,902,946
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            $
            1,662,476Interest-bearing
      liabilities:Demand
      and money market accounts
            
            $
            141,052
            
            
            
            449
            
            
            
            
            
            
            
            1.26
            
            
            $
            147,598
            
            
            
            1,200
            
            
            
            
            
            
            
            3.23Savings
      accounts
            
            
            28,157
            
            
            
            69
            
            
            
            
            
            
            
            0.98
            
            
            
            19,485
            
            
            
            20
            
            
            
            
            
            
            
            0.41Certificates
      of deposit
            
            
            984,109
            
            
            
            9,848
            
            
            
            
            
            
            
            3.97
            
            
            
            859,382
            
            
            
            10,237
            
            
            
            
            
            
            
            4.73Total
      interest-bearing deposits
            
            
            1,153,318
            
            
            
            10,366
            
            
            
            
            
            
            
            3.57
            
            
            
            1,026,465
            
            
            
            11,457
            
            
            
            
            
            
            
            4.43Borrowings
            
            
            514,278
            
            
            
            5,282
            
            
            
            
            
            
            
            4.07
            
            
            
            388,679
            
            
            
            4,327
            
            
            
            
            
            
            
            4.42Other
      interest-bearing liabilities
            
            
            26,822
            
            
            
            108
            
            
            
            
            
            
            
            1.59
            
            
            
            27,193
            
            
            
            129
            
            
            
            
            
            
            
            1.88Total
      interest-bearing liabilities
            
            
            1,694,418
            
            
            
            15,756
            
            
            
            
            
            
            
            3.69
            
            
            
            1,442,337
            
            
            
            15,913
            
            
            
            
            
            
            
            4.38Noninterest-bearing
      liabilities
            
            
            8,784
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            15,248Total
      liabilities
            
            
            1,703,202
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1,457,585Equity
            
            
            199,744
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            204,891Total
      liabilities and equity
            
            $
            1,902,946
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            $
            1,662,476Net
      interest income
            
            
            
            
            
            
            12,331
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            8,507Net
      interest rate spread (3)
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            2.44
            %
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1.70
            %Net
      interest-earning assets (4)
            
            $
            124,312
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            $
            152,250Net
      interest margin (5)
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            2.69
            %
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            2.12
            %Average
      interest-earning assets to average interest-bearing
      liabilities
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            107.34
            %
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            110.56
            %





______________


(1)  Includes
      net deferred loan fee amortization income of $435,000 and $498,000 for the
      three months ended September 30, 2008 and 2007,
    respectively.


(2)  Average
      balance of mortgage related and debt securities is based on amortized
      historical cost.


(3)  Net
      interest rate spread represents the difference between the yield on
      average interest-earning assets and the cost
of


average
interest-bearing liabilities.


(4)  Net
      interest-earning assets represent total interest-earning assets less total
      interest-bearing liabilities.


(5)  Net
      interest margin represents net interest income divided by average total
      interest-earning assets.











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Rate/Volume
Analysis


The
following table sets forth the effects of changing rates and volumes on our net
interest income for the periods indicated.  The rate column shows the
effects attributable to changes in rate (changes in rate multiplied by prior
volume).  The volume column shows the effects attributable to changes
in volume (changes in volume multiplied by prior rate).  The net
column represents the sum of the prior columns.  For purposes of this
table, changes attributable to changes in both rate and volume that cannot be
segregated have been allocated proportionately based on the changes due to rate
and the changes due to volume.







Nine
      Months Ended September 30,
            
            
            Three
      Months Ended September 30,2008
      versus 2007
            
            
            2008
      versus 2007Increase
      (Decrease) due to
            
            
            Increase
      (Decrease) due toVolume
            
            
            Rate
            
            
            Net
            
            
            Volume
            
            
            Rate
            
            
            Net(In
      Thousands)
            
            
            (In
      Thousands)Interest
      and dividend income:Loans
      receivable(1)
      (2)
            
            $
            5,319
            
            
            
            (812
            )
            
            
            4,507
            
            
            $
            2,747
            
            
            
            650
            
            
            
            3,397Mortgage
      related securities
            
            
            1,374
            
            
            
            212
            
            
            
            1,586
            
            
            
            279
            
            
            
            109
            
            
            
            388Other
      earning assets(3)
            
            
            546
            
            
            
            (1,057
            )
            
            
            (511
            )
            
            
            324
            
            
            
            (442
            )
            
            
            (118
            )Total
      interest-earning assets
            
            
            7,239
            
            
            
            (1,657
            )
            
            
            5,582
            
            
            
            3,350
            
            
            
            317
            
            
            
            3,667Interest
      expense:Demand
      and money market accounts
            
            
            58
            
            
            
            (1,646
            )
            
            
            (1,588
            )
            
            
            (51
            )
            
            
            (700
            )
            
            
            (751
            )Savings
      accounts
            
            
            24
            
            
            
            100
            
            
            
            124
            
            
            
            12
            
            
            
            37
            
            
            
            49Certificates
      of deposit
            
            
            2,189
            
            
            
            (2,563
            )
            
            
            (374
            )
            
            
            1,360
            
            
            
            (1,749
            )
            
            
            (389
            )Total
      interest-bearing deposits
            
            
            2,271
            
            
            
            (4,109
            )
            
            
            (1,838
            )
            
            
            1,321
            
            
            
            (2,412
            )
            
            
            (1,091
            )Borrowings
            
            
            3,952
            
            
            
            (826
            )
            
            
            3,126
            
            
            
            1,306
            
            
            
            (351
            )
            
            
            955Other
      interest bearing liabilities
            
            
            (3
            )
            
            
            (16
            )
            
            
            (19
            )
            
            
            (2
            )
            
            
            (19
            )
            
            
            (21
            )Total
      interest-bearing liabilities
            
            
            6,220
            
            
            
            (4,951
            )
            
            
            1,269
            
            
            
            2,625
            
            
            
            (2,782
            )
            
            
            (157
            )Net
      change in net interest income
            
            
            1,019
            
            
            
            3,294
            
            
            
            4,313
            
            
            
            725
            
            
            
            3,099
            
            
            
            3,824





______________


(1)
            Includes
      net deferred loan fee amortization income of $1,306,000, $1,683,000,
      $435,000 and $498,000 for the nine and three months ended September 30,
      2008 and 2007, respectively.


(2)
            Non-accrual
      loans have been included in average loans receivable
    balance.


(3)
            Average
      balance of available for sale securities is based on amortized historical
      cost.





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ASSET
QUALITY





The
following table summarizes nonperforming loans and assets:




NONPERFORMING
ASSETS







At
      September 30,
            
            
            At
      December 31,2008
            
            
            2007(Dollars
      in Thousands)Non-accrual
      loans:ResidentialOne-
      to four-family
            
            $
            30,488
            
            
            
            32,587Over
      four-family
            
            
            36,298
            
            
            
            38,218Construction
      and land
            
            
            17,152
            
            
            
            3,855Commercial
      real estate
            
            
            7,604
            
            
            
            4,358Home
      equity
            
            
            1,082
            
            
            
            1,332Total
      non-accrual loans
            
            
            92,624
            
            
            
            80,350Real
      estate owned
            
            
            20,304
            
            
            
            8,543Total
      non-performing assets
            
            $
            112,928
            
            
            
            88,893Total
      non-accrual loans to total loans receivable
            
            
            5.95
            %
            
            
            5.73
            %Total
      non-accrual loans to total assets
            
            
            4.85
            %
            
            
            4.70
            %Total
      non-performing assets to total assets
            
            
            5.92
            %
            
            
            5.20
            %








Total
non-accrual loans increased by $12.3 million to $92.6 million as of September
30, 2008, compared to $80.4 million as of December 31, 2007.  The
ratio of non-accrual loans to total loans at September 30, 2008 was 5.95%
compared to 5.73% at December 31, 2007.  The increase in non-accrual
loans was primarily attributable to the construction and land
category.  The $13.3 million increase in the construction and land
category was attributable to six lending relationships.  The largest
relationship consists of one loan with a principal balance of $5.8
million.  The Company believes that the value of the collateral, which
consists of land and improvements related to a 90-unit apartment complex that is
in the process of conversion to condominiums, is sufficient to allow for the
recovery of the outstanding balance should the borrower cease his efforts to
return the loan to a performing status.  The second largest
relationship consists of one loan with a principal balance of $3.5 million
collateralized by land and improvements related to an 84-unit condominium
development.  During the third quarter, the Company determined that
the value of the collateral was not sufficient to allow for the recovery of the
outstanding loan balance.  As a result of the collateral shortfall, a
$950,000 charge off was recorded.  The remaining four relationships
consist of four unrelated borrowers with loans totaling $4.0
million.  The collateral related to each of these loans consists of
land and improvements related to condominium developments.  During the
third quarter, the Company determined that the value of the collateral was not
sufficient to allow for the recovery of the outstanding loan
balances.  As a result of the collateral shortfall, an aggregate of
$2.6 million in charge-offs were recorded with respect to the four
relationships.





The $3.2
million increase in non-accrual commercial real estate loans was attributable to
two lending relationships.  The first relationship consists of a $2.2
million loan secured by a light industrial building and land.  During
the third quarter, the Company determined that the value of the collateral was
not sufficient to allow for the recovery of the outstanding loan
balance.  As a result of the collateral shortfall, a $215,000 charge
off was recorded.  The second relationship consists of a $2.1 million
loan related to a mixed use retail and residential building.  Based
upon a review of the underlying collateral, management has determined that the
value of the collateral was not sufficient to allow for the recovery of the
outstanding loan balance.  As a result of the collateral shortfall, a
$665,000 charge off was recorded.





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 Table of Contents


Of the
$92.6 million in total non-accrual loans as of September 30, 2008, $47.8 million
related to four borrower relationships or types of relationships.  The
first is a $12.2 million relationship with a borrower who has 16 loans that are
all secured by multi-family properties.  Based upon a review of the
underlying collateral, the Company has determined that the value of the
properties is not sufficient to allow for the recovery of the outstanding
balance.  As a result, a $2.7 million charge off was recorded during
the third quarter with respect to this relationship.  The second is a
relationship with a borrower who has seven loans totaling $7.7
million.  The Company believes that the collateral, which consists of
a single family home, two- to four-family and multi-family rental units and
commercial real estate, is not sufficient to recover the outstanding principal
balance of each of the loans, should the borrower cease efforts to return the
loan to a performing status.  As a result, a $1.8 million charge off
was recorded during the third quarter with respect to this
relationship.  In addition to the two borrower relationships noted
previously, a significant portion of total non-accrual loans relates to a number
of lending relationships with small real estate investors, whose collateral
consists of non-owner occupied one- to four-family properties.  As of
September 30, 2008, $14.6 million relates to this general
category.  Based upon a review of the underlying collateral, the
Company has determined that the value of the properties related to these loans
is not sufficient to allow for the recovery of the outstanding
balance.  As a result, $1.8 million in charge-offs were recorded
during the third quarter with respect to this general category of
borrowers.  An additional $13.3 million relates to a number of lending
relationships with real estate developers.  Based upon a review of the
underlying collateral, the Company has determined that the value of the
properties related to these loans is not sufficient to allow for the recovery of
the outstanding balance.  As a result, $3.5 million in charge-offs
were recorded during the third quarter with respect to this general category of
borrowers.





Total
real estate owned increased by $11.8 million, to $20.3 million as of September
30, 2008, compared to $8.5 million as of December 31, 2007.  Of this
increase, $5.3 million relates to two former lending
relationships.  The first relationship consisted of a real estate
investor with fourteen one-to four-family and multifamily properties with an
estimated net realizable value of $2.9 million.  The second
significant relationship consisted of a real estate investor with a 60-unit
multifamily property with an estimated net realizable value of $2.4
million.  In addition to these three relationships, $6.6 million of
the overall September 30, 2008 balance represented non-owner occupied one- to
four-family properties owned by small real estate
investors.  Foreclosed properties are recorded at the lower of
carrying value or fair value with charge-offs, if any, charged to the allowance
for loan losses upon transfer to real estate owned.  The fair value is
primarily based upon updated appraisals in addition to an analysis of current
real estate market conditions.  Upon foreclosure and transfer to real
estate owned the Company recognized approximately $6.5 million in charge-offs
related to these properties during the nine-month periods ended September 30,
2008.


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 Table of Contents


A summary
of the allowance for loan losses is shown below:





ALLOWANCE
FOR LOAN LOSSES





At
      or for the Nine MonthsEnded
      September 30,2008
            
            
            2007(Dollars
      in Thousands)Balance
      at beginning of period
            
            $
            12,839
            
            
            $
            7,195Provision
      for loan losses
            
            
            34,578
            
            
            
            8,852Charge-offs:MortgageOne-
      to four-family
            
            
            7,154
            
            
            
            979Over
      four-family
            
            
            7,828
            
            
            
            314Commercial
      real estate
            
            
            1,838
            
            
            
            -Construction
      and land
            
            
            4,333
            
            
            
            3,278Home
      equity
            
            
            348
            
            
            
            -Consumer
            
            
            3
            
            
            
            27Total
      charge-offs
            
            
            21,504
            
            
            
            4,598Recoveries:MortgageOne-
      to four-family
            
            
            155
            
            
            
            32Over
      four-family
            
            
            10
            
            
            
            -Construction
      and land
            
            
            125
            
            
            
            -Consumer
            
            
            7
            
            
            
            1Total
      recoveries
            
            
            297
            
            
            
            33Net
      charge-offs
            
            
            21,207
            
            
            
            4,565Allowance
      at end of period
            
            $
            26,210
            
            
            $
            11,482Ratios:Allowance
      for loan losses to non-accrual loans at end of period
            
            
            28.30
            %
            
            
            16.65
            %Allowance
      for loan losses to loans receivable at end of period
            
            
            1.69
            %
            
            
            0.83
            %Net
      charge-offs to average loans outstanding (annualized)
            
            
            1.89
            %
            
            
            0.44
            %





_______________





Net
charge-offs totaled $21.2 million, or 1.89% of average loans for the nine months
ended September 30, 2008 on an annualized basis, compared to $4.6 million, or
0.44% of average loans for the comparable period in 2007.  The increase in
charge-offs is supported by a reevaluation of assumptions used to determine the
fair value of collateral supporting non performing loans.  In addition,
compared to prior periods, the Company has observed an increased likelihood of
the borrower being unable to resolve the ongoing default in the terms of the
loan prior to completionof a sheriff's sale.  As such, charge-offs are
generally being recognized earlier in the foreclosure process then they have
been in prior periods.  Of the $21.2 million in net charge-offs for
the nine months ended September 30, 2008, $7.2 million related to loans secured
by one- to four-family loans.  The vast majority of charge-offs in
this category relate to losses sustained on properties owned and managed by
small real estate investors.  An additional $7.8 million in net
charge-offs related to over four-family loans.  Of this total,
approximately $3.6 million related to one relationship with a borrower with whom
the Company had nineteen loans collateralized by multifamily properties located
in the City of Milwaukee and its surrounding suburban areas.  Four of
these properties are now held by the Company as real estate
owned.  The remaining properties are in the process of
foreclosure.  Of the $4.2 million in net charge-offs related to
construction and land loans, $3.5 million related to loans made to five
unrelated borrowers to finance condominium developments.  All of these
properties are in the process of foreclosure.


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 Table of Contents


The
allowance for loan loss totaled $26.2 million or 1.69% of loans outstanding as
of September 30, 2008 compared to $12.8 million or 0.92% of loans outstanding as
of December 31, 2007.  The majority of the $13.4 million increase in
the allowance for loan loss during the nine months ended September 30, 2008 is
primarily attributable to the increase in non-accrual loans, growth of the
overall loan portfolio and an increase in loss experience directly related to
the weak real estate market.  Weakness in the residential real estate
market is well into its second year and the risk of loss on loans secured by
residential real estate continues to rise.  Due to these unprecedented
market conditions, the Company expanded its loan review process to identify
additional potential loan collateral short falls.  The result of this
expanded process resulted in the aforementioned increase in net charge-offs as
well as the increase in the overall level of the allowance for loan
losses.





The
allowance for loan losses has been determined in accordance with accounting
principles generally accepted in the United States (GAAP). We are responsible
for the timely and periodic determination of the amount of the allowance
required. Future provisions for loan losses will continue to be based upon our
assessment of the overall loan portfolio and the underlying collateral, trends
in nonperforming loans, current economic conditions and other relevant factors.
To the best of management’s knowledge, all probable losses have been provided
for in the allowance for loan losses.





The
establishment of the amount of the loan loss allowance inherently involves
judgments by management as to the adequacy of the allowance, which ultimately
may or may not be correct. Higher than anticipated rates of loan default would
likely result in a need to increase provisions in future years. See “Significant
Accounting Policies” above for a discussion on the use of judgment in
determining the amount of the allowance for loan losses.





Impact
of Inflation and Changing Prices





The
financial statements and accompanying notes of the Company have been prepared in
accordance with GAAP. GAAP generally requires the measurement of financial
position and operating results in terms of historical dollars without
consideration for changes in the relative purchasing power of money over time
due to inflation. The impact of inflation is reflected in the increased cost of
our operations. Unlike industrial companies, our assets and liabilities are
primarily monetary in nature. As a result, changes in market interest rates have
a greater impact on performance than do the effects of
inflation.


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 Table of Contents


Liquidity
and Capital Resources





We
maintain liquid assets at levels we consider adequate to meet our liquidity
needs.  Our liquidity ratio averaged 2.2% and 2.6% for the nine months
ended September 30, 2008 and 2007 respectively.  The liquidity ratio
is equal to average daily cash and cash equivalents for the period divided by
average total assets.  We adjust our liquidity levels to fund loan
commitments, repay our borrowings, fund deposit outflows and pay real estate
taxes on mortgage loans.  We also adjust liquidity as appropriate to
meet asset and liability management objectives.  The operational
adequacy of our liquidity position at any point in time is dependent upon the
judgment of the Chief Financial Officer as supported by the full Asset/Liability
Committee.  Liquidity is monitored on a daily, weekly and monthly
basis using a variety of measurement tools and indicators.




Our
primary sources of liquidity are deposits, amortization and prepayment of loans,
maturities of investment securities and other short-term investments, and
earnings and funds provided from operations.  While scheduled
principal repayments on loans are a relatively predictable source of funds,
deposit flows and loan prepayments are greatly influenced by market interest
rates, economic conditions, and rates offered by our competitors.  We
set the interest rates on our deposits to maintain a desired level of total
deposits.  In addition, we invest excess funds in short-term,
interest-earning assets, which provide liquidity to meet lending
requirements.  Additional sources of liquidity used for the purpose of
managing long- and short-term cash flows include $20 million in federal funds
lines of credit with a commercial bank and advances from the FHLBC.




A portion
of our liquidity consists of cash and cash equivalents, which are a product of
our operating, investing and financing activities.  At September 30,
2008 and 2007, respectively, $52.1 million and $22.6 million of our assets were
invested in cash and cash equivalents.  Our primary sources of cash
are principal repayments on loans, proceeds from the calls and maturities of
debt and mortgage-related securities, increases in deposit accounts, federal
funds purchased and advances from the FHLBC.




On
October 10, 2007, the FHLBC entered into a consensual cease and desist order
with its regulator, the Federal Housing Finance Board. Under the terms of the
order, capital stock repurchases and redemptions, including redemptions upon
membership withdrawal or other termination, are prohibited unless the FHLBC has
received approval of the Director of the Office of Supervision of the Federal
Housing Finance Board ("OS Director"). The order also provides that dividend
declarations are subject to the prior written approval of the OS Director.At the request of the
FHLBC, on July 24, 2008, the Finance Board amended the cease and desist order to
allow the FHLBC to redeem incremental purchases of capital stock tied to
increased levels of borrowing through advances after repayment of those new
advances.  We currently hold, at cost, $21.7 million of FHLBC stock,
all of which we believe we will ultimately be able to recover.  Based
upon correspondence we received from the FHLBC, there is currently no
expectation that this cease and desist order will impact the short- and
long-term funding options provided by the FHLBC.




Our cash
flows are derived from operating activities, investing activities and financing
activities as reported in our Consolidated Statements of Cash Flows included in
our Consolidated Financial Statements.




During
the nine months ended September 30, 2008 and 2007, loan originations, net of
collected principal, charge-offs and transfers to real estate owned, totaled
$151.9 million and $8.7 million, respectively, reflecting net growth in our
portfolio.




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Deposit
flows are generally affected by the level of interest rates, the interest rates
and products offered by local competitors, and other
factors.  Deposits increased by $82.8 million for the three months
ended September 30, 2008 primarily as the result of competitive pricing offered
in the local market as well as the non-local wholesale market.




Liquidity
management is both a daily and longer-term function of business
management.  If we require funds beyond our ability to generate them
internally, borrowing agreements exist with the FHLBC, which provide an
additional source of funds.  At September 30, 2008, we had $428.1
million in advances from the FHLBC, of which $25.1 million was due within 12
months, and an additional available borrowing limit of $99.7 million based on
collateral requirements of the FHLBC.  As an additional source of
funds, we also enter into repurchase agreements.  At September 30,
2008, we had $84.0 million in repurchase agreements.  The agreements
mature at various times beginning in 2017, however, both all are callable
beginning in 2009 and quarterly thereafter.




At
September 30, 2008, we had outstanding commitments to originate loans of $19.9
million, unfunded commitments under construction loans of $24.2 million,
unfunded commitments under business lines of credit of $10.6 million and
unfunded commitments under lines of credit and standby letters of credit of
$33.8 million.  At September 30, 2008, certificates of deposit
scheduled to mature in one year or less totaled $798.5million.  Based
on prior experience, management believes that a significant portion of such
deposits will remain with us, although there can be no assurance that this will
be the case.  In the event a significant portion of our deposits is
not retained by us, we will have to utilize other funding sources, such as FHLBC
advances in order to maintain our level of assets.  However, we cannot
assure that such borrowings would be available on attractive terms, or at all,
if and when needed.  Alternatively, we would reduce our level of
liquid assets, such as our cash and cash equivalents and securities
available-for-sale in order to meet funding needs.  In addition, the
cost of such deposits may be significantly higher if market interest rates are
higher or there is an increased amount of competition for deposits in our market
area at the time of renewal.




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Regulatory
Capital







WaterStone
Bank is subject to various regulatory capital requirements administered by the
federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory and possibly additional discretionary actions by
regulators that, if undertaken, could have a direct material effect on the
Company’s financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank’s assets,
liabilities, and certain off-balance-sheet items, as calculated under regulatory
accounting practices. The Bank’s capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings, and other factors.




Quantitative
measures established by regulation to ensure capital adequacy require the Bank
to maintain minimum amounts and ratios (set forth in the table below) of total
and Tier I capital (as defined in the regulations) to risk-weighted assets
(as defined) and of Tier I capital (as defined) to average assets (as
defined). Management believes that as of September 30, 2008, the Bank met all
capital adequacy requirements to which it is subject.  WaterStone Bank
expects to enter into an informal agreement with its federal and state
bank regulators whereby it will agree to maintain a minimum Tier 1
capital ratio of 8.00% and a minimum total risk based capital ratio of
10.00%.  At September 30, 2008, these higher capital requirements were
satisfied.




As of
September 30, 2008 the most recent notification from the Federal Deposit
Insurance Corporation categorized WaterStone Bank as “well capitalized” under
the regulatory framework for prompt corrective action. To be categorized as
“well capitalized,” WaterStone Bank must maintain minimum total risk-based,
Tier I risk-based and Tier I leverage ratios, as set forth in the
table below. There are no conditions or events since that notification that
management believes have changed WaterStone Bank’ category.




As a
state-chartered savings bank, WaterStone Bank is required to meet minimum
capital levels established by the state of Wisconsin in addition to federal
requirements. For the state of Wisconsin, regulatory capital consists of
retained income, paid-in-capital, capital stock equity and other forms of
capital considered to be qualifying capital by the Federal Deposit Insurance
Corporation.




The
actual capital amounts and ratios for WaterStone Bank as of September 30, 2008
are presented in the table below:









September
      30, 2008To
      Be Well-CapitalizedFor
      Capital
            
            
            Under
      Prompt CorrectiveActual
            
            
            Adequacy
      Purposes
            
            
            Action
      ProvisionsAmount
            
            
            Ratio
            
            
            Amount
            
            
            Ratio
            
            
            Amount
            
            
            Ratio(Dollars
      in Thousands)WaterStone
      BankTotal
      capital (to risk-weighted assets)
            
            $
            182,559
            
            
            
            12.01
            %
            
            $
            121,558
            
            
            
            8.00
            %
            
            $
            151,948
            
            
            
            10.00
            %Tier
      I capital (to risk-weighted assets)
            
            
            163,479
            
            
            
            10.76
            %
            
            
            60,779
            
            
            
            4.00
            %
            
            
            91,169
            
            
            
            6.00
            %Tier
      I capital (to average assets)
            
            
            163,479
            
            
            
            8.65
            %
            
            
            75,637
            
            
            
            4.00
            %
            
            
            94,547
            
            
            
            5.00
            %State
      of Wisconsin (to total assets)
            
            
            163,479
            
            
            
            8.65
            %
            
            
            113,391
            
            
            
            6.00
            %
            
            
            N/A
            
            
            
            N/A


_____________




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Contractual
Obligations, Commitments, Contingent Liabilities, and Off-balance Sheet
Arrangements




The
following tables present information indicating various contractual obligations
and commitments of the Company as of September 30, 2008 and the respective
maturity dates.




_________


One
      Year
            
            
            Through
            
            
            Through
            
            
            FiveTotal
            
            
            or
      Less
            
            
            Three
      Years
            
            
            Five
      Years
            
            
            Years(In
      Thousands)Deposits
      without a stated maturity (5)
            
            $
            162,905
            
            
            
            162,905
            
            
            
            -
            
            
            
            -
            
            
            
            -Certificates
      of deposit (5)
            
            
            1,012,781
            
            
            
            798,491
            
            
            
            192,729
            
            
            
            21,561
            
            
            
            -Federal
      Home Loan Bank advances (1)
            
            
            428,050
            
            
            
            25,050
            
            
            
            53,000
            
            
            
            -
            
            
            
            350,000Repurchase
      agreements (2)(5)
            
            
            84,000
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            84,000Operating
      leases (3)
            
            
            130
            
            
            
            104
            
            
            
            26
            
            
            
            -
            
            
            
            -Capital
      lease
            
            
            3,450
            
            
            
            3,450
            
            
            
            -
            
            
            
            -
            
            
            
            -State
      income tax obligation (4)
            
            
            2,484
            
            
            
            1,242
            
            
            
            1,242
            
            
            
            -
            
            
            
            -Salary
      continuation agreements
            
            
            2,401
            
            
            
            576
            
            
            
            848
            
            
            
            340
            
            
            
            637$
            1,696,201
            
            
            
            991,818
            
            
            
            247,845
            
            
            
            21,901
            
            
            
            434,637


______


(1)  Secured
      under a blanket security agreement on qualifying assets, principally,
      mortgage loans.  Excludes interest which will accrue on the
      advances.  All Federal Home Loan Bank advances with maturities
      exceeding five years are callable on a quarterly basis with the initial
      call at various times through March
2009.


(2)  The
repurchase agreements are callable on a quarterly basis with the initial call in
March 2009.


(3)  Represents
non-cancelable operating leases for offices and equipment.


(4)  Represents
remaining amounts due to the Wisconsin Department of Revenue related to the
operations of the Company’s Nevada subsidiary.


(5)Excludes
interest.





The
following table details the amounts and expected maturities of significant
off-balance sheet commitments as of September 30, 2008.





Other
      CommitmentsMore
      than
            
            
            More
      thanOne
      Year
            
            
            Three
      Years
            
            
            OverOne
      Year
            
            
            Through
            
            
            Through
            
            
            FiveTotal
            
            
            or
      Less
            
            
            Three
      Years
            
            
            Five
      Years
            
            
            Years(In
      Thousands)Real
      estate loan commitments (1)
            
            
            19,946
            
            
            
            19,946
            
            
            
            -
            
            
            
            -
            
            
            
            -Unused
      portion of home equity lines of credit (2)
            
            
            31,922
            
            
            
            31,922
            
            
            
            -
            
            
            
            -
            
            
            
            -Unused
      portion of business lines of credit
            
            
            10,578
            
            
            
            10,578
            
            
            
            -
            
            
            
            -
            
            
            
            -Unused
      portion of construction loans (3)
            
            
            24,212
            
            
            
            24,212
            
            
            
            -
            
            
            
            -
            
            
            
            -Standby
      letters of credit
            
            
            1,866
            
            
            
            1,629
            
            
            
            152
            
            
            
            85
            
            
            
            -Total
      Other Commitments
            
            
            88,524
            
            
            
            88,287
            
            
            
            152
            
            
            
            85
            
            
            
            -





______________


General:  Commitments
to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract and generally have fixed
expiration dates or other termination clauses.


(1)  Commitments
for loans are extended to customers for up to 90 days after which they
expire.


(2)  Unused
portions of home equity loans are available to the borrower for up to 10
years.


(3)  Unused
portions of construction loans are available to the borrower for up to 1
year.


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Item 3. Quantitative and Qualitative
Disclosures about Market Risk





Management
of Market Risk





General.The
majority of our assets and liabilities are monetary in
nature.  Consequently, our most significant form of market risk is
interest rate risk.  Our assets, consisting primarily of mortgage
loans, have longer maturities than our liabilities, consisting primarily of
deposits and other borrowings.  As a result, a principal part of our
business strategy is to manage interest rate risk and reduce the exposure of our
net interest income to changes in market interest rates.  Accordingly,
the WaterStone Bank Board of Directors has established an Asset/Liability
Committee which is responsible for evaluating the interest rate risk inherent in
our assets and liabilities, for determining the level of risk that is
appropriate given our business strategy, operating environment, capital,
liquidity and performance objectives, and for managing this risk consistent with
the guidelines approved by the Board of Directors.  Management
monitors the level of interest rate risk on a regular basis and the
Asset/Liability Committee meets at least weekly to review our asset/liability
policies and interest rate risk position, which are evaluated
quarterly.





Income
Simulation.  Simulation analysis is used to estimate our
interest rate risk exposure at a particular point in time.  At least
quarterly we review the potential effect changes in interest rates could have on
the repayment or repricing of rate sensitive assets and funding requirements of
rate sensitive liabilities.  Our most recent simulation used projected
repricing of assets and liabilities at September 30, 2008 on the basis of
contractual maturities, anticipated repayments and scheduled rate
adjustments.  Prepayment rate assumptions can have a significant
impact on interest income simulation results.  Because of the large
percentage of loans and mortgage-backed securities we hold, rising or falling
interest rates may have a significant impact on the actual prepayment speeds of
our mortgage-related assets that may in turn affect our interest rate
sensitivity position.  When interest rates rise, prepayment speeds
slow and the expected average lives of our assets tend to lengthen more than the
expected average lives of our liabilities and, therefore, negatively impact net
interest income and earnings.









Percentage
              Increase (Decrease) in
      Estimated
              Annual Net Interest Income
              Over 24 Months300
      basis point increase in rates
            
            
            -5.40
            %200
      basis point increase in rates
            
            
            (0.73
            )100
      basis point increase in rates
            
            
            0.99100
      basis point decrease in rates
            
            
            (6.17
            )200
      basis point decrease in rates
            
            
            (8.16
            )300
      basis point decrease in rates
            
            
            (14.38
            )








WaterStone
Bank’s Asset/Liability policy limits projected changes in net average annual
interest income to a maximum variance of (10%) to (50%) for various levels of
interest rate changes measured over a 24-month period when compared to the flat
rate scenario.  In addition, projected changes in the capital ratio
are limited to (0.15%) to (1.00%) for various levels of changes in interest
rates when compared to the flat rate scenario.  These limits are
re-evaluated on a periodic basis and may be modified, as
appropriate.  Because our balance sheet is asset sensitive, income is
projected to increase proportionately with increases in interest
rates.  At September 30, 2008, a 100 basis point immediate and
instantaneous increase in interest rates had the effect of increasing estimated
net interest income by 0.99% while a 100 basis point decrease in rates had the
affect of decreasing net interest income by 6.17%.  At September 30,
2008, a 100 basis point immediate and instantaneous increase in interest rates
had the effect of increasing the estimated return on assets by 0.02% while a 100
basis point decrease in rates had the effect of decreasing the return on assets
by 0.10%.  While we believe the assumptions used are reasonable, there
can be no assurance that assumed prepayment rates will approximate actual future
mortgage-backed security and loan repayment activity.







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Item 4. Controls and
Procedures





Disclosure
Controls and Procedures:Company management, with the
participation of the Company’s Chief Executive Officer and Chief Financial
Officer, has evaluated the effectiveness of the Company’s disclosure controls
and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as
of the end of the period covered by this report. Based on such evaluation, the
Company’s Chief Executive Officer and Chief Financial Officer have concluded
that, as of the end of such period, the Company’s disclosure controls and
procedures are effective in recording, processing, summarizing and reporting, on
a timely basis, information required to be disclosed by the Company in the
reports that it files or submits under the Exchange Act.





Internal
Control Over Financial Reporting:There have not been any
changes in the Company’s internal control over financial reporting (as such term
is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the
fiscal quarter to which this report relates that have materially affected, or
are reasonably likely to materially affect, the Company’s internal control over
financial reporting.


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PART II. OTHER
INFORMATION








Item 1. Legal
Proceedings





We are
not involved in any pending legal proceedings as a defendant other than routine
legal proceedings occurring in the ordinary course of business.  At
September 30, 2008, we believe that any liability arising from the resolution of
any pending legal proceedings will not be material to our financial condition or
results of operations.




Item 1A. Risk
Factors




In
addition to the “Risk Factors” in Item 1A of the Company’s annual report on Form
10-K for the year ended December 31, 2007, we set forth the additional risk
factors.




Our
Non-Interest Expense Will Increase As A Result Of Increases In FDIC Insurance
Premiums





The
Federal Deposit Insurance Corporation (“FDIC”) imposes an assessment against
institutions for deposit insurance.  This assessment is based on the
risk category of the institution and currently ranges from 5 to 43 basis points
of the institution’s deposits.  Federal law requires that the
designated reserve ratio for the deposit insurance fund be established by the
FDIC at 1.15% to 1.50% of estimated insured deposits.  If this reserve
ratio drops below 1.15% or the FDIC expects that it to do so within six months,
the FDIC must, within 90 days, establish and implement a plan to restore the
designated reserve ratio to 1.15% of estimated insured deposits within five
years (absent extraordinary circumstances).





Recent
bank failures coupled with deteriorating economic conditions have significantly
reduced the deposit insurance fund’s reserve ratio.  As of June 30,
2008, the designated reserve ratio was 1.01% of estimated insured deposits at
March 31, 2008.  As a result of this reduced reserve ratio, on October
16, 2008, the FDIC published a proposed rule that would restore the reserve
ratios to its required level.  The proposed rule would raise the
current deposit insurance assessment rates uniformly for all institutions by 7
basis points (to a range from 12 to 50 basis points) for the first quarter of
2009.  The proposed rule would also alter the way the FDIC calculates
federal deposit insurance assessment rates beginning in the second quarter of
2009 and thereafter.





Under the
proposed rule, the FDIC would first establish an institution’s initial base
assessment rate.  This initial base assessment rate would range,
depending on the risk category of the institution, from 10 to 45 basis
points.  The FDIC would then adjust the initial base assessment
(higher or lower) to obtain the total base assessment rate.  The
adjustments to the initial base assessment rate would be based upon an
institution’s levels of unsecured debt, secured liabilities, and brokered
deposits.  The total base assessment rate would range from 8 to 77.5
basis points of the institution’s deposits. There can be no assurance that the
proposed rule will be implemented by the FDIC or implemented in its proposed
form.





In
addition, the Emergency Economic Stabilization Act of 2008 (EESA) temporarily
increased the limit on FDIC insurance coverage for deposits to $250,000 through
December 31, 2009, and the FDIC took action to provide coverage for newly-issued
senior unsecured debt and non-interest bearing transaction accounts in excess of
the $250,000 limit, for which institutions will be assessed additional
premiums.





These
actions will significantly increase our non-interest expense in 2009 and in
future years as long as the increased premiums are in place.








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Item 6. Exhibits







(a) Exhibits:
See Exhibit Index, which follows the signature page hereof.


Signatures





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




















WATERSTONE FINANCIAL,
      INC.
              (Registrant)Date:
      November 7, 2008/s/Douglas
      S. GordonDouglas
      S. GordonChief
      Executive OfficerDate:
      November 7, 2008/s/
      Richard C. LarsonRichard
      C. LarsonChief
      Financial Officer





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EXHIBIT INDEX





WATERSTONE
FINANCIAL, INC.





Form 10-Q
for Quarter Ended September 30, 2008











Exhibit
      No.
            Description
            Filed
      Herewith31.1
            Sarbanes-Oxley
      Act Section 302 Certification signed by the Chief Executive Officer
      of Waterstone Financial, Inc.
            X31.2
            Sarbanes-Oxley
      Act Section 302 Certification signed by the Chief Financial Officer
      of Waterstone Financial, Inc.
            X32.1
            Certification
      pursuant to 18 U.S. C. Section 1350, as adopted pursuant to
      Section 906 of the Sarbanes-Oxley Act of 2002 signed by the Chief
      Executive Officer of Waterstone Financial, Inc.
            X32.2
            Certification
      pursuant to 18 U.S. C. Section 1350, as adopted pursuant to
      Section 906 of the Sarbanes-Oxley Act of 2002 signed by the Chief
      Financial Officer of Waterstone Financial, Inc.
            X


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