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, 2009OR*
            
            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 has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or for such shorter period that the registrant was required to submit
and post such files). Yes  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 31,249,897 at October 31, 2009.








Table of Contents


WATERSTONE FINANCIAL, INC.





10-Q
INDEX


























Page
      No.PART
      I. FINANCIAL INFORMATIONItem l.
      Financial StatementsConsolidated Statements of Financial Condition as
      of September 30, 2009 (unaudited) and December 31,
      2008
            3Consolidated
      Statements of Operations for the three and nine months ended September 30,
      2009 and 2008 (unaudited)
            4Consolidated
      Statements of Changes in Shareholders’ Equity for the nine months ended
      September 30, 2009 and 2008 (unaudited)
            5Consolidated Statements of
      Cash Flows for the nine months ended September 30, 2009 and 2008
      (unaudited)
            6-7Notes
      to Consolidated Financial Statements
            8-20Item 2. Management’s Discussion and Analysis
      of Financial Condition and Results of
Operations
            21-40Item 3.
      Quantitative and Qualitative Disclosures about Market
      Risk
            41-42Item 4. Controls
      and Procedures
            42PART II. OTHER
      INFORMATION
            43Item 1.
      Legal Proceedings
            43Item 1A. Risk
      Factors
            43Item 6.
      Exhibits
            44Signatures
            44CertificationCertificationCertificationCertification





- 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
      31,2009
            
            
            2008Assets
            
            (In
      Thousands, except share data)Cash
            
            $
            76,469
            
            
            
            14,847Federal
      funds sold
            
            
            14,348
            
            
            
            9,002Short
      term investments
            
            
            4,605
            
            
            
            -Cash
      and cash equivalents
            
            
            95,422
            
            
            
            23,849Securities
      available for sale (at fair value)
            
            
            202,695
            
            
            
            179,887Securities
      held to maturity (at amortized cost)fair
      value of $1,301 in 2009 and $8,165 in 2008
            
            
            2,648
            
            
            
            9,938Loans
      held for sale
            
            
            33,526
            
            
            
            12,993Loans
      receivable
            
            
            1,464,496
            
            
            
            1,559,758Less:
      Allowance for loan losses
            
            
            31,498
            
            
            
            25,167Loans
      receivable, net
            
            
            1,432,998
            
            
            
            1,534,591Office
      properties and equipment, net
            
            
            29,384
            
            
            
            30,560Federal
      Home Loan Bank stock, at cost
            
            
            21,653
            
            
            
            21,653Cash
      surrender value of life insurance
            
            
            33,742
            
            
            
            32,399Real
      estate owned
            
            
            40,994
            
            
            
            24,653Prepaid
      expenses and other assets
            
            
            14,919
            
            
            
            14,909Total
      assets
            
            $
            1,907,981
            
            
            
            1,885,432Liabilities
      and Shareholders’ EquityLiabilities:Demand
      deposits
            
            $
            57,965
            
            
            
            53,434Money
      market and savings deposits
            
            
            96,224
            
            
            
            100,930Time
      deposits
            
            
            1,033,936
            
            
            
            1,041,533Total
      deposits
            
            
            1,188,125
            
            
            
            1,195,897Short
      term borrowings
            
            
            53,000
            
            
            
            4,100Long
      term borrowings
            
            
            459,000
            
            
            
            482,900Advance
      payments by borrowers for taxes
            
            
            23,533
            
            
            
            862Other
      liabilities
            
            
            11,318
            
            
            
            30,406Total
      liabilities
            
            
            1,734,976
            
            
            
            1,714,165Shareholders’
      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 2009 and 2008Issued
      - 33,974,250 shares in 2009 and in 2008Outstanding
      - 31,249,897 shares in 2009 and in 2008
            
            
            340
            
            
            
            340Additional
      paid-in capital
            
            
            108,650
            
            
            
            107,839Accumulated
      other comprehensive loss, net of taxes
            
            
            (1,456
            )
            
            
            (6,449
            )Retained
      earnings
            
            
            115,215
            
            
            
            119,921Unearned
      ESOP shares
            
            
            (4,483
            )
            
            
            (5,123
            )Treasury
      shares (2,724,353 shares), at cost
            
            
            (45,261
            )
            
            
            (45,261
            )Total
      shareholders’ equity
            
            
            173,005
            
            
            
            171,267Total
      liabilities and shareholders’ equity
            
            $
            1,907,981
            
            
            
            1,885,432








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
      30,2009
            
            
            2008
            
            
            2009
            
            
            2008(In
      thousands, except per share data)Interest
      income:Loans
            
            $
            66,348
            
            
            $
            69,584
            
            
            $
            21,974
            
            
            $
            25,166Mortgage-related
      securities
            
            
            5,485
            
            
            
            5,661
            
            
            
            1,721
            
            
            
            1,921Debt
      securities, cash and cash equivalents
            
            
            2,640
            
            
            
            2,667
            
            
            
            973
            
            
            
            1,000Total
      interest income
            
            
            74,473
            
            
            
            77,912
            
            
            
            24,668
            
            
            
            28,087Interest
      expense:Deposits
            
            
            27,429
            
            
            
            31,803
            
            
            
            8,337
            
            
            
            10,384Borrowings
            
            
            15,065
            
            
            
            15,534
            
            
            
            5,087
            
            
            
            5,372Total
      interest expense
            
            
            42,494
            
            
            
            47,337
            
            
            
            13,424
            
            
            
            15,756Net
      interest income
            
            
            31,979
            
            
            
            30,575
            
            
            
            11,244
            
            
            
            12,331Provision
      for loan losses
            
            
            19,055
            
            
            
            34,578
            
            
            
            8,853
            
            
            
            23,301Net
      interest income after provision for loan losses
            
            
            12,924
            
            
            
            (4,003
            )
            
            
            2,391
            
            
            
            (10,970
            )Noninterest
      income:Service
      charges on loans and deposits
            
            
            883
            
            
            
            1,359
            
            
            
            312
            
            
            
            383Increase
      in cash surrender value of life insurance
            
            
            1,037
            
            
            
            1,208
            
            
            
            529
            
            
            
            626Mortgage
      banking income
            
            
            6,801
            
            
            
            3,333
            
            
            
            2,912
            
            
            
            1,354Total
      other-than-temporary impairment losses
            
            
            (8,205
            )
            
            
            -
            
            
            
            -
            
            
            
            -Portion
      of loss recognized in other comprehensive income (before
      taxes)
            
            
            7,093
            
            
            
            -
            
            
            
            -
            
            
            
            -Net
      impairment losses recognized in earnings
            
            
            (1,112
            )
            
            
            (1,997
            )
            
            
            -
            
            
            
            (1,997
            )Other
            
            
            639
            
            
            
            673
            
            
            
            202
            
            
            
            231Total
      noninterest income
            
            
            8,248
            
            
            
            4,576
            
            
            
            3,955
            
            
            
            597Noninterest
      expenses:Compensation,
      payroll taxes, and other employee benefits
            
            
            13,311
            
            
            
            12,787
            
            
            
            4,921
            
            
            
            4,493Occupancy,
      office furniture and equipment
            
            
            3,596
            
            
            
            3,606
            
            
            
            1,227
            
            
            
            1,187Advertising
            
            
            620
            
            
            
            953
            
            
            
            170
            
            
            
            421Data
      processing
            
            
            1,049
            
            
            
            1,055
            
            
            
            341
            
            
            
            358Communications
            
            
            508
            
            
            
            524
            
            
            
            159
            
            
            
            180Professional
      fees
            
            
            910
            
            
            
            697
            
            
            
            218
            
            
            
            184Real
      estate owned
            
            
            2,760
            
            
            
            2,758
            
            
            
            1,551
            
            
            
            1,518Other
            
            
            4,246
            
            
            
            2,511
            
            
            
            1,331
            
            
            
            895Total
      noninterest expenses
            
            
            27,000
            
            
            
            24,891
            
            
            
            9,918
            
            
            
            9,236Loss
      before income taxes
            
            
            (5,828
            )
            
            
            (24,318
            )
            
            
            (3,572
            )
            
            
            (19,609
            )Income
      taxes (benefit)
            
            
            (5
            )
            
            
            5,796
            
            
            
            -
            
            
            
            8,578Net
      loss
            
            
            (5,823
            )
            
            
            (30,114
            )
            
            
            (3,572
            )
            
            
            (28,187
            )Loss
      per share:Basic
            
            
            (0.19
            )
            
            
            (0.99
            )
            
            
            (0.12
            )
            
            
            (0.92
            )Diluted
            
            
            (0.19
            )
            
            
            (0.99
            )
            
            
            (0.12
            )
            
            
            (0.92
            )Weighted
      average shares outstanding:Basic
            
            
            30,670,671
            
            
            
            30,545,245
            
            
            
            30,689,552
            
            
            
            30,564,179Diluted
            
            
            30,670,671
            
            
            
            30,545,245
            
            
            
            30,689,552
            
            
            
            30,564,179








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
            
            
            Treasury
            
            
            Shareholders'Shares
            
            
            Amount
            
            
            Capital
            
            
            Income
      (Loss)
            
            
            Earnings
            
            
            Shares
            
            
            Shares
            
            
            Equity(In
      Thousands)Balances
      at December 31, 2007
            
            
            31,251
            
            
            $
            340
            
            
            
            106,306
            
            
            
            44
            
            
            
            146,367
            
            
            
            (5,977
            )
            
            
            (45,261
            )
            
            
            201,819Comprehensive
      income:Net
      income
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (30,114
            )
            
            
            —
            
            
            
            —
            
            
            
            (30,114
            )Other
      comprehensive loss:Net
      unrealized holding losson
      available for sale securities arising during the period, net of taxes of
      $1,610
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (5,587
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (5,587
            )Reclassification
      of adjustment
              fornet
      losses on availablefor
      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.Balances
      at December 31, 2008
            
            
            31,250
            
            
            $
            340
            
            
            
            107,839
            
            
            
            (6,449
            )
            
            
            119,921
            
            
            
            (5,123
            )
            
            
            (45,261
            )
            
            
            171,267Cumulative
      effect adjustment
              related
      to a change in
              accounting principle relatedto
      available for sale securities,
              net
      of taxes of $448
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (669
            )
            
            
            1,117
            
            
            
            
            
            
            
            
            
            
            
            448Comprehensive
      loss:Net
      loss
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (5,823
            )
            
            
            —
            
            
            
            —
            
            
            
            (5,823
            )Other
      comprehensive income:Net
      unrealized holding gain
              on available for salesecurities
      arising during the period, net of taxes of $2,499
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            4,996
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            4,996Reclassification
      of adjustment
              for
      net losses on availablefor
      sale securities realized during the period, net of taxes of
      $446
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            666
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            666Total
      comprehensive income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (161
            )ESOP
      shares committed to be released to Plan participants
            
            
            —
            
            
            
            —
            
            
            
            (446
            )
            
            
            —
            
            
            
            —
            
            
            
            640
            
            
            
            —
            
            
            
            194Stock
      based compensation
            
            
            —
            
            
            
            —
            
            
            
            1,257
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            1,257Balances
      at September 30, 2009
            
            
            31,250
            
            
            $
            340
            
            
            
            108,650
            
            
            
            (1,456
            )
            
            
            115,215
            
            
            
            (4,483
            )
            
            
            (45,261
            )
            
            
            173,005


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 30,2009
            
            
            2008(In
      Thousands)Operating
      activities:Net
      loss
            
            $
            (5,823
            )
            
            
            (30,114
            )Adjustments
      to reconcile net loss to netcash
      provided by (used in) operating activities:Provision
      for loan losses
            
            
            19,055
            
            
            
            34,578Depreciation
            
            
            1,504
            
            
            
            1,847Deferred
      income taxes
            
            
            (1,365
            )
            
            
            9,731Stock
      based compensation
            
            
            1,257
            
            
            
            1,311Net
      amortization of premium on debt and mortgage-related
      securities
            
            
            (189
            )
            
            
            (255
            )Amortization
      of unearned ESOP shares
            
            
            194
            
            
            
            666Gain
      on sale of loans held for sale
            
            
            (6,490
            )
            
            
            (2,083
            )Loans
      originated for sale
            
            
            (529,415
            )
            
            
            (212,628
            )Proceeds
      on sales of loans originated for sale
            
            
            515,372
            
            
            
            229,183Increase
      in accrued interest receivable
            
            
            (242
            )
            
            
            (975
            )Increase
      in cash surrender value of bank owned life insurance
            
            
            (1,037
            )
            
            
            (1,208
            )Increase
      (decrease) in accrued interest on deposits and borrowings
            
            
            (2,411
            )
            
            
            1,233Decrease
      in other liabilities
            
            
            (889
            )
            
            
            (1,136
            )Loss
      on impairment of securities
            
            
            1,112
            
            
            
            1,997Loss
      on sale of real estate owned and other assets
            
            
            547
            
            
            
            1,141Other
            
            
            605
            
            
            
            116Net
      cash provided by (used in) operating activities
            
            
            (8,215
            )
            
            
            33,404Investing
      activities:Net
      decrease (increase) in loans receivable
            
            
            44,703
            
            
            
            (196,897
            )Purchases
      of:Debt
      securities
            
            
            (41,499
            )
            
            
            (12,761
            )Mortgage-related
      securities
            
            
            (13,011
            )
            
            
            (25,524
            )Structured
      notes, held to maturity
            
            
            —
            
            
            
            (4,289
            )Premises
      and equipment, net
            
            
            (3,590
            )
            
            
            (1,049
            )Bank
      owned life insurance
            
            
            (306
            )
            
            
            (5,306
            )FHLB
      stock
            
            
            —
            
            
            
            (2,363
            )Proceeds
      from:Principal
      repayments on mortgage-related securities
            
            
            29,151
            
            
            
            15,313Maturities
      of debt securities
            
            
            8,988
            
            
            
            984Calls
      on structured notes
            
            
            7,289
            
            
            
            1,998Sales
      of real estate owned and other assets
            
            
            20,643
            
            
            
            9,218Net
      cash provided by (used in) investing activities
            
            
            52,368
            
            
            
            (220,676
            )








See
Accompanying Notes to Consolidated Financial Statements.


- 6
-
 Table of Contents


WATERSTONE
FINANCIAL, INC AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(Unaudited)








Nine
      months ended September 30,2009
            
            
            2008(In
      Thousands)Financing
      activities:Net
      increase (decrease) in deposits
            
            
            (7,772
            )
            
            
            181,151Net
      change in short-term borrowings
            
            
            25,000
            
            
            
            (28,434
            )Proceeds
      from long-term borrowings
            
            
            —
            
            
            
            65,000Net
      increase in advance payments by borrowers for taxes
            
            
            10,193
            
            
            
            3,777Net
      cash provided by financing activities
            
            
            27,421
            
            
            
            221,494Increase
      in cash and cash equivalents
            
            
            71,573
            
            
            
            34,222Cash
      and cash equivalents at beginning of period
            
            
            23,849
            
            
            
            17,884Cash
      and cash equivalents at end of period
            
            $
            95,422
            
            
            
            52,106Supplemental
      information:Cash
      paid or credited during the period for:Income tax payments
            
            
            1,247
            
            
            
            1,291Interest payments
            
            
            44,904
            
            
            
            46,104Noncash
      investing activities:Loans
      receivable transferred to real estate owned
            
            
            37,835
            
            
            
            22,272Noncash
      financing activities:Long-term FHLB advances reclassified to short-term
            
            
            23,900
            
            
            
            —

































































See
Accompanying Notes to Consolidated Financial Statements.


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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.





The
accompanying unaudited consolidated financial statements have been prepared in
accordance with generally accepted accounting principles (GAAP) 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, 2008 Annual Report
on Form 10-K. Operating results for the three and nine months ended September
30, 2009, are not necessarily indicative of the results that may be expected for
the year ending December 31, 2009.





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.  Subsequent events have been evaluated through the filing
of the unaudited consolidated financial statements which is November 6,
2009.





In the
third quarter 2009, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 168, “The FASB Accounting Standards Codification and
the Hierarchy of Generally Accepted Accounting Principles,” (SFAS 168). 
SFAS 168 establishes the Financial Accounting Standards Board (FASB) Accounting
Standards Codification (the Codification, or ASC) as the single source of
authoritative, nongovernmental GAAP recognized by the FASB.  Rules and
interpretive releases of the Securities and Exchange Commission (SEC) are also
sources of authoritative GAAP for SEC registrants.  The Codification is not
intended to change GAAP.  Effective with the adoption of SFAS 168, all
existing non-SEC accounting and reporting standards, except for grandfathered
guidance and certain recently-issued standards not yet integrated into the
Codification, were superseded and are considered nonauthoritative. 
References to GAAP in these Notes to Consolidated Financial Statements are
provided under the Codification structure where applicable. 
Recently-issued standards not yet integrated into the Codification and still
considered authoritative are referred to using the issued
terminology.








Note
2 — Reclassifications





Certain
items in the prior period consolidated financial statements have been
reclassified to conform to the September 30, 2009 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, 2009(In
      Thousands)Gross
            
            
            GrossAmortized
            
            
            unrealized
            
            
            unrealizedcost
            
            
            gains
            
            
            losses
            
            
            Fair
      valueMortgage-backed
      securities
            
            $
            42,561
            
            
            
            2,060
            
            
            
            —
            
            
            
            44,621Collateralized
      mortgage obligations
            
            
            80,064
            
            
            
            1,732
            
            
            
            (7,646
            )
            
            
            74,150Mortgage-related
      securities
            
            
            122,625
            
            
            
            3,792
            
            
            
            (7,646
            )
            
            
            118,771Government
      sponsored entity bonds
            
            
            36,001
            
            
            
            308
            
            
            
            (4
            )
            
            
            36,305Municipal
      securities
            
            
            41,245
            
            
            
            1,572
            
            
            
            (278
            )
            
            
            42,539Other
      debt securities
            
            
            5,250
            
            
            
            —
            
            
            
            (170
            )
            
            
            5,080Debt
      securities
            
            
            82,496
            
            
            
            1,880
            
            
            
            (452
            )
            
            
            83,924$
            205,121
            
            
            
            5,672
            
            
            
            (8,098
            )
            
            
            202,695










December
      31, 2008(In
      Thousands)Gross
            
            
            GrossAmortized
            
            
            unrealized
            
            
            unrealizedcost
            
            
            gains
            
            
            losses
            
            
            Fair
      valueMortgage-backed
      securities
            
            $
            38,966
            
            
            
            1,133
            
            
            
            (14
            )
            
            
            40,085Collateralized
      mortgage obligations
            
            
            100,896
            
            
            
            1,068
            
            
            
            (10,507
            )
            
            
            91,457Mortgage-related
      securities
            
            
            139,862
            
            
            
            2,201
            
            
            
            (10,521
            )
            
            
            131,542Government
      sponsored entity bonds
            
            
            11,007
            
            
            
            335
            
            
            
            —
            
            
            
            11,342Municipal
      securities
            
            
            32,697
            
            
            
            291
            
            
            
            (1,626
            )
            
            
            31,362Corporate
      notes
            
            
            992
            
            
            
            —
            
            
            
            (51
            )
            
            
            941Other
      debt securities
            
            
            5,250
            
            
            
            —
            
            
            
            (550
            )
            
            
            4,700Debt
      securities
            
            
            49,946
            
            
            
            626
            
            
            
            (2,227
            )
            
            
            48,345$
            189,808
            
            
            
            2,827
            
            
            
            (12,748
            )
            
            
            179,887







At
September 30, 2009, $8.9 million of the Company’s government sponsored entity
bonds and $88.4 million of the Company’s mortgage related securities were
pledged as collateral to secure repurchase agreement obligations of the
Company.




The
amortized cost and fair values of investment securities by contractual maturity
at September 30, 2009, 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
            
            $
            3,000
            
            
            
            3,002Due
      after one year through five years
            
            
            42,475
            
            
            
            42,862Due
      after five years through ten years
            
            
            11,667
            
            
            
            12,071Due
      after ten years
            
            
            25,354
            
            
            
            25,989Mortgage-related
      securities
            
            
            122,625
            
            
            
            118,771$
            205,121
            
            
            
            202,695




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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, 2009Less
      than 12 months
            
            
            12
      months or longer
            
            
            TotalFair
            
            
            Unrealized
            
            
            Fair
            
            
            Unrealized
            
            
            Fair
            
            
            Unrealizedvalue
            
            
            loss
            
            
            value
            
            
            loss
            
            
            value
            
            
            loss(In
      Thousands)Collateralized
      mortgage obligations
            
            
            1,882
            
            
            
            (5
            )
            
            
            28,616
            
            
            
            (7,641
            )
            
            
            30,498
            
            
            
            (7,646
            )Government
      sponsored entity bonds
            
            
            2,496
            
            
            
            (4
            )
            
            
            —
            
            
            
            —
            
            
            
            2,496
            
            
            
            (4
            )Municipal
      securities
            
            
            336
            
            
            
            (4
            )
            
            
            2,469
            
            
            
            (274
            )
            
            
            2,805
            
            
            
            (278
            )Other
      debt securities
            
            
            4,830
            
            
            
            (170
            )
            
            
            —
            
            
            
            —
            
            
            
            4,830
            
            
            
            (170
            )$
            9,544
            
            
            
            (183
            )
            
            
            31,085
            
            
            
            (7,915
            )
            
            
            40,629
            
            
            
            (8,098
            )





In the
first quarter of 2009, the Company elected to early adopt new guidance impacting
ASC Topic 820, Fair Value Measurements and Disclosures, related to determining
fair value when the volume and level of activity for the asset or liability have
significantly decreased and identifying transactions that are not orderly, ASC
Topic 825, Financial Instruments, related to interim disclosures about fair
value of financial instruments and ASC Topic 320, Investments — Debt and Equity
Instruments, related to recognition and presentation of other-than-temporary
impairments  In evaluating whether a credit loss exists for a given
debt security, management considers the length of time and extent to which the
fair value has been less than cost, financial condition of the issuer and the
underlying obligors, quality of credit enhancements, volatility of the fair
value of the security, the expected recovery period of the security, payment
structure of the security and ratings agency evaluations.




At
September 30, 2009, this evaluation indicated that collateralized mortgage
obligations with a combined amortized cost of $22.1 million and one municipal
security with a amortized cost of $408,000 may be other-than-temporarily
impaired.  Estimates of discounted cash flows based on expected yield
at time of original purchase, prepayment assumptions based on actual and
anticipated prepayment speed, actual and anticipated default rates and estimated
level of severity given the loan to value ratios, credit scores, geographic
locations, vintage and levels of subordination related to the security and its
underlying collateral resulted in a projected credit loss on two collateralized
mortgage obligations.  Both of these securities had been deemed
other-than-temporarily impaired in prior periods and a cumulative-effect
adjustment of $1.1 million was made to retained earnings as of January 1, 2009
to reflect the difference between the present value of cash flows expected to be
collected and the amortized cost basis as of the beginning of the period in
which the aforementioned FASB Staff Positions were
adopted.  Additional estimated credit losses on the two collateralized
mortgage obligations of $1.1 million were charged to earnings in the nine-month
period ended September 30, 2009.  There were no additional estimated
credit losses incurred during the quarter ended September 30, 2009 despite
recent credit downgrades.  These two securities had a fair value of
$3.4 million and $11.6 million and an amortized cost of $5.1 million and $17.1
million, respectively as of September 30, 2009.  As of September 30,
2009, unrealized losses on these collateralized mortgage obligations include
other-than-temporary impairment recognized in other comprehensive income (before
taxes) of $7.1 million.




The
following table presents the change in other-than-temporary credit related
impairment charges on collateralized mortgage obligations for which a portion of
the other-than-temporary impairments related to other factors was recognized in
other comprehensive loss.









(in
      thousands)Credit
      related impairments on securties as of December 31, 2008
            
            $
            755Credit
      related impairments not previously recognized
            
            
            1,112Credit
      related impairments on securities as of September 30, 2009
            
            $
            1,867







Exclusive
of the two aforementioned collateralized mortgage obligations, the Company has
determined that the decline in fair value of the remaining securities is not
attributable to credit deterioration, and as the Company does not intend to sell
nor is it more likely than not that it will be required to sell these securities
before recovery of the amortized cost basis, these securities are not considered
other-than-temporarily impaired.




Continued
deterioration of general economic market conditions could result in the
recognition of future other than temporary impairment losses within the
investment portfolio and such amounts could be material to our consolidated
financial statements.




Securities
Held to Maturity




As of
September 30, 2009, the Company held one security that has been designated as
held to maturity.  The security has an amortized cost of $2.6 million
and an estimated fair value of $1.3 million.  The final maturity of
this security is 2022, however, it is callable quarterly.  Due to the
magnitude of the difference between fair value and amortized cost and
considering additional factors as previously described, the Company assessed
whether this security is other-than-temporarily impaired.  Based
primarily on the ongoing financial support of the company that issued the
security by the United States government, the Company has determined that the
security is not other-than-temporarily impaired at September 30,
2009.  During the three months ended September 30, 2009, two
securities that had been designated as held to maturity were
called.  The securities had a total amortized cost of $7.3
million.




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Note
4 — Loans Receivable





Loans
receivable are summarized as follows:









September
      30,
            
            
            December
      31,2009
            
            
            2008(In
      Thousands)Mortgage
      loans:Residential
      real estate:One-
      to four-family
            
            $
            715,608
            
            
            
            790,486Over
      four-family residential
            
            
            539,165
            
            
            
            512,746Commercial
      real estate
            
            
            49,969
            
            
            
            55,193Construction
      and land
            
            
            83,204
            
            
            
            131,840Home
      equity
            
            
            87,669
            
            
            
            89,648Consumer
      loans
            
            
            607
            
            
            
            365Commercial
      business loans
            
            
            44,913
            
            
            
            43,006Gross
      loans receivable
            
            
            1,521,135
            
            
            
            1,623,284Less:Undisbursed
      loan proceeds
            
            
            54,588
            
            
            
            61,192Unearned
      loan fees
            
            
            2,051
            
            
            
            2,334Total
      loans receivable
            
            $
            1,464,496
            
            
            
            1,559,758










The
Company provides several types of loans to its customers, including residential,
construction, commercial and consumer loans.  The Company does not
have a concentration of loans in any specific industry.  Credit risks
tend to be geographically concentrated since a majority of the Company’s
customer base lies in the Milwaukee metropolitan area.  Furthermore,
as of September 30, 2009, 87.2% of the Company’s loan portfolio consists of
loans that are secured by real estate properties located primarily within the
Milwaukee metropolitan area.  Residential real estate collateralizing
$148.7 million, or 9.8%, of total mortgage loans is located outside of the state
of Wisconsin.





The
unpaid principal balance of loans serviced for others was $4.7 million and $4.9
million at September 30, 2009 and December 31, 2008, respectively. These loans
are not reflected in the consolidated financial statements.







- 11
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A summary
of the activity in the allowance for loan loss is as follows:








For
      the Nine Months EndedSeptember
      30,2009
            
            
            2008(Dollars
      in Thousands)Balance
      at beginning of period
            
            $
            25,167
            
            
            
            12,839Provision
      for loan losses
            
            
            19,055
            
            
            
            34,578Charge-offs
            
            
            (12,965
            )
            
            
            (21,504
            )Recoveries
            
            
            241
            
            
            
            297Balance
      at end of period
            
            $
            31,498
            
            
            
            26,210Allowance
      for loan losses to loans receivable
            
            
            2.15
            %
            
            
            1.69
            %Net
      charge-offs to average loans outstanding (annualized)
            
            
            1.11
            %
            
            
            1.89
            %Allowance
      for loan losses to non-performing loans
            
            
            33.69
            %
            
            
            28.30
            %Non-performing
      loans to loans receivable
            
            
            6.38
            %
            
            
            5.95
            %








Non-accrual
loans totaled $93.5 million at September 30, 2009 and $107.7 million at December
31, 2008.





Beginning
in 2007 and continuing through the current quarter, the Company experienced
significant deterioration in credit quality, primarily in its residential and
construction and land portfolios.  These two segments represent a
significant portion of the overall loan portfolio.  The downturn in
the residential real estate market that has continued into 2009 has reduced
demand and market prices for vacant land, new construction and existing
residential units.  The economic downturn and the depressed real
estate market have negatively impacted many residential real estate customers
and have resulted in the elevated level of nonperforming loans.




The
following table presents data on impaired loans at September 30, 2009 and
December 31, 2008.








September
      30,
            
            
            December
      31,2009
            
            
            2008(In
      Thousands)Impaired
      loans for which an allowance has been provided
            
            $
            101,790
            
            
            
            41,970Impaired
      loans for which no allowance has been provided
            
            
            41,046
            
            
            
            56,382Total
      loans determined to be impaired
            
            $
            142,836
            
            
            
            98,352Allowance
      for loan losses related to all impaired loans
            
            $
            16,053
            
            
            
            9,832








The
determination as to whether an allowance is required with respect to impaired
loans is based upon an analysis of the value of the underlying
collateral.  The valuation process is subject to the use of
significant estimates and actual results could differ from
estimates.  This analysis is primarily based upon third party
appraisals, or a discounted cash flow analysis in the case of an income
producing property.  In those cases in which no allowance has been
provided for an impaired loan, the Company has determined that the estimated
value of the underlying collateral exceeds the remaining outstanding balance of
the loan.  Of the total $41.0 million of impaired loans for which no
allowance has been provided, $16.0 million represent loans on which a total of
$5.8 million in charge-offs have been recorded to reduce the outstanding loans
balance to an amount that is commensurate with the estimated fair value of the
underlying collateral.  To the extent that further deterioration in
property values continues, the Company may have to reevaluate the sufficiency of
the collateral servicing these impaired loans resulting in additional provisions
to the allowance for loans losses or charge-offs.




At
September 30, 2009, total impaired loans for which an allowance has been
provided includes $31.2 million of troubled debt restructurings that are
performing in accordance with their restructured terms.  The vast
majority of debt restructurings include a modification of terms to allow for an
interest only payment and/or reduction in interest rate.  The
restructured terms are typically in place for six to twelve
months.  At December 31, 2008, there were $2.4 million in troubled
debt restructurings for which no allowance for loan losses was deemed
necessary.




The
Company serves the credit needs of its customers by offering a wide variety of
loan programs to customers, primarily in Wisconsin. The loan portfolio is widely
diversified by types of borrowers, property type, and market areas. Significant
loan concentrations are considered to exist for a financial institution when
there are amounts loaned to one borrower or to multiple borrowers engaged in
similar activities that would cause them to be similarly impacted by economic or
other conditions. At September 30, 2009 and 2008, no loans to one borrower or
industry concentrations existed in the Company’s loan portfolio in excess of 10%
of total loans.








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Note
5 — Deposits





A summary of the contractual maturities of
certificate accounts at September 30, 2009 is as follows:








(In
      Thousands)Within
      one year
            
            $
            936,334One
      to two years
            
            
            68,973Two
      to three years
            
            
            20,065Three
      to four years
            
            
            4,518Four
      through five years
            
            
            4,046$
            1,033,936







Note
6 — Borrowings




Borrowings
consist of the following:






September
      30, 2009
            
            
            December
      31, 2008Weighted
            
            
            
            
            
            WeightedAverage
            
            
            
            
            
            AverageBalance
            
            
            Rate
            
            
            Balance
            
            
            Rate(Dollars
      in Thousands)Federal
      Home Loan Bank Chicago (FHLBC) advances maturing:2009
            
            $
            4,100
            
            
            
            4.23
            %
            
            $
            4,100
            
            
            
            4.23
            %2010
            
            
            73,900
            
            
            
            3.61
            %
            
            
            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
            %
            
            
            65,000
            
            
            
            2.97
            %Repurchase
      agreements maturing
            2017
            
            
            84,000
            
            
            
            3.96
            %
            
            
            84,000
            
            
            
            3.96
            %$
            512,000
            
            
            
            3.85
            %
            
            $
            487,000
            
            
            
            3.99
            %












The $73.9
million in advances due in 2010 consist of five advances with rates ranging from
1.29% to 4.94% callable quarterly until maturity.




The
$220.0 million in advances due in 2016 consist of eight advances with rates
ranging from 4.01% to 4.82% callable quarterly until maturity.




The $65.0
million in advances due in 2017 consist of three advances with rates ranging
from 3.09% to 3.46% callable quarterly until maturity.




The $65.0
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 $84.0
million in repurchase agreements have rates ranging from 2.89% to 4.31% callable
quarterly until maturity.




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 60% of the carrying value of qualifying, unencumbered
one- to four-family mortgage loans, 25% of the carrying value of home equity
loans and 60% of the carrying value of over four-family loans.  In
addition, these advances are collateralized by FHLBC stock totaling $21.7
million at September 30, 2009 and December 31, 2008.




- 13
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Note
7 – Income Taxes




The
Company recorded an income tax benefit of $5,000 for the nine months ended
September 30, 2009.  This total was comprised of a $503,000 benefit
recorded in the first quarter of 2009 offset by a $498,000 expense recorded in
the second quarter of 2009.  The $503,000 benefit was the result of a
Wisconsin state tax law change (retroactive to January 1, 2009) related to the
net unrealized loss on securities available for sale owned by the Company’s
Nevada subsidiary.  The $498,000 federal tax expense recorded in the
second quarter of 2009 was the result of an increase in the deferred tax asset
valuation allowance.  During the nine months of 2008, the Company
recorded income tax expense of $5.8 million.  During this period, the
Company recognized income tax expense related to net deferred tax asset
valuation allowances of $16.1 million.





Under
generally accepted accounting principles, a valuation allowance is required to
be recognized if it is “more likely than not” that a deferred tax asset will not
be realized. The determination of the realizability of a deferred tax asset is
highly subjective and dependent upon judgment concerning management's evaluation
of both positive and negative evidence, the forecasts of future income,
applicable tax planning strategies, and assessments of current and future
economic and business conditions. Positive evidence includes the existence of
taxes paid in available carry back years as well as the probability that taxable
income will be generated in future periods, while negative evidence includes the
cumulative losses in the current year and prior two years and general business
and economic trends. At September 30, 2009 and December 31, 2008, the Company
determined that net deferred tax assets of $20.0 million and $19.2 million
required offsetting valuation allowances of $15.5 million and $13.5 million,
respectively, largely because of a cumulative loss in the most recent three-year
period caused by the significant loan loss provisions recorded during 2009 and
2008. In addition, general uncertainty surrounding future economic and business
conditions have increased the potential volatility and uncertainty of projected
earnings. Management is required to re-evaluate the deferred tax asset and the
related valuation allowance quarterly.












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
      31,2009
            
            
            2008(In
      Thousands)Financial
      instruments whose contract amounts representpotential
      credit risk:Commitments
      to extend credit under first mortgage loans
            
            $
            15,512
            
            
            
            15,340Unused
      portion of home equity lines of credit
            
            
            29,752
            
            
            
            30,368Unused
      portion of construction loans
            
            
            14,005
            
            
            
            20,241Unused
      portion of business lines of credit
            
            
            10,830
            
            
            
            10,584Standby
      letters of credit
            
            
            1,157
            
            
            
            1,866







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, 2009 and December 31, 2008, the Company had
$33.5 million and $13.0 million, respectively in forward loan sale
commitments.  A forward sale commitment is a derivative instrument
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
(loss) from mortgage banking operations.  In determining the fair
value of its derivative loan commitments, 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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Note
9 – Earnings (loss) per share





Earnings
per share are computed using the two-class method.  Basic earnings per
share is computed by dividing net income allocated to common shares by the
weighted average number of common shares outstanding during the applicable
period, excluding outstanding participating securities.  Participating
securities include unvested restricted shares.  Unvested restricted
shares are considered participating securities because holders of these
securities have the right to receive dividends at the same rate as holders of
the Company’s common stock.  Diluted earnings per share 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 and stock options are considered
outstanding for diluted earnings (loss) per share only.  Unvested
restricted stock and stock options totaling 151,400 and 466,900 shares for the
nine and three month periods ended September 30, 2009 and 201,200 and 621,200
shares for the nine and three month periods ended 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
      30,2009
            
            
            2008
            
            
            2009
            
            
            2008(In
      Thousands, except per share data)Net
      income (loss) available tocommon
      stockholders
            
            $
            (5,823
            )
            
            
            (30,114
            )
            
            $
            (3,572
            )
            
            
            (28,187
            )Weighted
      average shares outstanding
            
            
            30,671
            
            
            
            30,545
            
            
            
            30,690
            
            
            
            30,564Effect
      of dilutive potential common shares
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Diluted
      weighted average shares outstanding
            
            
            30,671
            
            
            
            30,545
            
            
            
            30,690
            
            
            
            30,564Basic
      earnings (loss) per share
            
            $
            (0.19
            )
            
            
            (0.99
            )
            
            $
            (0.12
            )
            
            
            (0.92
            )Diluted
      earnings (loss) per share
            
            $
            (0.19
            )
            
            
            (0.99
            )
            
            $
            (0.12
            )
            
            
            (0.92
            )








Note
10 – Fair Value Measurements





The
Company uses fair value measurements to record fair value adjustments to certain
assets and liabilities to determine fair value
disclosures.  Securities available for sale and loans held for sale
are recorded at fair value on a recurring basis.  Additionally, from
time to time, we may be required to record at fair value other assets on a
nonrecurring basis, such as portfolio loans and real estate
owned.  These nonrecurring fair value adjustments typically result
from the write-downs of individual assets.





Effective
January 1, 2009, the Company elected to measure loans held for sale originated
after December 31, 2008 at fair value.  We believe that the election
for loans held for sale will reduce timing differences and better match changes
in the value of these assets with the changes in the value of forward
commitments to sell mortgage loans which are used as economic hedges for these
assets.





Presented
below is information about assets recorded on our consolidated statement of
financial position at fair value on a recurring basis and assets recorded on our
consolidated statement of financial position on a nonrecurring
basis.





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Assets
and Liabilities Recorded at Fair Value on a Recurring Basis





The
following table presents information about our assets recorded on our
consolidated statement of financial position at their fair value on a recurring
basis as of September 30, 2009, 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, 2009
            
            
            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
            
            $
            202,695
            
            
            
            -
            
            
            
            187,645
            
            
            
            15,050











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 used to adjust the issuer spread.  Prepayment
models are used for mortgage related securities with prepayment
features.





The table
below presents reconciliation for all assets measured at fair value on a
recurring basis using significant unobservable inputs (Level 3) during
2009.








Available-for-sale
      securties(In
      Thousands)Balance
      December 31, 2008
            
            $
            4,242Transfer
      into level 3
            
            
            9,870Unrealized
      holding losses arising during the period:Included
      in other comprehensive loss
            
            
            1,478Other
      than temporary impairment included in net loss
            
            
            (1,112
            )Principal
      repayments
            
            
            (550
            )Net
      accretion of discount/amortization of premium
            
            
            5Cumulative-effect
      adjustment
            
            
            1,117Balance
      September 30, 2009
            
            $
            15,050








Level 3
available-for-sale securities include two corporate collateralized mortgage
obligations.  The market for these securities was not active as of
September 30, 2009.  As such, the Company valued these securities
based on the present value of estimated future cash flows





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Loans held for sale – The
Company elected to carry our loans held for sale at 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, 2009, loans held-for-sale totaled $33.5 million.  Loans
held-for-sale are considered to be Level 2 in the fair value hierarchy of
valuation techniques.







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 on our
consolidated statements of financial condition at fair value.  Fair
value is determined based on third party appraisals.  Appraised values are adjusted to
consider disposition costs and also to take into consideration the age of the
most recent appraisal.  At September 30, 2009, loans determined
to be impaired with an outstanding balance of $70.6 million were carried net of
specific reserves of $14.3 million for a fair value of $56.3
million.  Impaired loans 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.Appraised values are adjusted to
consider disposition costs and also to take into consideration the age of the
most recent appraisal.  At September 30, 2009, real estate
owned totaled $41.0 million.  Real estate owned is considered to be
Level 2 in the fair value hierarchy of valuation techniques.





The
carrying amounts and fair values of the Company’s financial instruments consist
of the following at September 30, 2009 and December 31, 2008:









September
      30, 2009
            
            
            December
      31, 2008Carrying
            
            
            Fair
            
            
            Carrying
            
            
            Fairamount
            
            
            value
            
            
            amount
            
            
            value(In
      Thousands)Financial
      AssetsCash
      and cash equivalents
            
            $
            95,422
            
            
            
            95,422
            
            
            
            23,849
            
            
            
            23,849Securities
      available-for-sale
            
            
            202,695
            
            
            
            202,695
            
            
            
            179,887
            
            
            
            179,887Securities
      held-to-maturity
            
            
            2,648
            
            
            
            1,301
            
            
            
            9,938
            
            
            
            8,165Loans
      held for sale
            
            
            33,526
            
            
            
            33,526
            
            
            
            12,993
            
            
            
            12,993Loans
      receivable
            
            
            1,464,496
            
            
            
            1,455,853
            
            
            
            1,559,758
            
            
            
            1,553,577FHLB
      stock
            
            
            21,653
            
            
            
            21,653
            
            
            
            21,653
            
            
            
            21,653Cash
      surrender value of life insurance
            
            
            33,742
            
            
            
            33,742
            
            
            
            32,399
            
            
            
            32,399Accrued
      interest receivable
            
            
            4,562
            
            
            
            4,562
            
            
            
            4,323
            
            
            
            4,323Financial
      LiabilitiesDeposits
            
            
            1,188,125
            
            
            
            1,191,861
            
            
            
            1,195,897
            
            
            
            1,202,939Advance
      payments by borrowers for taxes
            
            
            23,533
            
            
            
            23,533
            
            
            
            862
            
            
            
            862Borrowings
            
            
            512,000
            
            
            
            522,191
            
            
            
            487,000
            
            
            
            501,858Accrued
      interest payable
            
            
            3,128
            
            
            
            3,128
            
            
            
            5,539
            
            
            
            5,539Obligations
      under capital leases
            
            
            -
            
            
            
            -
            
            
            
            3,308
            
            
            
            3,308Forward
      commitments to sell residential mortgage loans
            
            
            370
            
            
            
            370
            
            
            
            21
            
            
            
            21Other
      Financial InstrumentsStand-by
      letters of credit
            
            
            6
            
            
            
            6
            
            
            
            12
            
            
            
            12







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The
following methods and assumptions were used by the Company in determining its
fair value disclosures for financial instruments.




a)      Cash
      and Cash Equivalents




The
carrying amounts reported in the consolidated statements of financial condition
for cash and cash equivalents approximate those assets’ fair
values.




b)      Securities




Fair
values for securities are based on quoted market prices of these or comparable
instruments or valuation techniques previously discussed.




c)      Loans
      Held for Sale




Fair
      value is estimated using the prices of the Company’s existing commitments
      to sell such loans and/or the quoted market price for commitments to sell
      similar loans.




d)      Loans
      Receivable




Fair
values for loans receivable are based upon third party appraisals or are
estimated using a discounted cash flow calculation that applies current interest
rates to estimated future cash flows of the loans receivable.  Fair
values for loans deemed to be impaired are determined as previously
discussed.




e)      FHLB
      Stock




For FHLB
stock, the carrying amount is the amount at which shares can be redeemed with
the FHLB and is a reasonable estimate of fair value.




f)      Cash
      Surrender Value of Life Insurance




The
carrying amounts reported in the consolidated statements of financial condition
for the cash surrender value of life insurance approximate those assets’ fair
values.




g)       Deposits
      and Advance Payments by Borrowers for
Taxes




The fair
values for interest-bearing and noninterest-bearing negotiable order of
withdrawal accounts, savings accounts, and money market accounts are, by
definition, equal to the amount payable on demand at the reporting date (i.e.,
their carrying amounts). The fair values for fixed-rate certificates of deposit
are estimated using a discounted cash flow calculation that applies interest
rates currently being offered on certificates of similar remaining maturities to
a schedule of aggregated expected monthly maturities of the outstanding
certificates of deposit. The advance payments by borrowers for taxes are equal
to their carrying amounts at the reporting date.




h)      Borrowings




Fair
values for borrowings are estimated using a discounted cash flow calculation
that applies current interest rates to estimated future cash flows of the
borrowings.




i)      Accrued
      Interest Payable and Accrued Interest
Receivable




For
accrued interest payable and accrued interest receivable, the carrying amount is
a reasonable estimate of fair value due to their short-term nature.




j)      Obligations
      under Capital Leases




The fair
value of obligations under capital leases is determined using a present value of
future minimum lease payments discounted at the current interest rate at the
time of lease inception.  The Company executed a purchase option on
its capital lease during the first quarter of 2009.




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k)     Forward
      commitments to sell residential mortgage loans
              
              The
      fair value of forward commitments to sell residential mortgage loans is
      the estimated amount that the Company would receive or pay to terminate
      the forward delivery contract at the reporting date based upon market
      prices for similar financial
instruments.




l)       Standby
      Letters of Credit




Commitments
to extend credit and standby letters of credit are generally not marketable.
Furthermore, interest rates on any amounts drawn under such commitments would be
generally established at market rates at the time of the draw. Fair values for
the Company’s commitments to extend credit and standby letters of credit are
based on fees currently charged to enter into similar agreements, taking into
account the remaining terms of the agreements, the counterparty’s credit
standing, and discounted cash flow analyses.







Note
11 – Recent Accounting Developments





In the
first quarter 2009, the Company elected to early adopt new guidance impacting
ASC Topic 820, Fair Value Measurements and Disclosures, related to determining
fair value when the volume and level of activity for the asset or liability have
significantly decreased and identifying transactions that are not orderly. 
This new guidance requires an assessment of whether certain factors exist to
indicate that the market for an instrument is not active at the measurement
date. If, after evaluating those factors, the evidence indicates the market is
not active, the Company must determine whether recent quoted transaction prices
are associated with distressed transactions. If the Company concludes that the
quoted prices are associated with distressed transactions, an adjustment to the
quoted prices may be necessary or the Company may conclude that a change in
valuation technique or the use of multiple techniques may be appropriate to
estimate an instrument’s fair value.  For further information about fair
value measurements, refer to Notes 3 and 10.





In the
first quarter 2009, the Company elected to early adopt new guidance impacting
ASC Topic 825, Financial Instruments, related to interimdisclosures about fair
value of financial instruments. This new guidance
requires that disclosures on the estimated fair value of financial instruments
be included in interim financial statements. It also requires disclosure of the
method(s) and significant assumptions used to estimate the fair value of
financial instruments in the interim financial statements.  For further
information concerning the estimated fair value of financial instruments, refer
to Note 10.





In the
first quarter 2009, the Company elected to early adopt new guidance impacting
ASC Topic 320, Investments — Debt and Equity Instruments, related to recognition
and presentation of other-than-temporary impairments.This new guidance
changed the method for determining whether OTTI exists for debt securities by
requiring an assessment of the likelihood of selling the security prior to
recovering its amortized cost basis. It also changed the amount of an impairment
charge to be recorded in the consolidated statements of income. If the Company
intends to sell the security or it is more-likely-than-not that the Company will
be required to sell the security prior to recovery of its amortized cost basis,
the security would be written down to fair value with the full amount of any
impairment charge recorded as a loss in “net securities gains (losses)” in the
consolidated statements of income. If the Company does not intend to sell the
security and it is more-likely-than-not that the Company will not be required to
sell the security prior to recovery of its amortized cost basis, only the credit
component of any impairment of a debt security would be recognized as a loss in
“net securities gains (losses)” in the consolidated statements of income, with
the remaining impairment recorded in OCI.  For further information, refer
to Note 3.





On
January 1, 2009, the Company adopted new guidance impacting ASC Topic 260,
Earnings Per Share, related to determining whether instruments granted in
share-based payment transactions are participating securities.  The
guidance clarified that unvested share-based payment awards that contain
nonforfeitable rights to dividends or dividend equivalents are considered
participating securities and should be included in the calculation of basic
earnings per share using the two-class method and was applied retrospectively to
all prior periods presented.  The adoption had no impact on the three or
nine months ended September 30, 2009 basic net income per common
share.  For further earnings per share information, refer to Note
9.





During
the second quarter 2009, the Company adopted guidance impacting ASC Topic 855,
Subsequent Events.  The objective of the guidance is to establish
general standards of accounting for and disclosure of events that occur after
the balance sheet date, but before financial statements are issued or are
available to be issued.  The adoption did not have an impact on
financial position, results of operation or liquidity.





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In
June 2009, the FASB issued SFAS No. 166, “Accounting for Transfers of
Financial Assets, an amendment of FASB Statement No. 140,” (SFAS
166).  SFAS 166 removes the concept of a qualifying special-purpose entity
from ASC Topic 860, Transfers and Servicing, and eliminates the exception for
qualifying special-purpose entities from consolidation guidance.  In
addition, SFAS 166 establishes specific conditions for reporting a transfer of a
portion of a financial asset as a sale.  If the transfer does not meet
established sale conditions, the transferor and transferee must account for the
transfer as a secured borrowing.  An enterprise that continues to transfer
portions of a financial asset that do not meet the established sale conditions
would be eligible to record a sale only after it has transferred all of its
interest in that asset.  The effective date is fiscal years beginning after
November 15, 2009.  Accordingly, the Company will adopt the provisions
in the first quarter 2010.  The Company is currently evaluating the impact
of the provisions.





Also, in
June 2009, the FASB issued SFAS No. 167, “Amendments to FASB
Interpretation No. 46(R),” (SFAS 167).  SFAS 167 replaces the
quantitative-based risks and rewards calculation for determining which
enterprise, if any, is the primary beneficiary and is required to consolidate
the variable interest entity with a qualitative approach focused on identifying
which enterprise has both the power to direct the activities of the variable
interest entity that most significantly impact the entity’s economic performance
and has the obligation to absorb losses or the right to receive benefits that
could be significant to the entity.  In addition, SFAS 167 requires
reconsideration of whether an entity is a variable interest entity when any
changes in facts and circumstances occur such that the holders of the equity
investment at risk, as a group, lose the power from voting rights or similar
rights of those investments to direct the activities of the entity that most
significantly impact the entity’s economic performance.  It also requires
ongoing assessments of whether an enterprise is the primary beneficiary of a
variable interest entity and additional disclosures about an enterprise’s
involvement in variable interest entities. The effective date is fiscal years
beginning after November 15, 2009.  Accordingly, the Company will
adopt the provisions in the first quarter 2010.  The Company is currently
evaluating the impact of the provisions.





In
August 2009, the FASB issued Accounting Standards Update (ASU)
No. 2009-05 (ASU 2009-05), which provides amendments to ASC Topic 820, Fair
Value Measurements and Disclosures, for the fair value measurement of
liabilities.  ASU 2009-05 provides clarification that in circumstances in
which a quoted price in an active market for the identical liability is not
available, a reporting entity is required to measure fair value using one or
more of the following techniques: a valuation technique that uses the quoted
price of the identical liability when traded as an asset or a quoted price for a
similar liability when traded as an asset, or another valuation method that is
consistent with the principles of ASC Topic 820, Fair Value Measurements and
Disclosures.  ASU 2009-05 also provides clarification that when estimating
the fair value of a liability, a reporting entity is not required to include a
separate input or adjustments to other inputs relating to the existence of a
restriction that prevents the transfer of the liability.  The effective
date is the first reporting period beginning after issuance.  Accordingly,
the Corporation will adopt the provisions of ASU 2009-5 in the fourth quarter
2009.  The Company does not expect the adoption of the provisions of ASU
2009-5 to have a material effect on the Company’s financial condition and
results of operations.




















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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:





·
            regulatory
      action requiring maintenance of minimum regulatory capital ratios higher
      than generally applicable minimum ratios; noncompliance could result in
      additional regulatory enforcement action; compliance could result in lower
      future return on equity and dilution for current stock
      holders;


·
            adverse
      changes in the real estate markets;


·
            adverse
      changes in the securities markets;


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


·
            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;


·
            significantly
      increased competition among depository and other financial
      institutions;


·
            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 2008 Annual Report on Form 10-K).





Overview





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, 2009 and 2008 and the financial condition as of
September 30, 2009 compared to the financial condition as of December 31,
2008.




Generally,
our results of operations are highly dependent on our net interest income and
the provision for loan losses.  In recent periods our results of
operations have also been negatively impacted by other than temporary impairment
of securities available for sale, by increased real estate owned expense and by
higher deposit insurance premiums.  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 97.0% of total loans receivable on
September 30, 2009.  Further, 82.5% of loans receivable are
residential mortgage loans with over four-family loans comprising 35.4% of all
loans on September 30, 2009.  WaterStone Bank funds loan production
primarily with retail deposits and Federal Home Loan Bank
advances.  On September 30, 2009, deposits comprised 68.5% of total
liabilities.  Time deposits, also known as certificates of deposit,
accounted for 87.0% of total deposits at September 30, 2009.  Federal
Home Loan Bank advances outstanding on September 30, 2009 totaled $512.0
million, or 29.5% of total liabilities.  During the current period of
low interest rates and economic weakness, we have determined that an investment
philosophy emphasizing short-term liquid investments is prudent and will
position the Company to take advantage of the opportunities that will exist as
the local and national economies recover from the recession.




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During
the nine and three month periods ended September 30, 2009, our results of
operations continued to be adversely affected by elevated levels
of  nonperforming  loans and real estate owned which have
resulted in high provisions for loan losses and loan charge-offs.  We
have sought to address the deterioration of the real estate market by increasing
our provisions for loan losses over the past two years.  The continued
downturn in the local real estate market requires the Company to continually
reevaluate the assumptions used to determine the fair value of collateral
related to loans receivable to ensure that the allowance for loan losses
continues to be an accurate reflection of management’s best estimate of the
amount needed to provide for the probable and estimable loss on impaired loans
and other inherent losses in the loan portfolio.  As a result, the
Company determined that a provision for loan losses of $19.1 million was
necessary during the nine months ended September 30, 2009 in order to maintain
the allowance for loan losses at an appropriate level.  Additional
information regarding loan quality and its impact on our financial condition and
results of operations can be found in the Asset Quality
discussion.  Our results of operations are also affected by
noninterest income and noninterest expense.  Noninterest income
consists primarily of mortgage banking fee income and service
charges.  A significant increase in the sale of mortgage loans in the
secondary market, resulting from a decline in mortgage interest rates during the
period, yielded a $3.5 million increase in mortgage banking income during the
nine months ended September 30, 2009 compared to the nine months ended September
30, 2008.  In addition to the increase in mortgage banking activity,
the increase in noninterest income compared to the prior period resulted from an
$885,000 decrease in impairment charge on securities considered to be other than
temporarily impaired.  Noninterest expense consists primarily of
compensation and employee benefits, FDIC insurance premiums, occupancy expenses
and real estate owned expense.  In 2009 our noninterest expense has
been and will continue to be adversely affected by higher deposit insurance
premium assessments from the FDIC.  FDIC insurance premium expense,
which included a $876,000 special assessment during the nine months ended
September 30, 2009, has increased $1.7 million compared to the nine months ended
September 30, 2008.  Our results of operations also may be affected
significantly by general and local economic and competitive conditions,
governmental policies and actions of regulatory authorities.




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.




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.





Under
generally accepted accounting principles, a valuation allowance is required to
be recognized if it is “more likely than not” that a deferred tax asset will not
be realized.  The determination of the realizability of the deferred
tax assets is highly subjective and dependent upon judgment concerning
management's evaluation of both positive and negative evidence, the forecasts of
future income, applicable tax planning strategies, and assessments of current
and future economic and business conditions. Positive evidence includes the
existence of taxes paid in available carry-back years as well as the probability
that taxable income will be generated in future periods, while negative evidence
includes the cumulative losses in the current year and prior two years and
general business and economic trends.  At September 30, 2009 and at
December 31, 2008, the Company determined that valuation allowances were
necessary, largely based on the cumulative loss during the most recent
three-year period caused by the significant loan loss provisions recorded during
2009 and 2008.  In addition, general uncertainty surrounding future
economic and business conditions have increased the potential volatility and
uncertainty of projected earnings.  Management is required to
re-evaluate the deferred tax asset and the related valuation allowance
quarterly.




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Positions
taken in the Company’s tax returns may be subject to challenge by the taxing
authorities upon examination.  The benefit of uncertain tax positions
are initially recognized in the financial statements only 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 greater than 50% likely of
being 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 within income tax expense in the income
statement.




Management
believes its tax policies and practices are critical because the determination
of the tax provision and current and deferred tax assets and liabilities have a
material impact on our net income and the carrying value of our
assets.  We have no plans to change the tax recognition methodology in
the future.  If our estimated deferred tax valuation allowance is
adjusted it will affect our future results of operations.  At
September 30, 2009, the Company had a deferred tax valuation allowance of $15.1
million.  The net recorded deferred tax asset, after valuation
allowance, at September 30, 2009 was $4.5 million.  The remaining
deferred tax asset was supported by remaining carry-backs of income taxes paid
in prior years and available tax planning strategies.  The deferred
tax asset is also net of deferred tax liabilities associated with net unrealized
gains on available for sale investment securities recorded in other
comprehensive income.  The comparable net deferred tax asset valuation
allowance at December 31, 2008 totaled $13.5 million and the net deferred tax
asset after valuation allowance was $5.6 million.









Comparison
of Operating Results for the Nine Months Ended September 30, 2009 and
2008





General
- Net loss for the nine months ended September 30, 2009 totaled $5.8 million, or
$0.19 for both basic and diluted loss per share, compared to net loss of $30.1
million, or $0.99 for both basic and diluted loss per share, for the nine months
ended September 30, 2008.  The nine months ended September 30, 2009
generated an annualized loss on average assets of 0.41% and an annualized loss
on average equity of 4.63%, compared to an annualized loss on average assets of
2.21% and an annualized loss on average equity of 20.02% for the comparable
period in 2008.  The net loss for the nine months ended September 30,
2009 reflects continuing deterioration in asset quality which resulted in a
$19.1 million provision for loan losses during the current year.  The
current year to date provision represents a $15.5 million decrease from the
$34.6 million provision for loan losses for the nine months ended September 30,
2008.  Increases of $1.4 million in net interest income, $3.5 million
in mortgage banking income, an $885,000 decrease in impairment charge on
securities considered to be other than temporarily impaired and a decrease of
$5.8 million in income tax expense for the first nine months of 2009 over the
prior period were FDIC insurance expense increases of $1.7 million (which
include the FDIC special assessment) and an increase in compensation expense of
$524,000.  Loan charge-off activity and specific loan reserves are
discussed in additional detail in the Asset Quality section.  The net
interest margin for the nine months ended September 30, 2009 was 2.34% compared
to 2.35% for the nine months ended September 30, 2008.





Total
Interest Income - Total interest income decreased $3.4 million, or 4.4%,
to $74.5 million during the nine months ended September 30, 2009 from $77.9
million during the nine months ended September 30, 2008.





Interest
income on loans decreased $3.2 million, or 4.7%, to $66.3 million during the
nine months ended September 30, 2009 from $69.6 million during the nine months
ended September 30, 2008.   The decrease in interest income was
primarily due to a 54 basis point decrease in the average yield on loans to
5.79% for the nine-month period ended September 30, 2009 from 6.23% for the
comparable period in 2008.  The decrease in interest income
attributable to the decrease in the yield on loans was partially offset by a
$40.3 million, or 2.7%, increase in the average balance of average loans
outstanding to $1.53 billion during the nine months ended September 30, 2009
from $1.49 billion during the comparable period in 2008.  In addition
to the decrease in interest income due to a decrease in the average yield, $1.5
million of the overall decrease compared to the prior year related to interest
income recognized on a loan during the nine months ended September 30, 2008 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 $1.5 million represented interest income that was collected but not
recognized during the facilitation period.  The loan was paid in full
during the third quarter of 2008, which resulted in full recognition of interest
collected in prior periods.This transaction had the
affect of increasing the average yield on interest earning assets by 13 basis
points for the nine months ended September 30, 2008.  Unrecognized
interest income on non-accrual loans totaled $4.9 million during the nine months
ended September 30, 2009.  This had the effect of reducing the average
yield on loans during the same period by 43 basis
points.  Unrecognized interest income on non-accrual loans totaled
$3.2 million during the nine months ended September 30, 2008, effectively
reducing the average yield on loans for that period by 28 basis
points.





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Interest
income from mortgage-related securities decreased $176,000, or 3.1%, to $5.5
million during the nine months ended September 30, 2009 from $5.7 million during
the nine months ended September 30, 2008.  The decrease in interest
income was primarily due to a $8.6 million, or 6.2%, decrease in the average
balance of mortgage-related securities to $129.3 million for the nine months
ended September 30, 2009 from $137.9 million during the comparable period in
2008.  The decrease in interest income, reflecting a decrease in
average balance, was partially offset by an increase in average
yield.  The average yield on mortgage-related securities increased 18
basis points to 5.67% for the nine months ended September 30, 2009 from 5.49%
for the comparable period in 2008.  The decline in the average balance
of mortgage-related securities during the nine months ended September 30, 2009
reflects management’s decision to deemphasize investments in mortgage-related
securities and emphasize more liquid government agency and higher yielding
municipal debt securities.





Finally,
interest income from debt securities, federal funds sold and short-term
investments remained stable at $2.6 million for both the nine months ended
September 30, 2009 and 2008.  Interest income decreased due to a 109
basis point decline in the average yield on other earning assets to 2.15% for
the nine months ended September 30, 2009 from 3.24% for the comparable period in
2008.  The decline in average yield provided by these investments
reflects the overall interest rate environment as opposed to a shift in
investment strategy or product mix.  The decrease in average rate was
offset by an increase of $53.8 million, or 48.9%, in the average balance of
other earning assets to $163.8 million during the nine months ended September
30, 2009 from $110.0 million during the comparable period in
2008.  The increase in average balance reflects a strategic shift
towards higher levels of liquidity.  The Company intends to maintain
higher than usual liquidity given the current economic environment and
relatively low rates of return available on loans and mortgage related
securities.  The average balance of debt securities, federal funds
sold and short-term investments includes FHLBC stock of $21.7 million and $20.6
million for the nine month-periods ended September 30, 2009 and 2008,
respectively.  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.





Total
Interest Expense-Total interest expense decreased by $4.8 million, or 10.2%, to $42.5
million during the nine months ended September 30, 2009 from $47.3 million
during the nine months ended September 30, 2008.  This decrease was
the result of a decrease of 67 basis points in the cost of funds to 3.27% for
the nine months ended September 30, 2008 from 3.94% for the comparable period
ended September 30, 2008, partially offset by an increase of $128.5 million, or
8.0%, in average interest bearing deposits and borrowings outstanding to $1.73
billion for the nine months ended September 30, 2009 compared to an average
balance of $1.61 billion for the nine months ended September 30,
2008.





Interest
expense on deposits decreased $4.4 million, or 13.8%, to $27.4 million during
the nine months ended September 30, 2009 from $31.8 million during the
comparable period in 2008.  This was due to a decrease in the cost of
total average deposits of 85 basis points to 3.03% for the nine months ended
September 30, 2009 compared to 3.88% for the comparable period during
2008.  The decrease in interest expense attributable to the decrease
in the cost of deposits was partially offset by an increase of $113.2 million,
or 10.3%, in the average balance of other interest bearing deposits to $1.21
billion during the nine months ended September 30, 2009 from $1.1 billion during
the comparable period in 2008.  The decrease in the cost of deposits
reflects the Federal Reserve’s reduction of short term interest rates which are
typically used by financial institutions in pricing deposit
products.





Interest
expense on borrowings decreased $469,000, or 3.0%, to $15.1 million during the
nine months ended September 30, 2009 from $15.5 million during the comparable
period in 2008.  The decrease resulted primarily from a 24 basis point
decrease in the average cost of borrowings to 3.90% during the nine months ended
September 30, 2009 from 4.14% during the comparable period in
2008.  The decrease due to rate was partially offset by a $20.2
million, or 4.1%, increase in average borrowings outstanding to $512.2 million
during the nine months ended September 30, 2009 from $492.0 million during the
comparable period in 2008.  The increased use of borrowings as a
source of funding during nine months ended September 30, 2009 reflected our
assessment that such sources of funds provided favorable rates and terms
compared to retail funding sources.  The reduction in short term
interest rates by the Federal Reserve allowed banks such as WaterStone Bank to
borrow funds at lower rates, helping to reduce our cost of funds.





Net
Interest Income - Net interest income increased by $1.4 million or 4.6%,
to $32.0 million during the nine months ended September 30, 2009 as compared to
$30.6 million during the comparable period in 2008.  Net interest
income continues to be positively affected by a decrease in short and medium
term interest rates in 2009, as compared to 2008 and by our interest bearing
liabilities repricing at a faster rate than our interest earning
assets.  The increase in net interest income resulted primarily from a
14 basis point increase in our interest rate spread to 2.18% for the nine month
period ended September 30, 2009 from 2.04% for the comparable period in
2008.  The 14 basis point increase in the interest rate spread
resulted from a 67 basis point decrease in the cost of interest bearing
liabilities, which was partially offset by a 53 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 $43.0 million, or 32.0%, to $91.5
million for the nine months ended September 30, 2009 from $134.5 million from
the comparable period in 2008.  The decrease in net average earning
assets was primarily attributable to an increase in loans transferred to real
estate owned.  The average balance of real estate owned totaled $37.3
million for the nine months ended September 30, 2009 compared to $13.7 million
for the nine months ended September 30, 2008.





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Provision
for Loan Losses – Our provision for loan losses decreased $15.5 million,
to $19.1 million during the nine months ended September 30, 2009, from $34.6
million during the comparable period during 2008.  During the third quarter of 2008, the
Company received updated appraisals on a number of properties that
collateralized nonperforming loans.  The decline in value noted in
those appraisals, in addition to the continued downturn in the local real estate
market, prompted the Company to obtain updated appraisals on a larger number of
at risk loans and to reevaluate the assumptions used to determine the fair value
of collateral related to both performing and nonperforming
loans.  This reevaluation contributed to the provision for loan losses
of $34.6 million during the nine months ended September 30,
2008.While it has decreased from the prior year, the
provision for loan losses remains at historically high levels.  The
provision for the nine months ended September 30, 2009 was primarily the result
of $12.7 million of net loan charge-offs combined with continued weakness in
local real estate markets.  The increase in charge-offs reflects
management’s continued evaluation of assumptions used to determine the fair
value of collateral supporting nonperforming loans.  In addition,
compared to prior periods, the Company has observed an increased likelihood of
borrowers being unable to resolve ongoing loan defaults 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 the Asset Quality section for an analysis of
charge-offs, nonperforming assets, specific reserves and additional
provisions.





Noninterest
Income - Total noninterest income increased $3.7 million, or 80.3%, to
$8.2 million during the nine months ended September 30, 2009 from $4.6 million
during the comparable period in 2008.  The increase primarily resulted
from an increase in mortgage banking income.  Mortgage banking income
increased $3.5 million to $6.8 million for the nine months ended September 30,
2009, compared to $3.3 million during the comparable period in
2008.  The increase was the result of increased mortgage loan
refinancing  triggered by declines in  mortgage interest
rates during the period.  During the nine months ended September 30,
2009, the Company sold $515.4 million of mortgage loans into the secondary
market, as compared to $229.2 million during the comparable period in
2008.





Noninterest
Expense - Total noninterest expense increased $2.1 million, or 8.5%, to
$27.0 million during the nine months ended September 30, 2009 from $24.9 million
during the comparable period in 2008.  The increase was primarily
attributable to increased FDIC insurance premiums, including a special
assessment charged to income during the second quarter of 2009.





Compensation,
payroll taxes and other employee benefit expense increased $524,000, or 4.1%, to
$13.3 million during the nine months ended September 30, 2009 compared to $12.8
million during the comparable period in 2008.  This increase resulted
primarily from an increase in compensation and payroll taxes and health
insurance expense, partially offset by a reduction in expense related to the
ESOP.  Due primarily to an increase in loan sales into the secondary
market, total compensation, in the form of commissions, and payroll taxes
increased $637,000, or 6.4%, to $10.8 million for the nine months ended
September 30, 2009 compared to $10.1 million during the comparable period in
2008.  Company paid health insurance expense increased $260,000 to
$904,000 during the nine months ended September 30, 2009 compared to $645,000
during the comparable period in 2008.  Partially offsetting the
increase in compensation and health insurance expense, ESOP expense decreased
$471,000, to $195,000 during the nine months ended September 30, 2009 compared
to $666,000 during the comparable period in 2008.  This decrease
reflects the decrease in the Company’s average share price during the nine
months ended September 30, 2009 compared to the comparable period in
2008.





Real
estate owned expense remained constant at $2.8 million for the nine months ended
September 30, 2009 and 2008.  Real estate owned expense includes the
net gain or loss recognized upon the sale of a foreclosed property, as well as
the net operating and carrying costs related to the
properties.  During the nine months ended September 30, 2009, net
operational expenses increased $321,000 to $2.2 million from $1.8 million during
the comparable period in 2008.  The increase in net operational
expense compared to the prior period resulted from an increase in the number of
foreclosed properties.  The average balance of real estate owned
totaled $37.3 million for the nine months ended June 30, 2009 compared to $13.7
million for the nine months ended September 30, 2008.  Net loss
recognized on the sale of real estate owned totaled $596,000 during the nine
months ended September 30, 2009, compared to a net loss of $915,000 during the
comparable period in 2008.





Other
noninterest expense increased $1.7 million, or 69.2%, to $4.2 million during the
nine months ended September 30, 2009 from $2.5 million during the comparable
period in 2008.  The increase resulted primarily from an increase in
FDIC deposit insurance premiums.  FDIC insurance premium expense
increased $1.7 million to $2.0 million during the nine months ended September
30, 2009 from $319,000 during the comparable period during 2008.  The
increase results from both an increase in the premium rate as well as a special
assessment totaling $876,000 that was paid on September 30, 2009.





Income
Taxes – We recorded an income tax benefit of $5,000 for the nine months
ended September 30, 2009.  This total was comprised of a $503,000
benefit recorded in the first quarter of 2009 offset by a $498,000 expense
recorded in the second quarter of 2009.  The $503,000 benefit was the
result of a Wisconsin state tax law change (retroactive to January 1, 2009)
related to the net unrealized loss on securities available for sale owned by the
Company’s Nevada subsidiary.  The $498,000 federal tax expense
recorded in the second quarter of 2009 was the result of an increase in the
deferred tax asset valuation allowance.  During the nine months ended
September 30, 2008, we recorded income tax expense of $5.8 million, which was
primarily the result of the establishment of deferred tax asset valuation
allowances of $16.1 million.







Net
Loss-As a
result of the foregoing factors, net loss for the nine months ended September
30, 2009 was $5.8 million as compared to a net loss of $30.1 million during the
comparable period in 2008.




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Comparison
of Operating Results for the Three Months Ended September 30, 2009 and
2008





General
- Net loss for the three months ended September 30, 2009 totaled $3.6 million,
or $0.12 for both basic and diluted loss per share compared to net loss of $28.2
million, or $0.92 for both basic and diluted loss per share for the three months
ended September 30, 2008.  The three months ended September 30, 2009
generated an annualized loss on average assets of 0.74% and an annualized loss
on average equity of 8.31%, compared to an annualized loss on average assets of
5.89% and an annualized loss on average equity of 56.14% for the comparable
period in 2008.  The decrease in our net loss in 2009 as compared with
2008 reflects a $14.4 million decrease in the provision for loan losses, an $8.6
million decrease in income tax expense and a $3.4 million increase in
noninterest income, partially offset by a $1.1 million decrease in net interest
income and a $683,000 increase in noninterest expense.  Loan
charge-off activity and specific loan reserves are discussed in additional
detail in the Asset Quality section.  The net interest margin for the
three months ended September 30, 2009 was 2.46% compared to 2.69% for the three
months ended September 30, 2008.





Total
Interest Income - Total interest income decreased $3.4 million, or 12.2%,
to $24.7 million during the three months ended September 30, 2009 compared to
$28.1 million for the three months ended September 30, 2008.





Interest
income on loans decreased $3.2 million, or 12.7%, to $22.0 million for the three
months ended September 30, 2009 compared to $25.2 million for the comparable
period of 2008.  The decrease resulted primarily from a 59 basis point
decrease in the average yield on loans to 5.84% for the three-month period ended
September 30, 2009 from 6.43% for the comparable period in 2008.  The
decrease in interest income due to the decline in average yield  was
compounded by a decrease of $62.2 million, or 4.0%, in the average loan balance
to $1.49 billion during the three-month period ended September 30, 2009 from
$1.55 billion during the comparable period in 2008.  In addition to
the decrease in interest income due to a decline in both average yield and
average balance, $1.5 million of the overall decrease compared to the prior year
related to interest income recognized on a loan during the nine months ended
September 30, 2008 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 $1.5 million represented interest income
that was collected but not recognized during the facilitation
period.  The loan was paid in full during the third quarter of 2008,
which resulted in full recognition of interest collected in prior periods.This transaction had the
affect of increasing the average yield on interest earning assets by 38 basis
points for the three months ended September 30, 2008.  Unrecognized
interest income on non-accrual loans totaled $1.3 million during the three
months ended September 30, 2009.  This had the effect of reducing the
average yield on loans during the same period by 35 basis
points.  Unrecognized interest income on non-accrual loans totaled
$1.0 million during the three months ended September 30, 2008 effectively
reducing the average yield on loans for that period by 26 basis
points.





Interest
income from mortgage-related securities decreased $199,000, or 10.4%, to $1.7
million for the three months ended September 30, 2009 compared to $1.9 million
for the comparable quarter in 2008.  This was primarily due to a
decrease of $16.0 million, or 11.6%, in the average balance of mortgage related
securities to $121.8 million for the three months ended September 30, 2009 from
$137.9 million during the comparable period in 2008.  The decline in
average balance during the three months ended September 30, 2009 reflects a
strategic shift in the investment portfolio mix towards more liquid government
agency securities and higher yielding municipal debt securities.  The
decrease in interest income on mortgage related securities was due to a decline
in average balance and was partially offset by a 7 basis point increase in the
average yield to 5.60% for the three months ended September 30, 2009 from 5.53%
for the comparable period in 2008.





Finally,
interest income from debt securities, federal funds sold and short-term
investments decreased $27,000, or 2.7%, to $973,000 for the three months ended
September 30, 2009 compared to $1.0 million for the comparable period in
2008.  The decrease in interest income was the result of a 121 basis
point decrease in the average yield on other earning assets to 1.91% for the
three months ended September 30, 2009 from 3.12% for the comparable period in
2008.  The decrease in interest income due to a decrease in average
yield was partially offset by an increase in average balance of $75.4 million,
or 59.3%, to $202.4 million during the three months ended September 30, 2009
from $127.1 million during the comparable period in 2008.  The Company
intends to maintain higher than usual liquidity given the current economic
environment and relatively low rates of return available on loans and mortgage
related securities.  The average balance of debt securities, federal
funds sold and short-term investments includes FHLBC stock of $21.7 million and
$20.6 million for the three month-periods ended September 30, 2009 and 2008,
respectively.  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 decreased by $2.3 million, or 14.8%, to $13.4
million during the three months ended September 30, 2009 from $15.8 million
during the three months ended September 30, 2008.  This decrease was
the result of a decrease of 61 basis points in the cost of funds to 3.08% for
the three months ended September 30, 2009 from 3.69% for the comparable period
ended September 30, 2008, partially offset by an increase of $35.7 million, or
2.1%, in average interest bearing deposits and borrowings outstanding to $1.73
billion for the three months ended September 30, 2009 compared to an average
balance of $1.69 billion for the three months ended September 30,
2008.





Interest
expense on deposits decreased $2.0 million, or 19.7%, to $8.3 million during the
three months ended September 30, 2009 from $10.4 million during the comparable
period in 2008.  This was due to a decrease in the cost of average
deposits of 81 basis points to 2.76% for the three months ended September 30,
2009 compared to 3.57% for the comparable period during 2008.  The
decrease in interest expense attributable to the decrease in the cost of
deposits was partially offset by an increase of $43.4 million, or 3.8%, in the
average balance of other interest bearing deposits to $1.20 billion during the
three months ended September 30, 2009 from $1.15 billion during the comparable
period in 2008.  The decrease in the cost of deposits reflects a lower
short term interest rate environment in 2009 when compared with 2008 which
reflects 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 decreased $285,000, or 5.3%, to $5.1 million during the
three months ended September 30, 2009 from $5.4 million during the comparable
period in 2008.  The decrease in interest expense resulted primarily
from a 16 basis point decrease in the average cost of borrowings to 3.91% during
the three months ended September 30, 2009 from 4.07% during the comparable
period in 2008.  The decrease in interest expense also reflects a $2.3
million, or 0.4%, decrease in average borrowings outstanding to $512.0 million
during the three months ended September 30, 2009 from $514.3 million during the
comparable period in 2008.





Net
Interest Income - Net interest income decreased by $1.1 million or 8.8%,
to $11.2 million during the three months ended September 30, 2009 as compared to
$12.3 million during the comparable period in 2008.  The decrease in
net interest income primarily resulted from income recognized on a loan during
the three months ended September 30, 2008 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 $1.5 million represented
interest income that was collected but not recognized during the facilitation
period.  The loan was paid in full during the third quarter of 2008,
which resulted in full recognition of interest collected in prior
periods.  This transaction had the affect of increasing the average
yield on interest earning assets by 38 basis points for the three months ended
September 30, 2008.As a result, our interest
rate spread decreased 13 basis points to 2.31% for the three month period ended
September 30, 2009 from 2.44% for the comparable period in 2008.  The
13 basis point decrease in the interest rate spread resulted from a 74 basis
point decrease in the average yield on interest earning assets, which was
partially offset by a 61 basis point decrease in the average cost of interest
bearing liabilities.  The decrease in net interest income resulting
from a decrease in our net interest rate spread was compounded by a decrease in
net average earning assets of $38.5 million, or 31.0%, to $85.8 million for the
three months ended September 30, 2009 from $124.3 million from the comparable
period in 2008.  The decrease in net average earning assets was
primarily attributable to an increase in loans transferred to real estate
owned.  The average balance of real estate owned totaled $45.7 million
for the three months ended September 30, 2009 compared to $19.6 million for the
three months ended September 30, 2008.





Provision
for Loan Losses – The provision for loan losses decreased $14.4 million,
or 62.0%, to $8.9 million during the three months ended September 30, 2009, from
$23.3 million during the comparable period in 2008.  While still at a
level that exceeds the historical average, the provision for the three months
ended September 30, 2009 reflects a decrease in both nonperforming loans and
overall delinquent loans compared to the comparable period in
2008.  See the Asset Quality section for an analysis of charge-offs,
nonperforming assets, specific reserves and additional provisions.





Noninterest
Income - Total noninterest income increased $3.4 million to $4.0 million
during the three months ended September 30, 2009 from $597,000 during the
comparable period in 2008.  The increase resulted primarily from an
increase in mortgage banking income and a decrease in impairment losses
recognized on securities.  Mortgage banking income increased $1.6
million, or 115.0%, to $2.9 million for the three months ended September 30,
2009, compared to $1.4 million during the comparable period in
2008.  The increase resulted from an increase in mortgage refinancing
triggered by a decrease in mortgage interest rates.  During the three
months ended September 30, 2009, the Company sold $162.0 million in mortgage
loans in the secondary market, as compared to $51.6 million during the
comparable period in 2008.  In addition to the increase related to
mortgage banking activities, noninterest income was positively affected on a
comparative basis due to a reduction in impairment losses.  During the
quarter ended September 30, 2008, the Company recognized an other than temporary
impairment loss totaling $2.0 million on a collateralized mortgage
obligation.  There were no impairment losses in the comparable 2009
period.





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 Table of Contents





Noninterest
Expense - Total noninterest expense increased $683,000, or 7.4%, to $9.9
million during the three months ended September 30, 2009 from $9.2 million
during the comparable period in 2008.  The increase was primarily
attributable to an increase of $427,000 in compensation, payroll taxes and other
employee benefits and a $331,000 increase in FDIC insurance
premiums.





Compensation,
payroll taxes and other employee benefit expense increased $427,000, or 9.5%, to
$4.9 million during the three months ended September 30, 2009 compared to $4.5
million during the comparable period in 2008.  This increase resulted
primarily from an increase in compensation and payroll taxes.  Due
primarily to an increase in loan originations and sales in the secondary market,
total compensation expense increased $302,000, or 8.4%, to $3.9 million for the
three months ended compared to $3.6 million during the comparable period in
2008.  In addition to an increase in compensation expenses, expense
related to the Company’s self funded health insurance plan increased $119,000,
or 49.1%, to $361,000 during the three months ended September 30, 2009 compared
to $242,000 during the comparable period in 2008.





Real
estate owned expense increased $33,000, or 2.1%, to $1.6 million for the three
months ended September 30, 2009 compared to $1.5 million during the three months
ended September 30, 2008.  Real estate owned expense includes the net
gain or loss recognized upon the sale of a real estate property acquired through
foreclosure, as well as the net operating and carrying costs related to the
properties.  During the three months ended September 30, 2009, net
operational expenses decreased $205,000, or 27.2%, to $550,000 from $755,000
during the comparable period in 2008.  Net losses on the sale of real
estate owned increased $238,000, or 31.1% to $1.0 million during the three
months ended September 30, 2009, compared to $763,000 during the comparable
period in 2008.





Other
noninterest expense increased $437,000, or 48.8%, to $1.3 million during the
three months ended September 30, 2009 from $895,000 during the comparable period
in 2008.  The increase resulted primarily from an increase in the FDIC
insurance premiums related to deposits.  FDIC insurance premium
expense increased $331,000, or 150.0% to $552,000 during the three months ended
September 30, 2009 from $221,000 during the comparable period during
2008.





Income
Taxes – There was no income tax expense incurred during the three months
ended September 30, 2009 due to having previously utilized all net operating
loss carry backs.  Income tax expense of $8.6 million was recognized
for the three months ended September 30, 2008.  The 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.




Net
Income-As a
result of the foregoing factors, net loss for the three months ended September
30, 2009 was $3.6 million as compared to net a net loss of $28.2 million during
the comparable period in 2008.







Comparison
of Financial Condition at September 30, 2009 and December 31, 2008





Total
Assets - Total assets increased by $22.5 million, or 1.2%, to $1.91
billion at September 30, 2009 from $1.89 billion at December 31, 2008. The
increase in total assets is comprised of increases in cash and cash equivalents
of $71.6 million, securities available for sale of $22.8 million, loans held for
sale of $20.5 million and real estate owned of $16.3 million.  These
increases were partially offset by a decrease in loans receivable of $95.3
million.





Cash and
Cash Equivalents–Cash and cash equivalents increased by $71.6 million to $95.4 million at
September 30, 2009 from $23.8 million at December 31, 2008.  The
increase in cash and cash equivalents reflects the Company’s decision to
maintain higher than usual liquidity given the current economic environment and
relatively low rates of return available on securities and other
investments.





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Securities
Available for Sale– Securities available for sale increased by $22.8
million, or 12.7%, to $202.7 million at September 30, 2009 from $179.9 million
at December 31, 2008.  The increase in the available for sale
portfolio relates to an increase in government agency and municipal
securities.  The $22.8 million increase in securities available for
sale was primarily comprised of the reinvestment of $7.4 million of earnings
into securities, a $7.5 million reduction in the net unrealized loss and $7.3
million of securities held to maturity reinvested in securities available for
sale.





Debt
securities increased by $35.6 million to $83.9 million at September 30, 2009
compared to $48.3 million at December 31, 2008.  The increase in debt
securities was partially offset by a $12.8 million decrease in mortgage related
securities to $118.8 million at September 30, 2009 from $131.5 million as of
December 31, 2009.  The shift in the mix of the portfolio towards less
volatile, shorter-term debt securities reflects a strategic decision to increase
portfolio liquidity.  During the nine months ended September 30, 2009,
the Company identified one previously unimpaired available for sale security
with a September 30, 2009 fair value of $11.6 million that was determined to be
other than temporarily impaired.  As a result of the Company’s
analysis, a $6.4 million impairment has been recognized as of September 30,
2009, with respect to this security.  Of the total impairment on this
security, $977,000 has been identified as a credit loss and has been recognized
as a current year expense.  The remaining $5.4 million impairment
(before taxes) is included in other comprehensive income.





Loans
Held for Sale–Loans held for sale increased by $20.5 million to $33.5 million at
September 30, 2009, from $13.0 million at December 31, 2008.  The
increase in loans held for sale resulted primarily from an increase in
origination activity driven by a decrease in mortgage interest rates during the
current period.





Loans
Receivable - Loans receivable decreased $95.3 million, or 6.1%, to $1.46
billion at September 30, 2009 from $1.56 billion at December 31,
2008.  The decrease in loans receivable reflects a decline in loan
demand combined with the Company’s more stringent loan underwriting requirements
in the current economic environment.  The 2009 decrease in loans
receivable was primarily attributable to a $74.9 million decrease in one- to
four-family loans and a $48.6 million decrease in land and construction loans,
which was partially offset by a $26.4 million increase in over four-family
loans.  During the nine-month period ended September 30, 2009, $37.8
million in loans were transferred to real estate owned.





The
following table shows loan origination, principal repayment activity, transfers
to real estate owned, charge offs and sales during the periods
indicated.







As
      of or for the
            
            
            As
      of or for theNine
      Months Ended September 30,
            
            
            Year
      Ended2009
            
            
            2008
            
            
            December
      31, 2008(In
      Thousands)Total
      gross loans receivable and held for sale atbeginning
      of period
            
            $
            1,636,277
            
            
            $
            1,495,970
            
            
            
            1,495,970Real
      estate loans originated for investment:ResidentialOne-
      to four-family
            
            
            20,987
            
            
            
            174,973
            
            
            
            205,526Over
      four-family
            
            
            53,566
            
            
            
            107,833
            
            
            
            122,113Construction
      and land
            
            
            4,492
            
            
            
            46,677
            
            
            
            51,367Commercial
      real estate
            
            
            7,352
            
            
            
            13,414
            
            
            
            14,876Home
      equity
            
            
            7,781
            
            
            
            15,490
            
            
            
            20,672Total
      real estate loans originated for investment
            
            
            94,178
            
            
            
            358,387
            
            
            
            414,554Consumer
      loans originated for investment
            
            
            136
            
            
            
            179
            
            
            
            280Commerical
      business loans originated for investment
            
            
            8,956
            
            
            
            17,906
            
            
            
            21,934Total
      loans originated for investment
            
            
            103,270
            
            
            
            376,472
            
            
            
            436,768Principal
      repayments
            
            
            (154,860
            )
            
            
            (181,122
            )
            
            
            (228,099
            )Transfers
      to real estate owned
            
            
            (37,835
            )
            
            
            (22,272
            )
            
            
            (32,946
            )Loan
      principal charged-off
            
            
            (12,724
            )
            
            
            (21,207
            )
            
            
            (25,301
            )Net
      activity in loans held for investment
            
            
            (102,149
            )
            
            
            151,871
            
            
            
            150,422Loans
      originated for sale
            
            
            529,415
            
            
            
            217,518
            
            
            
            255,891Loans
      sold
            
            
            (508,882
            )
            
            
            (231,990
            )
            
            
            (266,006
            )Net
      activity in loans held for sale
            
            
            20,533
            
            
            
            (14,472
            )
            
            
            (10,115
            )Total
      gross loans receivable and held for sale at end of period
            
            $
            1,554,661
            
            
            $
            1,633,369
            
            
            
            1,636,277








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Real
Estate Owned– Total real estate owned increased $16.3 million, or 66.3%,
to $41.0 million at September 30, 2009 from $24.7 million at December 31,
2008.  The $16.3 million increase was primarily due to a $4.5 million
increase in construction and land properties and a $4.1 million increase in one-
to four-family real estate properties.





Deposits
– Total deposits decreased $7.8 million, or 0.7%, to $1.19 billion at September
30, 2009 from $1.20 billion at December 31, 2008.  Total time deposits
decreased $7.6 million, or 0.7%, to $1.03 billion from $1.04 billion at December
31, 2008.  Time deposits originated through the wholesale market
decreased $35.9 million, or 34.4%, to $68.2 million at September 30, 2009 from
$104.1 million at December 31, 2008.  Time deposits originated through
local retail outlets increased $28.3 million, or 3.0%, to $965.7 million at
September 30, 2009 from $937.4 million at December 31, 2008.  The
decrease in time deposits originated through the wholesale market was partially
offset by an increase in time deposits originated through our local
markets.  The shift in the mix of deposits away from the wholesale
market is intended to decrease our reliance on this source of funding. Total
money market and savings deposits decreased $4.7 million, or 4.7%, to $96.2
million at September 30, 2009 from $100.9 million at December 31,
2008.  Total demand deposits increased $4.5 million, or 8.5%, to $58.0
million at September 30, 2009 from $53.4 million at December 31,
2008.





Borrowings
– Total borrowings increased $25.0 million, or 5.1%, to $512.0 million at
September 30, 2009 from $487.0 million at December 31, 2008.  Early in
2009 a $25.0 million FHLBC advance was entered into to fund the disbursement of
advance payments by borrowers for taxes.  The FHLBC advance matures in
January of 2010 and bears an interest rate of 1.29%.





Advance
Payments by Borrowers for Taxes - Advance payments by borrowers for taxes
and insurance increased $22.7 million to $23.5 million at September 30, 2009
from $862,000 at December 31, 2008.  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 $19.1 million, or 62.8%, to
$11.3 million at September 30, 2009 from $30.4 million at December 31,
2008.  The decrease resulted from a $12.8 million decrease in
outstanding escrow checks and a $3.3 million decrease in capital lease
obligations.  The decrease related to outstanding escrow checks is
seasonal.  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 $13,000 at September 30, 2009 and $12.8 million at
December 31, 2008.  With respect to the elimination of the capital
lease obligation, the Company executed a purchase option of its capital lease on
a branch location during March 2009.





Shareholders’
Equity – Shareholders’ equity increased $1.7 million, or 1.0%, to $173.0
million at September 30, 2009 from $171.3 million at December 31,
2008.  The increase was primarily due to a $5.0 million decrease in
accumulated other comprehensive loss resulting from an increase in the market
value of available for sale securities.  In addition to the decrease
in accumulated other comprehensive loss, shareholders’ equity was positively
affected by a $811,000 increase in additional paid in capital and a $640,000
decrease in unearned ESOP shares.  The increases in shareholders’
equity were partially offset by an $4.7 million decrease in retained
earnings.  The decrease in retained earnings was the result of the net
loss of $5.8 million recognized during the nine months ended September 30, 2009,
partially offset by a $1.1 million cumulative-effect adjustment for a change in
accounting principle.  The cumulative-effect adjustment resulting from
the adoption of new guidance impacting ASC Topic 320, Investments – Debt and
Equity Instruments, relates to a security that had been deemed
other-than-temporarily impaired during the year ended December 31,
2008.  The adjustment was made to reflect the difference between the
present value of cash flows expected to be collected and the amortized cost
basis as of January 1, 2009, the effective date of the change in accounting
principle.


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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 30,2009
            
            
            2008Average
      Balance
            
            
            Interest
      and Dividends
            
            
            
            
            
            Yield/Cost
            
            
            Average
      Balance
            
            
            Interest
      and Dividends
            
            
            
            
            
            Yield/Cost(Dollars
      in Thousands)Interest-earning
      assets:Loans
      receivable, net
            
            $
            1,533,203
            
            
            
            66,348
            
            
            
            (1
            )
            
            
            5.79
            %
            
            $
            1,492,917
            
            
            
            69,584
            
            
            
            (1
            )
            
            
            6.23
            %Mortgage
      related securities(2)
            
            
            129,337
            
            
            
            5,485
            
            
            
            
            
            
            
            5.67
            
            
            
            137,942
            
            
            
            5,661
            
            
            
            
            
            
            
            5.49Debt
      securities (2),
      federal funds sold and short-term investments
            
            
            163,772
            
            
            
            2,640
            
            
            
            
            
            
            
            2.15
            
            
            
            109,965
            
            
            
            2,667
            
            
            
            
            
            
            
            3.24Total
      interest-earning assets
            
            
            1,826,312
            
            
            
            74,473
            
            
            
            
            
            
            
            5.45
            
            
            
            1,740,824
            
            
            
            77,912
            
            
            
            
            
            
            
            5.98Noninterest-earning
      assets
            
            
            89,601
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            79,949Total
      assets
            
            $
            1,915,913
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            $
            1,820,773Interest-bearing
      liabilities:Demand
      and money market accounts
            
            $
            116,844
            
            
            
            298
            
            
            
            
            
            
            
            0.34
            
            
            $
            144,037
            
            
            
            1,790
            
            
            
            
            
            
            
            1.66Savings
      accounts
            
            
            35,450
            
            
            
            140
            
            
            
            
            
            
            
            0.53
            
            
            
            25,552
            
            
            
            184
            
            
            
            
            
            
            
            0.96Certificates
      of deposit
            
            
            1,056,271
            
            
            
            26,969
            
            
            
            
            
            
            
            3.41
            
            
            
            925,755
            
            
            
            29,797
            
            
            
            
            
            
            
            4.30Total
      interest-bearing deposits
            
            
            1,208,565
            
            
            
            27,407
            
            
            
            
            
            
            
            3.03
            
            
            
            1,095,344
            
            
            
            31,771
            
            
            
            
            
            
            
            3.88Borrowings
            
            
            512,183
            
            
            
            14,959
            
            
            
            
            
            
            
            3.90
            
            
            
            491,986
            
            
            
            15,233
            
            
            
            
            
            
            
            4.14Other
      interest-bearing liabilities
            
            
            14,104
            
            
            
            128
            
            
            
            
            
            
            
            1.21
            
            
            
            19,003
            
            
            
            333
            
            
            
            
            
            
            
            2.35Total
      interest-bearing liabilities
            
            
            1,734,852
            
            
            
            42,494
            
            
            
            
            
            
            
            3.27
            
            
            
            1,606,333
            
            
            
            47,337
            
            
            
            
            
            
            
            3.94Noninterest-bearing
      liabilities
            
            
            13,089
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            13,555Total
      liabilities
            
            
            1,747,941
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1,619,888Equity
            
            
            167,972
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            200,883Total
      liabilities and equity
            
            $
            1,915,913
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            $
            1,820,771Net
      interest income
            
            
            
            
            
            
            31,979
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            30,575Net
      interest rate spread (3)
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            2.18
            %
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            2.04
            %Net
      interest-earning assets (4)
            
            $
            91,460
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            $
            134,491Net
      interest margin (5)
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            2.34
            %
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            2.35
            %Average
      interest-earning assets to average interest-bearing
      liabilities
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            105.27
            %
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            108.37
            %


__________




(1)  Includes net deferred loan fee amortization income of
      $728,000 and $1,306,000 for the nine months ended September 30, 2009 and
      2008, 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.


______________


- 31
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 Table of Contents







Three
      Months Ended September 30,2009
            
            
            2008Average
      Balance
            
            
            Interest
      and Dividends
            
            
            
            
            
            Yield/Cost
            
            
            Average
      Balance
            
            
            Interest
      and Dividends
            
            
            
            
            
            Yield/Cost(Dollars
      in Thousands)Interest-earning
      assets:Loans
      receivable, net
            
            $
            1,491,604
            
            
            
            21,974
            
            
            
            (1
            )
            
            
            5.84
            %
            
            $
            1,553,779
            
            
            
            25,166
            
            
            
            (1
            )
            
            
            6.43
            %Mortgage
      related securities(2)
            
            
            121,847
            
            
            
            1,721
            
            
            
            
            
            
            
            5.60
            
            
            
            137,890
            
            
            
            1,921
            
            
            
            
            
            
            
            5.53Debt
      securities (2),
      federal funds sold and short-term investments
            
            
            202,415
            
            
            
            973
            
            
            
            
            
            
            
            1.91
            
            
            
            127,061
            
            
            
            1,000
            
            
            
            
            
            
            
            3.12Total
      interest-earning assets
            
            
            1,815,866
            
            
            
            24,668
            
            
            
            
            
            
            
            5.39
            
            
            
            1,818,730
            
            
            
            28,087
            
            
            
            
            
            
            
            6.13Noninterest-earning
      assets
            
            
            97,573
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            84,216Total
      assets
            
            $
            1,913,439
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            $
            1,902,946Interest-bearing
      liabilities:Demand
      and money market accounts
            
            $
            108,699
            
            
            
            69
            
            
            
            
            
            
            
            0.25
            
            
            $
            141,052
            
            
            
            449
            
            
            
            
            
            
            
            1.26Savings
      accounts
            
            
            43,272
            
            
            
            76
            
            
            
            
            
            
            
            0.69
            
            
            
            28,157
            
            
            
            69
            
            
            
            
            
            
            
            0.98Certificates
      of deposit
            
            
            1,044,787
            
            
            
            8,180
            
            
            
            
            
            
            
            3.11
            
            
            
            984,109
            
            
            
            9,848
            
            
            
            
            
            
            
            3.97Total
      interest-bearing deposits
            
            
            1,196,758
            
            
            
            8,325
            
            
            
            
            
            
            
            2.76
            
            
            
            1,153,318
            
            
            
            10,366
            
            
            
            
            
            
            
            3.57Borrowings
            
            
            512,000
            
            
            
            5,040
            
            
            
            
            
            
            
            3.91
            
            
            
            514,278
            
            
            
            5,282
            
            
            
            
            
            
            
            4.07Other
      interest-bearing liabilities
            
            
            21,323
            
            
            
            59
            
            
            
            
            
            
            
            1.10
            
            
            
            26,822
            
            
            
            108
            
            
            
            
            
            
            
            1.59Total
      interest-bearing liabilities
            
            
            1,730,081
            
            
            
            13,424
            
            
            
            
            
            
            
            3.08
            
            
            
            1,694,418
            
            
            
            15,756
            
            
            
            
            
            
            
            3.69Noninterest-bearing
      liabilities
            
            
            12,749
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            8,784Total
      liabilities
            
            
            1,742,830
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1,703,202Equity
            
            
            170,609
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            199,744Total
      liabilities and equity
            
            $
            1,913,439
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            $
            1,902,946Net
      interest income
            
            
            
            
            
            
            11,244
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            12,331Net
      interest rate spread (3)
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            2.31
            %
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            2.44
            %Net
      interest-earning assets (4)
            
            $
            85,785
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            $
            124,312Net
      interest margin (5)
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            2.46
            %
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            2.69
            %Average
      interest-earning assets to average interest-bearing
      liabilities
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            104.96
            %
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            107.34
            %


__________




(1)  Includes net deferred loan fee amortization income of
      $194,000 and $435,000 for the three months ended September 30, 2009 and
      2008, 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 30,2009
      versus 2008
            
            
            2009
      versus 2008Increase
      (Decrease) due to
            
            
            Increase
      (Decrease) due toVolume
            
            
            Rate
            
            
            Net
            
            
            Volume
            
            
            Rate
            
            
            Net(In
      Thousands)Interest
      and dividend income:Loans
      receivable(1)
      (2)
            
            $
            1,848
            
            
            
            (5,084
            )
            
            
            (3,236
            )
            
            $
            (979
            )
            
            
            (2,213
            )
            
            
            (3,192
            )Mortgage
      related securities
            
            
            (361
            )
            
            
            185
            
            
            
            (176
            )
            
            
            (227
            )
            
            
            27
            
            
            
            (200
            )Other
      earning assets(3)
            
            
            1,048
            
            
            
            (1,075
            )
            
            
            (27
            )
            
            
            450
            
            
            
            (477
            )
            
            
            (27
            )Total
      interest-earning assets
            
            
            2,535
            
            
            
            (5,974
            )
            
            
            (3,439
            )
            
            
            (756
            )
            
            
            (2,663
            )
            
            
            (3,419
            )Interest
      expense:Demand
      and money market accounts
            
            
            (287
            )
            
            
            (1,205
            )
            
            
            (1,492
            )
            
            
            (84
            )
            
            
            (296
            )
            
            
            (380
            )Savings
      accounts
            
            
            57
            
            
            
            (101
            )
            
            
            (44
            )
            
            
            31
            
            
            
            (24
            )
            
            
            7Certificates
      of deposit
            
            
            3,862
            
            
            
            (6,690
            )
            
            
            (2,828
            )
            
            
            570
            
            
            
            (2,238
            )
            
            
            (1,668
            )Total
      interest-bearing deposits
            
            
            3,632
            
            
            
            (7,996
            )
            
            
            (4,364
            )
            
            
            517
            
            
            
            (2,558
            )
            
            
            (2,041
            )Borrowings
            
            
            612
            
            
            
            (886
            )
            
            
            (274
            )
            
            
            (23
            )
            
            
            (219
            )
            
            
            (242
            )Other
      interest bearing liabilities
            
            
            (72
            )
            
            
            (133
            )
            
            
            (205
            )
            
            
            (19
            )
            
            
            (30
            )
            
            
            (49
            )Total
      interest-bearing liabilities
            
            
            4,172
            
            
            
            (9,015
            )
            
            
            (4,843
            )
            
            
            475
            
            
            
            (2,807
            )
            
            
            (2,332
            )Net
      change in net interest income
            
            
            (1,637
            )
            
            
            3,041
            
            
            
            1,404
            
            
            
            (1,231
            )
            
            
            144
            
            
            
            (1,087
            )





______________


(1)
            Includes
      net deferred loan fee amortization income of $728,000, $1,306,000,
      $194,000 and $435,000 for the nine and three months ended September 30,
      2009 and 2008, 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 31,2009
            
            
            2008(Dollars
      in Thousands)Non-accrual
      loans:ResidentialOne-
      to four-family
            
            $
            52,211
            
            
            
            42,182Over
      four-family
            
            
            29,656
            
            
            
            35,787Construction
      and land
            
            
            7,014
            
            
            
            18,271Commercial
      real estate
            
            
            2,685
            
            
            
            9,325Home
      equity
            
            
            1,094
            
            
            
            2,015Commercial
            
            
            839
            
            
            
            150Total
      non-accrual loans
            
            
            93,499
            
            
            
            107,730Real
      estate ownedOne-
      to four-family
            
            
            20,870
            
            
            
            16,720Over
      four-family
            
            
            9,959
            
            
            
            6,057Construction
      and land
            
            
            5,624
            
            
            
            1,094Commercial
      real estate
            
            
            4,541
            
            
            
            782Total
      real estate owned
            
            
            40,994
            
            
            
            24,653Total
      nonperforming assets
            
            $
            134,493
            
            
            
            132,383Total
      performing troubled debt restructurings
            
            $
            31,192
            
            
            
            2,409Total
      non-accrual loans to total loans receivable
            
            
            6.38
            %
            
            
            6.91
            %Total
      non-accrual loans and performing troubled debtrestructurings
      to total loans receivable
            
            
            8.51
            %
            
            
            7.06
            %Total
      non-accrual loans to total assets
            
            
            4.90
            %
            
            
            5.71
            %Total
      nonperforming assets to total assets
            
            
            7.05
            %
            
            
            7.02
            %











The
following table summarizes loan delinquency in total dollars and as a percentage
of the total loan portfolio:




LOAN
      DELINQUENCY








At
      September 30,
            
            
            At
      December 31,2009
            
            
            2008(Dollars
      in Thousands)Loans
      past due less than 90 days
            
            
            33,337
            
            
            
            56,013Loans
      past due in excess of 90 days
            
            
            75,127
            
            
            
            89,907Total
      loans past due
            
            
            108,464
            
            
            
            145,920Total
      loans past due to total loans receivable
            
            
            7.41
            %
            
            
            9.36
            %








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Total
non-accrual loans decreased by $14.2 million to $93.5 million as of September
30, 2009, compared to $107.7 million as of December 31, 2008.  The
ratio of non-accrual loans to total loans at September 30, 2009 was 6.38%
compared to 6.91% at December 31, 2008.  The decrease in non-accrual
loans was primarily attributable to the transfer of loans to real estate owned
upon completion of foreclosure action.  During the nine months ended
September 30, 2009, $37.8 million in loans were transferred to real estate
owned.  Of the overall $14.2 million decrease in non-accrual loans,
$11.3 million relates to a decrease in the construction and land
category.  The decrease in this category was attributable to $12.4
million in loans that were transferred to real estate owned during the nine
months ended September 30, 2009.  Of the total $12.4 million
transferred to real estate owned, $5.8 million worth of that real estate was
subsequently sold for approximately $6.0 million.





Of the
$93.5 million in total non-accrual loans as of September 30, 2009, $19.7 million
related to three borrower relationships involving 15 loans secured by
residential and mixed use commercial real estate.  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, $3.8 million in charge-offs has been recorded
with respect to these loans and $1.7 million in additional specific reserves has
been recorded.  As of September 30, 2009, an additional $21.1 million
of nonaccrual loans outstanding is attributable to 145 mortgage loans made to
residential real estate investors.  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, $3.3 million in charge-offs and
$3.3 million in specific reserves have been recorded with respect to this
general category of borrowers.  An additional $5.2 million of the
September 30, 2009 nonaccrual balance is attributable to two mortgage loans made
to 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, $1.7 million in charge-offs has been recorded
with respect to these borrowers.  Finally, $7.5 million of the overall
balance of non-accrual loans relates to seven mortgage loans secured by single
family residences located outside of the state of Wisconsin.  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, $1.3 million in
charge-offs and $435,000 in specific reserves have been recorded with respect to
these borrowers.





Total
real estate owned increased by $16.3 million, to $41.0 million as of September
30, 2009, compared to $24.7 million as of December 31, 2008.  During
the nine months ended September 30, 2009, $37.8 million was transferred from
loans to real estate owned upon completion of foreclosure.  During the
same period, proceeds from the sale of real estate owned totaled $20.6 million
which resulted in a net loss of $596,000.  The Company owned 171
properties as of September 30, 2009, compared to 136 properties at December 31,
2008.  Of this increase, $9.2 million represents properties acquired
through foreclosure related to five former borrowers.  The real estate
consists of 13 separate properties including residential, commercial, mixed use,
residential development and raw land.  The real estate estimated fair
values range from a low of $146,000 for a mixed use property to $2.1 million for
a commercial property.  An additional $3.9 million of the increase in
real estate owned is attributable to four single family residences located
outside of the state of Wisconsin.  These properties have estimated
fair values ranging from $318,000 to $2.5 million.  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.


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





ALLOWANCE
FOR LOAN LOSSES





At
      or for the Nine MonthsEnded
      September 30,2009
            
            
            2008(Dollars
      in Thousands)Balance
      at beginning of period
            
            $
            25,167
            
            
            $
            12,839Provision
      for loan losses
            
            
            19,055
            
            
            
            34,578Charge-offs:MortgageOne-
      to four-family
            
            
            9,522
            
            
            
            7,154Over
      four-family
            
            
            1,523
            
            
            
            7,828Commercial
      real estate
            
            
            676
            
            
            
            1,838Construction
      and land
            
            
            638
            
            
            
            4,333Home
      Equity
            
            
            604
            
            
            
            348Consumer
            
            
            2
            
            
            
            3Total
      charge-offs
            
            
            12,965
            
            
            
            21,504Recoveries:MortgageOne-
      to four-family
            
            
            140
            
            
            
            155Over
      four-family
            
            
            23
            
            
            
            10Construction
      and land
            
            
            77
            
            
            
            125Consumer
            
            
            1
            
            
            
            7Total
      recoveries
            
            
            241
            
            
            
            297Net
      charge-offs
            
            
            12,724
            
            
            
            21,207Allowance
      at end of period
            
            $
            31,498
            
            
            $
            26,210Ratios:Allowance
      for loan losses to non-accrual loans at end of period
            
            
            33.69
            %
            
            
            28.30
            %Allowance
      for loan losses to loans receivable at end of period
            
            
            2.15
            %
            
            
            1.69
            %Net
      charge-offs to average loans outstanding (annualized)
            
            
            1.11
            %
            
            
            1.89
            %








_______________





Net
charge-offs totaled $12.7 million, or 1.11% of average loans for the nine months
ended September 30, 2009 on an annualized basis, compared to $21.2 million, or
1.89% of average loans for the comparable period in 2008.  While still
at a level that exceeds the Company’s historical average, the decrease in net
charge-offs for the nine months ended September 30, 2009 compared to the nine
months ended September 30, 2008 is consistent with the decrease in both
nonperforming loans and overall delinquent loans period over
period.  Of the $12.7 million in net charge-offs for the nine months
ended September 30, 2009, $9.4 million related to loans secured by one- to
four-family loans.  The majority of charge-offs in this category
relate to two borrower types, small real estate investors and out-of-state
single family borrowers.  Lending relationships with small real estate
investors, whose collateral consists of non-owner occupied one- to four-family
properties accounts for $4.9 million of net charge-offs related to one-to
four-family loans for the nine months ended September 30, 2009.  An
additional $4.1 million of charge-offs relate to borrowers with single family
residences located outside of the state of Wisconsin.


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The
allowance for loan loss totaled $31.5 million or 2.15% of loans outstanding as
of September 30, 2009 compared to $25.2 million or 1.61% of loans outstanding as
of December 31, 2008.  The $6.3 million increase in the allowance for
loan loss primarily results from a decline in the estimated net realizable value
of underlying collateral related to both nonperforming and delinquent
loans.  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
remains elevated.





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.


Liquidity
and Capital Resources





We
maintain liquid assets at levels we consider adequate to meet our liquidity
needs.  Our liquidity ratio averaged 4.2% and 2.2% for the nine months
ended September 30, 2009 and 2008, 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 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 advances from the FHLBC and
access to the Federal Reserve Bank discount window.




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,
2009 and 2008, respectively, $95.4 million and $52.1 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.




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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, 2009, the collection of principal payment on
loans, net of loan originations provided cash flow of $44.7
million.  During the comparable period of the prior year, loan
originations, net of collected principal, resulted in the use of $196.9 million
in cash.  The decrease in loans receivable is reflective of the
general decline in loan demand combined with the Company’s tightened
underwriting standards given the current economic environment.  The
decrease in the loan portfolio during the nine months ended September 30, 2009
was primarily attributable to a $74.9 million decrease in one- to four-family
loans.




Deposit
flows are generally affected by the level of interest rates, the interest rates
and products offered by local competitors, and other
factors.  Deposits decreased by $7.8 million for the nine months ended
September 30, 2009 primarily as the result of a $35.9 million reduction in
brokered deposits.  At September 30, 2009, brokered deposits totaled
$68.2 million or 5.7% of total deposits.




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, 2009, we had $428.0
million in advances from the FHLBC, of which $53.0 million was due within 12
months.  As an additional source of funds, we also enter into
repurchase agreements.  At September 30, 2009, we had $84.0 million in
repurchase agreements.  The agreements mature at various times
beginning in 2017, however, all are callable quarterly until
maturity.




At
September 30, 2009, we had outstanding commitments to originate loans of $15.5
million, unfunded commitments under construction loans of $14.0 million,
unfunded commitments under business lines of credit of $10.8 million and
unfunded commitments under home equity lines of credit and standby letters of
credit of $30.9 million.  At September 30, 2009, certificates of
deposit scheduled to mature in one year or less totaled $936.3million.  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.




On
September 29, 2009, the Federal Deposit Insurance Corporation issued a proposed
rule pursuant to which all insured depository institutions would be required to
prepay their estimated assessments for the fourth quarter of 2009, and for all
of 2010, 2011 and 2012.  Under the proposed rule, this pre-payment would be
due on December 31, 2009.  Under the proposed rule, the assessment rate for
the fourth quarter of 2009 and for 2010 would be based on each institution’s
total base assessment rate for the third quarter of 2009, modified to assume
that the assessment rate in effect on September 30, 2009 had been in effect for
the entire third quarter, and the assessment rate for 2011 and 2012 would be
equal to the modified third quarter assessment rate plus an additional 3 basis
points.  In addition, each institution’s base assessment rate for each
period would be calculated using its third quarter assessment base, adjusted
quarterly for an estimated 5% annual growth rate in the assessment base through
the end of 2012.




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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, 2009, the Bank met all
capital adequacy requirements to which it is subject.  On November 18,
2008, WaterStone Bank entered into an informal agreement with its federal and
state bank regulators whereby it has agreed to maintain a minimum Tier I capital
ratio of 8.00% and a minimum total risk based capital ratio of
10.00%.  At September 30, 2009 these higher capital requirements were
satisfied.  Banking regulators can take actions at any time which
could include raising minimum capital amounts.  Noncompliance with
such actions can result in more severe restrictions and civil money
penalties.  While formal enforcement actions taken by banking
regulators are publicly disclosed, applicable law prohibits disclosure of
specific examination findings by a financial institution.




As of
September 30, 2009 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.




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, 2009
are presented in the table below:









September
      30, 2009To
      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)
              
              $
              181,723
              
              
              
              13.86
              %
              
              $
              104,913
              
              
              
              8.00
              %
              
              $
              131,142
              
              
              
              10.00
              %Tier
      I capital (to risk-weighted assets)
              
              
              165,805
              
              
              
              12.64
              %
              
              
              52,457
              
              
              
              4.00
              %
              
              
              78,685
              
              
              
              6.00
              %Tier
      I capital (to average assets)
              
              
              165,805
              
              
              
              8.69
              %
              
              
              76,316
              
              
              
              4.00
              %
              
              
              95,395
              
              
              
              5.00
              %State
      of Wisconsin capital required (to total assets)
              
              
              165,805
              
              
              
              8.72
              %
              
              
              114,056
              
              
              
              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, 2009 and the respective
maturity dates.









Contractual
      ObligationsMore
      than
            
            
            More
      thanOne
      Year
            
            
            Three
      Years
            
            
            OverOne
      Year
            
            
            Through
            
            
            Through
            
            
            FiveTotal
            
            
            or
      Less
            
            
            Three
      Years
            
            
            Five
      Years
            
            
            Years(In
      Thousands)Deposits
      without a stated maturity (5)
            
            $
            154,189
            
            
            
            154,189
            
            
            
            -
            
            
            
            -
            
            
            
            -Certificates
      of deposit (5)
            
            
            1,033,936
            
            
            
            936,334
            
            
            
            89,038
            
            
            
            8,564
            
            
            
            -Federal
      Home Loan Bank advances (1)
            
            
            428,000
            
            
            
            53,000
            
            
            
            25,000
            
            
            
            -
            
            
            
            350,000Repurchase
      agreements (2)(5)
            
            
            84,000
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            84,000Operating
      leases (3)
            
            
            55
            
            
            
            55
            
            
            
            -
            
            
            
            -
            
            
            
            -State
      income tax obligation (4)
            
            
            1,242
            
            
            
            1,242
            
            
            
            -
            
            
            
            -
            
            
            
            -Salary
      continuation agreements
            
            
            1,825
            
            
            
            576
            
            
            
            442
            
            
            
            340
            
            
            
            467$
            1,703,247
            
            
            
            1,145,396
            
            
            
            114,480
            
            
            
            8,904
            
            
            
            434,467







_______________


(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.


(2)  The
repurchase agreements are callable on a quarterly basis until
maturity.


(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, 2009.








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)
            
            $
            15,512
            
            
            
            15,512
            
            
            
            -
            
            
            
            -
            
            
            
            -Unused
      portion of home equity lines of credit (2)
            
            
            29,752
            
            
            
            29,752
            
            
            
            -
            
            
            
            -
            
            
            
            -Unused
      portion of business lines of credit
            
            
            10,830
            
            
            
            10,830
            
            
            
            -
            
            
            
            -
            
            
            
            -Unused
      portion of construction loans (3)
            
            
            14,005
            
            
            
            14,005
            
            
            
            -
            
            
            
            -
            
            
            
            -Standby
      letters of credit
            
            
            1,157
            
            
            
            917
            
            
            
            240
            
            
            
            -
            
            
            
            -Total
      Other Commitments
            
            $
            71,256
            
            
            
            71,016
            
            
            
            240
            
            
            
            -
            
            
            
            -





______________


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, 2009 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
            
            
            (3.27%)200
      basis point increase in rates
            
            
            (0.79%)100
      basis point increase in rates
            
            
            0.12%100
      basis point decrease in rates
            
            
            (2.52%)200
      basis point decrease in rates
            
            
            (4.56%)300
      basis point decrease in rates
            
            
            (21.24%)












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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 slightly liability
sensitive, net interest income is expected to decline proportionately with
increased interest rates.  However, due to the historically low
short-term current interest rate environment and related low cost of deposits,
significant declines in interest rates do not result in a proportionate decline
in the cost of deposits even though deposit liabilities reprice slightly faster
than do loans.  At September 30, 2009, a 100 basis point immediate and
instantaneous increase in interest rates had the effect of increasing estimated
net interest income by 0.12% while a 100 basis point decrease in rates had the
affect of decreasing estimated net interest income by 2.52%.  At
September 30, 2009, a 100 basis point immediate and instantaneous increase in
interest rates had no effect on the estimated return on assets while a 100 basis
point decrease in rates had the effect of decreasing the estimated return on
assets by 0.07%.  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.










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, 2009, 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, 2008, we set forth the following additional
risk factor.




The
Company Operates in a Highly Regulated Environment and is Subject to Supervision
and Examination by Various Regulatory Agencies




As a
savings bank holding company, the Company is regulated by the Office of Thrift
Supervision, and the Bank is regulated separately by various federal and state
banking regulators.  This regulation is primarily intended to protect
the Bank’s customers and their deposits rather than the Company’s
shareholders.  In addition, the Company’s common stock is registered
under the Exchange Act and it is subject to regulation by the Securities and
Exchange Commission and to public reporting requirements.




Under
applicable laws, the Office of Thrift Supervision, the FDIC, as the Bank’s
primary federal regulator and deposit insurer, and the Wisconsin Department of
Financial Institutions as the Bank’s chartering authority, have the ability to
impose sanctions, restrictions and requirements on the Company and on the Bank
if they determine, upon examination or otherwise, violations of laws with which
the Company and the Bank must comply, or weaknesses or failures with respect to
general standards of safety and soundness.  Banking regulators can
take actions at any time which could have an adverse impact on the Company and
on the Bank.  These actions could include raising minimum capital
amounts, restricting growth or other actions.  Noncompliance can
result in more severe restrictions and civil money penalties.  While
formal enforcement actions taken by banking regulators are publicly disclosed,
applicable law prohibits disclosure of specific examination findings by a
financial institution.




Challenges Posed byThe Current Operating Environment




The
Company is operating in a difficult and uncertain economic environment which
presents greater challenges in increasing capital levels.  Options
normally available to increase capital levels such as issuing common or
preferred stock or borrowing funds at cost effective rates may not be
available.  Sales of either fixed assets or pools of loans forced by
an immediate need to increase capital may also result in a negative impact to
the Company.  In addition to the deteriorating credit quality due to
the economic downturn and contraction of the U.S. real estate market which have
been reflected in higher provision for loan losses and loan charge-offs, these
same trends may also cause valuation changes and losses in other balance sheet
items, most notably the investment portfolio.  All of these factors
have reduced the Company’s capital levels over the past 18 months and may
continue to do so in future periods.







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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 6, 2009/s/Douglas
      S. GordonDouglas
      S. GordonChief
      Executive OfficerDate:
      November 6, 2009/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, 2009











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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