Table of Contents

** **

 

** **

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

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**FORM 10-Q**

** **

| **x**  | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**   |
|--------|----------------------------------------------------------------------------------------------------------|
|   |                                                                                                     |
|   | **For the Quarterly Period Ended September 30,  2009**                                              |
|   |                                                                                                     |
|   | **OR**                                                                                                   |
|   | ** **                                                                                               |
| **o**  | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |

 

**For thetransition period fro**m **           to** **           **

 

**Commissionfile number 0-19972**

 

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**HFFINANCIAL CORP.**

(Exact name of registrantas specified in its charter)

 

| **Delaware**                                                     | ** ** | **46-0418532**                        |
|------------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |       | (I.R.S. Employer  Identification No.) |
|                                                             |       |                                  |
| **225  South Main Avenue,  Sioux Falls, SD**                     | ** ** | **57104**                             |
| (Address of principal  executive offices)                        |       | (ZIP Code)                            |

 

(**605) 333-7556**

(Registrant’s telephonenumber, including area code)

 

Indicate by check mark whether the Registrant (1) hasfiled all reports required to be filed by Section 13 or Section 15(d) ofthe Securities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the Registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90days.    Yes  x    No  o

 

IndicatebycheckmarkwhethertheRegistranthassubmittedelectronicallyandpostedonitscorporateWebsite,ifany,everyInteractiveDataFilerequiredtobesubmittedandpostedpursuanttoRule405ofRegulationS-T(Section232.405ofthischapter)duringthepreceding12months(orforsuchshorterperiodthattheRegistrantwasrequiredtosubmitandpostsuchfiles).  Yes  o  No  o

 

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

 

| Large accelerated filer  o           |   | Accelerated filer o              |
|------------------------------------------------|--------|--------------------------------------------|
|                                           |   |                                       |
| Non-accelerated filer  o                  |   | Smaller reporting company x |
| (Do not check if a  smaller reporting company) |   |                                       |

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

 

As of November 6, 2009, there were 4,043,912shares of the registrant’s common stock outstanding.

 

 

 

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Table ofContents

 

**Quarterly Report on Form 10-Q**

**Table of Contents**

 
| ** **                                   | ** **                                                                                         | ** ** | **Page Number** |
|----------------------------------------------|----------------------------------------------------------------------------------------------------|------------|----------------------|
|                                         |                                                                                               |       |                 |
| **PART I — FINANCIAL INFORMATION** |                                                                                               |       |
|                                         |                                                                                               |       |                 |
| Item 1.                                      | Financial Statements (Unaudited):                                                                  |       |                 |
|                                         |                                                                                               |       |                 |
|                                         | Consolidated  Statements of Financial Condition At September 30, 2009 and  June 30, 2009 |       | 1                    |
|                                         |                                                                                               |       |                 |
|                                         | Consolidated Statements of Income for the Three Months  Ended September 30, 2009 and 2008     |       | 2                    |
|                                         |                                                                                               |       |                 |
|                                         | Consolidated Statements of Cash Flows for the Three  Months Ended September 30, 2009 and 2008 |       | 3                    |
|                                         |                                                                                               |       |                 |
|                                         | Notes to  Consolidated Financial Statements                                                        |       | 4                    |
|                                         |                                                                                               |       |                 |
| Item 2.                                      | Management’s  Discussion and Analysis of Financial Condition and Results of Operations        |       | 19                   |
|                                         |                                                                                               |       |                 |
| Item 3.                                      | Quantitative  and Qualitative Disclosures about Market Risk                                        |       | 38                   |
|                                         |                                                                                               |       |                 |
| Item 4.                                      | Controls and  Procedures                                                                           |       | 40                   |
|                                         |                                                                                               |       |                 |
| **PART II  — OTHER INFORMATION**   |                                                                                               |       |
|                                         |                                                                                               |       |                 |
| Item 1.                                      | Legal Proceedings                                                                                  |       | 40                   |
|                                         |                                                                                               |       |                 |
| Item 1A.                                     | Risk Factors                                                                                       |       | 40                   |
|                                         |                                                                                               |       |                 |
| Item 2.                                      | Unregistered  Sales of Equity Securities and Use of Proceeds                                       |       | 43                   |
|                                         |                                                                                               |       |                 |
| Item 4.                                      | Submission of  Matters to a Vote of Security Holders                                               |       | 43                   |
|                                         |                                                                                               |       |                 |
| Item 5.                                      | Other Information                                                                                  |       | 43                   |
|                                         |                                                                                               |       |                 |
| Item 6.                                      | Exhibits                                                                                           |       | 43                   |
|                                         |                                                                                               |       |                 |
| Form 10-Q                               | Signature Page                                                                                     |       | 44                   |

 

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Table of Contents

 

**PART I - FINANCIAL INFORMATION**

 

**Item 1.  *Financial Statements***

 

**HF FINANCIAL CORP.**

**CONSOLIDATED STATEMENTS OF FINANCIALCONDITION**

**(DOLLARS IN THOUSANDS, except sharedata)**

 
| ** **                                                                                                                                                          | ** ** | **September 30,  2009** | ** ** | **June 30,  2009** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-------------------------|------------|
| ** **                                                                                                                                                          | ** ** | **(Unaudited)**              | ** ** | **(Audited)**           | ** ** |
| **ASSETS**                                                                                                                                                          |       |                         | ** ** | ** **              | ** ** |
| Cash  and cash equivalents                                                                                                                                          |       | $                            | 18,717     |                    | $          | 18,511 |   |
| Securities  available for sale                                                                                                                                      |       | 221,137                      |       | 222,910                 |       |
| Federal  Home Loan Bank stock                                                                                                                                       |       | 12,476                       |       | 12,476                  |       |
| Loans  held for sale                                                                                                                                                |       | 22,792                       |       | 14,881                  |       |
|                                                                                                                                                                |       |                         |       |                    |       |
| Loans  and leases receivable                                                                                                                                        |       | 833,824                      |       | 851,282                 |       |
| Allowance  for loan and lease losses                                                                                                                                |       | (8,503                       | )          | (8,470                  | )          |
| Net  loans and leases receivable                                                                                                                                    |       | 825,321                      |       | 842,812                 |       |
|                                                                                                                                                                |       |                         |       |                    |       |
| Accrued  interest receivable                                                                                                                                        |       | 9,370                        |       | 7,598                   |       |
| Office  properties and equipment, net of accumulated depreciation                                                                                                   |       | 17,356                       |       | 16,917                  |       |
| Foreclosed  real estate and other properties                                                                                                                        |       | 1,316                        |       | 1,085                   |       |
| Cash  value of life insurance                                                                                                                                       |       | 14,733                       |       | 14,594                  |       |
| Servicing  rights                                                                                                                                                   |       | 11,998                       |       | 11,768                  |       |
| Goodwill,  net                                                                                                                                                      |       | 4,951                        |       | 4,951                   |       |
| Other  assets                                                                                                                                                       |       | 8,295                        |       | 8,293                   |       |
| Total  assets                                                                                                                                                       |       | $                            | 1,168,462  |                    | $          | 1,176,796 |   |
|                                                                                                                                                                |       |                         |       |                    |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                       |       |                         |       |                    |       |
| ** **                                                                                                                                                          | ** ** |                         |       |                    |       |
| LIABILITIES                                                                                                                                                         |       |                         |       |                    |       |
| Deposits                                                                                                                                                            |       | $                            | 830,241    |                    | $          | 837,868 |   |
| Advances  from Federal Home Loan Bank and other borrowings                                                                                                          |       | 207,278                      |       | 212,869                 |       |
| Subordinated  debentures payable to trusts                                                                                                                          |       | 27,837                       |       | 27,837                  |       |
| Advances  by borrowers for taxes and insurance                                                                                                                      |       | 15,994                       |       | 11,899                  |       |
| Accrued  expenses and other liabilities                                                                                                                             |       | 16,640                       |       | 17,648                  |       |
| Total  liabilities                                                                                                                                                  |       | 1,097,990                    |       | 1,108,121               |       |
|                                                                                                                                                                |       |                         |       |                    |       |
| STOCKHOLDERS’  EQUITY                                                                                                                                          |       |                         |       |                    |       |
|                                                                                                                                                                |       |                         |       |                    |       |
| Preferred  stock, $.01 par value, 500,000 shares authorized, none outstanding                                                                                       |       | —                       |       | —                  |       |
| Common  stock, $.01 par value, 10,000,000 shares authorized, 6,127,873 and 6,109,437  shares issued at September 30, 2009 and June 30, 2009, respectively |       | 61                           |       | 61                      |       |
| Common  stock subscribed for but not issued                                                                                                                         |       | —                       |       | 224                     |       |
| Additional  paid-in capital                                                                                                                                         |       | 23,287                       |       | 22,911                  |       |
| Retained  earnings, substantially restricted                                                                                                                        |       | 81,137                       |       | 80,735                  |       |
| Accumulated  other comprehensive (loss), net of related deferred tax effect                                                                                         |       | (3,116                       | )          | (4,359                  | )          |
| Less  cost of treasury stock, 2,083,455 and 2,083,455 shares at September 30,  2009 and June 30, 2009, respectively                                       |       | (30,897                      | )          | (30,897                 | )          |
| Total  stockholders’ equity                                                                                                                                    |       | 70,472                       |       | 68,675                  |       |
| Total  liabilities and stockholders’ equity                                                                                                                    |       | $                            | 1,168,462  |                    | $          | 1,176,796 |   |

 

*See accompanying notes to unauditedconsolidated financial statements.*

 

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**HF FINANCIAL CORP.**

**CONSOLIDATED STATEMENTS OF INCOME**

**(DOLLARS IN THOUSANDS, except sharedata)**

**(Unaudited)**

 
| ** **                                                               | ** ** | **Three  Months Ended** | ** ** |
|--------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                               | ** ** | **September 30,**  | ** ** |
| ** **                                                               | ** ** | **2009**                | ** ** | **2008** | ** ** |
| Interest,  dividend and loan fee income:                                 |       |                    |       |   |   |
| Loans  and leases receivable                                             |       | $                       | 12,343     |   | $ | 13,018 |   |
| Investment  securities and interest-earning deposits                     |       | 2,290                   |       | 2,813 |   |
|                                                                     |       | 14,633                  |       | 15,831 |   |
| Interest  expense:                                                       |       |                    |       |   |   |
| Deposits                                                                 |       | 3,524                   |       | 4,577 |   |
| Advances  from Federal Home Loan Bank and other borrowings               |       | 2,358                   |       | 2,565 |   |
|                                                                     |       | 5,882                   |       | 7,142 |   |
| Net  interest income                                                     |       | 8,751                   |       | 8,689 |   |
| Provision  for losses on loans and leases                                |       | 343                     |       | 387 |   |
|                                                                     |       |                    |       |   |   |
| Net  interest income after provision for losses on loans and leases      |       | 8,408                   |       | 8,302 |   |
|                                                                     |       |                    |       |   |   |
| Noninterest  income:                                                     |       |                    |       |   |   |
| Fees  on deposits                                                        |       | 1,446                   |       | 1,551 |   |
| Loan  servicing income                                                   |       | 491                     |       | 557 |   |
| Gain  on sale of loans, net                                              |       | 496                     |       | 251 |   |
| Trust  income                                                            |       | 257                     |       | 222 |   |
| Gain  on sale of securities, net                                         |       | 533                     |       | 80 |   |
|                                                                     |       |                    |       |   |   |
| Total  other-than-temporary impairment losses                            |       | (3,914                  | )          | — |   |
| Portion  of loss recognized in other comprehensive income (before taxes) |       | 2,056                   |       | — |   |
| Net  impairment losses recognized in earnings                            |       | (1,858                  | )          | — |   |
|                                                                     |       |                    |       |   |   |
| Other                                                                    |       | 333                     |       | 388 |   |
|                                                                     |       | 1,698                   |       | 3,049 |   |
| Noninterest  expense:                                                    |       |                    |       |   |   |
| Compensation  and employee benefits                                      |       | 5,163                   |       | 5,121 |   |
| Occupancy  and equipment                                                 |       | 1,084                   |       | 977 |   |
| FDIC  insurance                                                          |       | 325                     |       | 141 |   |
| Check  and data processing expense                                       |       | 698                     |       | 622 |   |
| Professional  fees                                                       |       | 600                     |       | 508 |   |
| Marketing  and community development                                     |       | 471                     |       | 411 |   |
| Foreclosed  real estate and other properties, net                        |       | 19                      |       | 117 |   |
| Other                                                                    |       | 589                     |       | 506 |   |
|                                                                     |       | 8,949                   |       | 8,403 |   |
|                                                                     |       |                    |       |   |   |
| Income  before income taxes                                              |       | 1,157                   |       | 2,948 |   |
|                                                                     |       |                    |       |   |   |
| Income  tax expense                                                      |       | 302                     |       | 973 |   |
|                                                                     |       |                    |       |   |   |
| Net  income available to common shareholders                             |       | $                       | 855        |   | $ | 1,975 |   |
|                                                                     |       |                    |       |   |   |
| Comprehensive  income                                                    |       | $                       | 2,098      |   | $ | 1,543 |   |
|                                                                     |       |                    |       |   |   |
| Basic  earnings per common share:                                        |       | $                       | 0.21       |   | $ | 0.50 |   |
| Diluted  earnings per common share:                                      |       | 0.21                    |       | 0.49 |   |
| Dividends  declared per common share                                     |       | 0.11                    |       | 0.11 |   |

 

*Seeaccompanying notes to unaudited consolidated financial statements.*

 

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**HF FINANCIAL CORP.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(DOLLARS IN THOUSANDS, except sharedata)**

**(Unaudited)**

 
| ** **                                                                                             | ** ** | **Three  Months Ended September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                             | ** ** | **2009**                                   | ** ** | **2008** | ** ** |
| Cash  flows from operating activities                                                                  | ** ** | ** **                                 | ** ** | ** ** | ** ** |
| Net  income                                                                                            |       | $                                          | 855        |   | $ | 1,975 |   |
| Adjustments  to reconcile net income to net cash (used in) operating activities                        |       |                                       |       |   |   |
| Provision  for losses on loans and leases                                                              |       | 343                                        |       | 387 |   |
| Depreciation                                                                                           |       | 497                                        |       | 392 |   |
| Amortization  of discounts and premiums on securities and other                                        |       | 707                                        |       | 284 |   |
| Stock  based compensation                                                                              |       | 152                                        |       | 125 |   |
| Net  change in loans held for resale                                                                   |       | (7,415                                     | )          | (4,324 | ) |
| (Gain)  on sale of loans, net                                                                          |       | (496                                       | )          | (251 | ) |
| Realized  (gain) on sale of securities, net                                                            |       | (533                                       | )          | (80 | ) |
| Other-than-temporary  impairments recognized in noninterest income                                     |       | 1,858                                      |       | — |   |
| (Gains)  losses and provision-for-losses on sales of foreclosed real estate and other  properties, net |       | (5                                         | )          | 2 |   |
| Change  in other assets and liabilities                                                                |       | (3,936                                     | )          | (4,763 | ) |
| Net  cash (used in) operating activities                                                               |       | (7,973                                     | )          | (6,253 | ) |
|                                                                                                   |       |                                       |       |   |   |
| Cash  flows from investing activities                                                                  |       |                                       |       |   |   |
| Loan  participations purchased                                                                         |       | (921                                       | )          | (804 | ) |
| Net  change in loans outstanding                                                                       |       | 17,536                                     |       | (17,812 | ) |
| Securities  available for sale                                                                         |       |                                       |       |   |   |
| Sales,  maturities, repayments and adjustments                                                         |       | 23,783                                     |       | 21,095 |   |
| Purchases                                                                                              |       | (21,505                                    | )          | (22,304 | ) |
| Purchase  of Federal Home Loan Bank stock                                                              |       | —                                     |       | (2,352 | ) |
| Redemption  of Federal Home Loan Bank stock                                                            |       | —                                     |       | 1,499 |   |
| Purchase  of office properties and equipment                                                           |       | (936                                       | )          | (551 | ) |
| Purchase  of servicing rights                                                                          |       | (349                                       | )          | (466 | ) |
| Proceeds  from sale of foreclosed real estate and other properties                                     |       | 147                                        |       | 15 |   |
| Net  cash provided by (used in) investing activities                                                   |       | 17,755                                     |       | (21,680 | ) |
|                                                                                                   |       |                                       |       |   |   |
| Cash  flows from financing activities                                                                  |       |                                       |       |   |   |
| Net  (decrease) in deposit accounts                                                                    |       | (7,627                                     | )          | (19,215 | ) |
| Proceeds  of advances from Federal Home Loan Bank and other borrowings                                 |       | 991,599                                    |       | 698,178 |   |
| Payments  on advances from Federal Home Loan Bank and other borrowings                                 |       | (997,190                                   | )          | (659,365 | ) |
| Increase  in advances by borrowers                                                                     |       | 4,095                                      |       | 5,947 |   |
| Proceeds  from issuance of common stock                                                                |       | —                                     |       | 484 |   |
| Cash  dividends paid                                                                                   |       | (453                                       | )          | (447 | ) |
| Net  cash provided by (used in) financing activities                                                   |       | (9,576                                     | )          | 25,582 |   |
|                                                                                                   |       |                                       |       |   |   |
| Increase  (decrease) in cash and cash equivalents                                                      |       | 206                                        |       | (2,351 | ) |
| Cash  and cash equivalents                                                                             |       |                                       |       |   |   |
| Beginning                                                                                              |       | 18,511                                     |       | 21,170 |   |
| Ending                                                                                                 |       | $                                          | 18,717     |   | $ | 18,819 |   |
|                                                                                                   |       |                                       |       |   |   |
| Supplemental  Disclosures of Cash Flows Information                                                    |       |                                       |       |   |   |
| Cash  payments for interest                                                                            |       | $                                          | 5,509      |   | $ | 8,063 |   |
| Cash  payments for income and franchise taxes, net                                                     |       | 310                                        |       | 152 |   |

 

*Seeaccompanying notes to unaudited consolidated financial statements.*

 

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**HF FINANCIAL CORP.**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

**FORTHE THREE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008**

**(Unaudited)**

 

**NOTE1—SELECTED ACCOUNTING POLICIES**

 

*Basis ofFinancial Statement Presentation*

 

The consolidated financial information of HF Financial Corp. (the “Company”)and its wholly-owned subsidiaries included in this Quarterly Report on Form 10-Qis unaudited.  However, in the opinion ofmanagement, adjustments (consisting of normal recurring adjustments) necessaryfor a fair presentation for the interim periods have been included.  Results for any interim period are notnecessarily indicative of results to be expected for the fiscal year.  Interim consolidated financial statements andthe notes thereto should be read in conjunction with the consolidated financialstatements and notes thereto included in the Company’s Annual Report on Form 10-Kfor the fiscal year ended June 30, 2009 (“fiscal 2009”), filed with theSecurities and Exchange Commission.  Theaccounting and reporting policies of the Company and its subsidiaries conformto accounting principles generally accepted in the United States of America (“GAAP”)and to general practice within the industry.

 

The interim consolidated financial statements include the accounts ofthe Company, its wholly-owned subsidiaries, Home Federal Bank (the “Bank”), HFFinancial Group, Inc. (“HF Group”) and HomeFirst Mortgage Corp. (the “MortgageCorp.”), and the Bank’s wholly-owned subsidiaries, Mid America Capital Services, Inc.(“Mid America Capital”), Hometown Investment Services, Inc. (“Hometown”),Home Federal Securitization Corp. (“HFSC”), Mid-America Service Corporation andPMD, Inc.  The interim consolidatedfinancial statements reflect the deconsolidation of the wholly-owned subsidiarytrusts of the Company: HF Financial Capital Trust III (“Trust III”), HFFinancial Capital Trust IV (“Trust IV”), HF Financial Capital Trust V (“Trust V”)and HF Financial Capital Trust VI (“Trust VI”). See Note 10 of “Notes toConsolidated Financial Statements.”  Allintercompany balances and transactions have been eliminated in consolidation.

 

Management has evaluated subsequent events for potential disclosure orrecognition through November 16, 2009, the date of the filing of theconsolidated financial statements with the Securities and Exchange Commission.

 

**NOTE 2—REGULATORY CAPITAL**

 

The following table setsforth the Bank’s compliance with its minimum capital requirements for awell-capitalized institution at September 30, 2009:

 
| ** **                                           | ** ** | **Amount**                  | ** ** | **Percent** | ** ** |
|------------------------------------------------------|------------|-----------------------------|------------|-------------|------------|
| ** **                                           | ** ** | **(Dollars  in Thousands)** | ** ** |
| Tier  I (core) capital (to adjusted total assets):   |       |                        |       |        |       |
| Required                                             |       | $                           | 58,143     |        | 5.00       | % |
| Actual                                               |       | 99,609                      |       | 8.57        |       |
| Excess  over required                                |       | 41,466                      |       | 3.57        |       |
|                                                 |       |                        |       |        |       |
| Total  Risk-based capital (to risk-weighted assets): |       |                        |       |        |       |
| Required                                             |       | $                           | 95,558     |        | 10.00      | % |
| Actual                                               |       | 107,731                     |       | 11.27       |       |
| Excess  over required                                |       | 12,173                      |       | 1.27        |       |

 

**NOTE3—EARNINGS PER COMMON SHARE**

 

Basic earnings per common share is computed bydividing income available to common stockholders (the numerator) by theweighted-average number of common shares outstanding (the denominator) duringthe period.  Shares issued during theperiod and shares reacquired during the period are weighted for the portion ofthe period they were outstanding. The weighted average number of basic commonshares outstanding for the three months ended September 30, 2009 and 2008was 4,030,391 and 3,972,055, respectively.

 

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Dilutive earnings per common share is similar to thecomputation of basic earnings per common share except the denominator isincreased to include the number of additional common shares that would havebeen outstanding if the dilutive options outstanding had been exercised. Theweighted average number of common and dilutive potential common sharesoutstanding for the three months ended September 30, 2009 and 2008 was4,041,650 and 4,004,126, respectively.

 

**NOTE 4****—****INVESTMENTS IN SECURITIES**

 

The amortized cost and fairvalues of investments in securities, all of which are classified as availablefor sale according to management’s intent, are as follows:

 
| ** **                               | ** ** | **September 30,  2009**         | ** **    | **September 30,  2008** | ** ** |
|------------------------------------------|------------|--------------------------------------|---------------|------------------------------|------------|
| ** **                               | ** ** | ** **                           | ** **    | **Gross**                    | ** ** | ** ** | ** ** | ** ** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                               | ** ** | **Amortized**                        | ** **    | **Unrealized**               | ** ** | **Fair** | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **                               | ** ** | **Cost**                             | ** **    | **Gains**                    | ** ** | **(Losses)** | ** ** | **Value** | ** ** | **Cost** | ** ** | **Gains** | ** ** | **(Losses)** | ** ** | **Value** | ** ** |
| ** **                               | ** ** | **(Dollars in Thousands)** | ** **    |
|                                     |       |                                 |          |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Debt  securities:                        |       |                                 |          |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |
| U.S.  government agencies                |       | $                                    | 2,632         |                         | $          | 40 |   | $ | — |   | $ | 2,672 |   | $ | 6,402 |   | $ | 202 |   | $ | — |   | $ | 6,604 |   |
| Federal  Home Loan Bank                  |       | —                               |          | —                       |       | — |   | — |   | 3,947 |   | 67 |   | — |   | 4,014 |   |
| Municipal  bonds                         |       | 14,210                               |          | 444                          |       | (37 | ) | 14,617 |   | 12,932 |   | 44 |   | (399 | ) | 12,577 |   |
| Trust  preferred securities              |       | 10,028                               |          | —                       |       | (4,379 | ) | 5,649 |   | 12,373 |   | — |   | (2,874 | ) | 9,499 |   |
|                                     |       | 26,870                               |          | 484                          |       | (4,416 | ) | 22,938 |   | 35,654 |   | 313 |   | (3,273 | ) | 32,694 |   |
|                                     |       |                                 |          |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Equity  securities:                      |       |                                 |          |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |
| FNMA                                     |       | —                               |          | —                       |       | — |   | — |   | 8 |   | — |   | (8 | ) | — |   |
| Federal  Ag Mortgage                     |       | 7                                    |          | —                       |       | (3 | ) | 4 |   | 7 |   | — |   | (5 | ) | 2 |   |
| Other  investments                       |       | 253                                  |          | —                       |       | — |   | 253 |   | 253 |   | — |   | — |   | 253 |   |
|                                     |       | 260                                  |          | —                       |       | (3 | ) | 257 |   | 268 |   | — |   | (13 | ) | 255 |   |
|                                     |       |                                 |          |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Residential  mortgage- backed securities |       | 194,819                              |          | 4,030                        |       | (907 | ) | 197,942 |   | 193,773 |   | 605 |   | (1,632 | ) | 192,746 |   |
|                                     |       | $                                    |  221,949 |                         | $          | 4,514 |   | $ | (5,326 | ) | $ | 221,137 |   | $ | 229,695 |   | $ | 918 |   | $ | (4,918 | ) | $ | 225,695 |   |

 

Management has implemented aprocess to identify securities that could potentially have a credit impairmentthat is other-than-temporary.  Thisprocess involves evaluation of the length of time and extent to which the fairvalue has been less than the amortized cost basis, review of availableinformation regarding the financial position of the issuer, monitoring therating of the security, cash flow projections, and the Company’s intent to sella security or whether it is more likely than not we will be required to sellthe security before the recovery of its amortized cost which, in some cases,may extend to maturity.  To the extent wedetermine that a security is deemed to be other-than-temporarily impaired, animpairment loss is recognized.

 

For all securities that areconsidered temporarily impaired, the Company does not intend to sell thesesecurities (has not made a decision to sell) and it is not more likely than notthat the Company will be required to sell the security before recovery of itsamortized cost, which may occur at maturity. The Company believes that it will collect all principal and interest dueon all investments that have amortized cost in excess of fair value that areconsidered only temporarily impaired.

 

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The following table presentsthe fair value and age of gross unrealized losses by investment category at September 30,2009*:*

 
| ** **                              | ** ** | **Less than  12 Months**    | ** **   | **12 Months  or More** | ** ** | **Total**  | ** ** |
|-----------------------------------------|------------|-----------------------------|--------------|------------------------|------------|------------|------------|
| ** **                              | ** ** | ** **                  | ** **   | **Gross**              | ** ** | ** ** | ** ** | **Gross** | ** ** | ** ** | ** ** | **Gross** | ** ** |
| ** **                              | ** ** | **Fair**                    | ** **   | **Unrealized**         | ** ** | **Fair**   | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| ** **                              | ** ** | **Value**                   | ** **   | **(Losses)**           | ** ** | **Value**  | ** ** | **(Losses)** | ** ** | **Value** | ** ** | **(Losses)** | ** ** |
| ** **                              | ** ** | **(Dollars  in Thousands)** | ** **   |
| Debt  securities:                       |       |                        |         |                   |       |       |       |   |   |   |   |   |   |
| Municipal  bonds                        |       | $                           | 682          |                   | $          | (3         | )          | $ | 1,899 |   | $ | (34 | ) | $ | 2,581 |   | $ | (37 | ) |
| Trust  preferred securities             |       | —                      |         | —                 |       | 5,649      |       | (4,379 | ) | 5,649 |   | (4,379 | ) |
|                                    |       | 682                         |         | (3                     | )          | 7,548      |       | (4,413 | ) | 8,230 |   | (4,416 | ) |
| Equity  securities:                     |       |                        |         |                   |       |       |       |   |   |   |   |   |   |
| Federal  Ag Mortgage                    |       | 3                           |         | (3                     | )          | —     |       | — |   | 3 |   | (3 | ) |
|                                    |       | 3                           |         | (3                     | )          | —     |       | — |   | 3 |   | (3 | ) |
| Residential  mortgage-backed securities |       | 45,199                      |         | (370                   | )          | 21,254     |       | (537 | ) | 66,453 |   | (907 | ) |
|                                    |       | $                           |  45,884 |                   | $          | (376       | )          | $ | 28,802 |   | $ | (4,950 | ) | $ | 74,686 |   | $ | (5,326 | ) |

 

The unrealized lossesreported for municipal bonds relate to 16 municipal general obligation orrevenue bonds.  The unrealized losses areprimarily attributed to changes in credit spreads or market interest rateincreases since the securities were originally acquired, rather than due tocredit or other causes.  Management does not believe any individualunrealized losses as of September 30, 2009, represent another-than-temporary impairment for these investments.  The Company does not have the intent to sellthese securities (has not made a decision to sell) and has assessed that it isnot more likely than not that the Company will be required to sell thesesecurities before anticipated recovery of fair value.

 

Theunrealized losses reported for residential mortgage-backed securities relate to61 securities issued by the Federal National Mortgage Association (“FNMA”), theGovernment National Mortgage Association (“GNMA”), or the Federal Home LoanMortgage Corporation (“FHLMC”).  Theseunrealized losses are primarily attributable to changes in interest rates andthe contractual cash flows of those investments which are guaranteed by anagency of the U.S. government. Residential mortgage-backed securities also include one “private-label”collateralized mortgage obligation with an amortized amount of $2.0 million,which has maintained its AAA rating as of September 30, 2009.  Management does not believe any of theseunrealized losses as of September 30, 2009, represent another-than-temporary impairment for those investments.  The Company does not have the intent to sellthese securities (has not made a decision to sell) and has assessed that it isnot more likely than not that the Company will be required to sell thesesecurities before anticipated recovery of fair value.

 

The unrealized losses reported for trust preferred securities are attributableto six rated pooled securities. Rating downgrades regarding these investmentshave occurred during the first quarter of fiscal year 2010 placing each in abelow investment grade rating. The securities have an amortized cost of $3.7million rated B3, $2.5 million rated Caa1, and $3.8 million rated Ca.  The market for these securities is currentlyinactive. The CUSIPs of the trust preferred securities are 74041EAC9 and74042TAE1 rated B3, 740417AB6 and 74042CAE8 rated Caa1, and 74041RAB2 and55312HAE9 rated Ca. The Company performed assessments of available informationfor each security during the first quarter ended September 30, 2009, andalso considered factors such as overall deal structure and its position withinthe structure, quality of underlying issuers within each pool, defaults andrecoveries, loss severities and prepayments. Based upon scenarios developed inregard to this information, management compared the present value of bestestimates of cash flows expected to be collected from each security at thesecurity’s effective interest rate to the amortized cost basis of eachsecurity. Management determined that three trust preferred securities exhibitedan other-than-temporary impairment. The difference between the present value ofcash flows and the amortized cost basis for each of the three securities wasrecorded as credit loss impairment and recognized in earnings in the amount of$1.9 million. The amortized cost basis of the three securities was reduced bythe amount of credit loss. The remaining impairment amount related to otherfactors of $2.1 million was recognized in other comprehensive income, net ofapplicable taxes. The unrealized losses on these trust preferred securities canprimarily be attributed to changes in credit spreads since the securities wereacquired. See Note 13 “Financial Instruments” for additional informationrelated to the determination of fair value. The Company does not have theintent to sell these six securities (has not made a decision to sell) and hasassessed that it is not more likely than not that the Company will be requiredto sell these securities before anticipated recovery of fair value. Within thissegment, five securities with amortized cost of $8.2 million are quarterlyvariable-rate securities tied to 3-month LIBOR.

 

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The following table presents the amountsrecognized in the Consolidated Statements of Income for other-than-temporaryimpairments related to credit losses charged to earnings:

 
| ** **                                                                                                                                                                              | ** ** | **Three  Months Ended**      | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                                                                                                                              | ** ** | **September 30,  2009** | ** ** |
| ** **                                                                                                                                                                              | ** ** | **(Dollars  in Thousands)**  | ** ** |
|                                                                                                                                                                                    |       |                         |       |
| Beginning  balance of credit losses on securities held as of July 1, 2009 for which  a portion of other-than-temporary impairment was recognized in other  comprehensive income    |       | $                            | 405        |   |
|                                                                                                                                                                                    |       |                         |       |
| Credit  losses for which an other-than-temporary impairment was not previously  recognized                                                                                              |       | 1,858                        |       |
|                                                                                                                                                                                    |       |                         |       |
| Ending  balance of credit losses on securities held as of September 30, 2009 for  which a portion of other-than-temporary impairment was recognized in other  comprehensive income |       | $                            | 2,263      |   |

 

The composition and maturities of the investment securities portfolio,excluding equity securities, are indicated in the following table:

 
| ** **                                   | ** ** | **At  September 30, 2009** | ** ** |
|----------------------------------------------|------------|---------------------------------|------------|
| ** **                                   | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **TOTAL** | ** ** |
| ** **                                   | ** ** | **Less than**                   | ** ** | **1 to 5** | ** ** | **5 to 10** | ** ** | **Over 10** | ** ** | **Amortized** | ** ** | **Fair** | ** ** |
| ** **                                   | ** ** | **1 Year**                      | ** ** | **Years** | ** ** | **Years** | ** ** | **Years** | ** ** | **Cost** | ** ** | **Values** | ** ** |
| ** **                                   | ** ** | **(Dollars  in Thousands)**     | ** ** |
|                                         |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| U.S.  government agencies & corporations |       | $                               | 1,125      |   | $ | 1,507 |   | $ | — |   | $ | — |   | $ | 2,632 |   | $ | 2,672 |   |
| Municipal  bonds                             |       | 982                             |       | 3,632 |   | 6,881 |   | 2,715 |   | 14,210 |   | 14,617 |   |
| Trust  preferred securities                  |       | —                          |       | — |   | — |   | 10,028 |   | 10,028 |   | 5,649 |   |
| Residential  mortgage-backed securities      |       | —                          |       | 2,818 |   | 27,647 |   | 164,354 |   | 194,819 |   | 197,942 |   |
| Total  investment securities                 |       | $                               | 2,107      |   | $ | 7,957 |   | $ | 34,528 |   | $ | 177,097 |   | $ | 221,689 |   | $ | 220,880 |   |

 

**NOTE5—LOAN SERVICING**

 

Mortgage loans serviced for others (primarily the South Dakota HousingDevelopment Authority) are not included in the accompanying consolidatedstatements of financial condition.

 

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The following tables summarize the activity in, and the main assumptionsused to estimate the amortization of servicing rights:

 
| ** **                               | ** ** | **Three  Months Ended**              | ** ** |
|------------------------------------------|------------|--------------------------------------|------------|
| ** **                               | ** ** | **September 30,**               | ** ** |
| ** **                               | ** ** | **2009**                             | ** ** | **2008** | ** ** |
| ** **                               | ** ** | **(Dollars in Thousands)** | ** ** |
|                                     |       |                                 |       |   |   |
| Balance,  beginning                      |       | $                                    | 11,768     |   | $ | 11,189 |   |
| Additions                                |       | 654                                  |       | 585 |   |
| Amortization                             |       | (424                                 | )          | (348 | ) |
| Balance,  ending                         |       | $                                    | 11,998     |   | $ | 11,426 |   |
|                                     |       |                                 |       |   |   |
| Servicing  fees received                 |       | $                                    | 915        |   | $ | 905 |   |
| Balance  of loans serviced at:           |       |                                 |       |   |   |
| Beginning  of period                     |       | 1,046,600                            |       | 994,065 |   |
| End  of period                           |       | 1,073,658                            |       | 1,016,293 |   |
|                                     |       |                                 |       |   |   |
| Weighted-average  prepayment speed (CPR) |       | 10.57                                | %          | 10.09 | % |
| Discount  rate                           |       | 10.00                                | %          | 10.00 | % |

 

**NOTE6—SEGMENT REPORTING**

 

Operating segments are defined as components of an enterprise for whichdiscrete financial information is available that is evaluated regularly by thechief operating decision makers in deciding how to allocate resources and inassessing performance.  The Company’sreportable segments are “banking” (including leasing activities) and “other.”  The “banking” segment is conducted throughthe Bank and Mid America Capital and the “other” segment is composed of smallernon-reportable segments, the Company and intersegment eliminations.

 

The management approach is used as the conceptual basis for identifyingreportable segments and is based on the way that management organizes thesegments within the enterprise for making operating decisions, allocatingresources and monitoring performance, which is primarily based on products.

 
| ** **                                | ** ** | **Three  Months Ended September 30,** | ** ** |
|-------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                | ** ** | **2009**                                   | ** ** | **2008** | ** ** |
| ** **                                | ** ** | **Banking**                                | ** ** | **Other** | ** ** | **Total** | ** ** | **Banking** | ** ** | **Other** | ** ** | **Total** | ** ** |
| ** **                                | ** ** | **(Dollars  in Thousands)**                | ** ** |
|                                      |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Net  interest income                      |       | $                                          | 9,241      |   | $ | (490 | ) | $ | 8,751 |   | $ | 9,118 |   | $ | (429 | ) | $ | 8,689 |   |
| Provision  for losses on loans and leases |       | (343                                       | )          | — |   | (343 | ) | (387 | ) | — |   | (387 | ) |
| Non-interest  income                      |       | 1,582                                      |       | 116 |   | 1,698 |   | 2,931 |   | 118 |   | 3,049 |   |
| Intersegment  non-interest income         |       | (24                                        | )          | (39 | ) | (63 | ) | (38 | ) | (22 | ) | (60 | ) |
| Non-interest  expense                     |       | (8,530                                     | )          | (419 | ) | (8,949 | ) | (8,050 | ) | (353 | ) | (8,403 | ) |
| Intersegment  non-interest expense        |       | —                                     |       | 63 |   | 63 |   | — |   | 60 |   | 60 |   |
| Income  (loss) before income taxes        |       | $                                          | 1,926      |   | $ | (769 | ) | $ | 1,157 |   | $ | 3,574 |   | $ | (626 | ) | $ | 2,948 |   |
|                                      |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Total  assets at September 30        |       | $                                          | 1,163,296  |   | $ | 5,166 |   | $ | 1,168,462 |   | $ | 1,122,049 |   | $ | 6,035 |   | $ | 1,128,084 |   |

 

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**NOTE7—DEFINED BENEFIT PLAN**

 

The Company has a noncontributory (cash balance) defined benefitpension plan covering all employees of the Company and its wholly-ownedsubsidiaries who have attained the age of 21 and have completed 1,000 hours ofservice in a plan year.  The benefits arebased on 6% of each eligible participant’s annual compensation, plus incomeearned in the accounts at a rate determined annually based on 30-year treasurynote rates.  The Company’s funding policyis to make the minimum annual required contribution plus such amounts as theCompany may determine to be appropriate from time to time.  One hundred percent vesting occurs afterthree years with a retirement age of the later of age 65 or three years ofparticipation.  The Company has adoptedall plan provisions required by the Pension Protection Act of 2006.  Information relative to the components of netperiodic benefit cost for the Company’s defined benefit plan is presentedbelow:

 
| ** **                         | ** ** | **Three Months Ended**      | ** ** |
|------------------------------------|------------|-----------------------------|------------|
| ** **                         | ** ** | **September 30,**      | ** ** |
| ** **                         | ** ** | **2009**                    | ** ** | **2008** | ** ** |
| ** **                         | ** ** | **(Dollars  in Thousands)** | ** ** |
|                               |       |                        |       |   |   |
| Service  cost                      |       | $                           | 142        |   | $ | 119 |   |
| Interest  cost                     |       | 144                         |       | 120 |   |
| Amortization  of prior losses      |       | 45                          |       | 15 |   |
| Expected  return on plan assets    |       | (139                        | )          | (114 | ) |
| Total  costs recognized in expense |       | $                           | 192        |   | $ | 140 |   |

 

The Company previously disclosed in its consolidatedfinancial statements for fiscal 2009, which are included in Part II, Item8 “Financial Statements and Supplementary Data” of the Company’s Annual Reporton Form 10-K, that it contributed $2.35 million in fiscal 2009 to fund itsqualified pension plan.  The Companyanticipates that a contribution of $425,000 will be made in the second quarterof fiscal 2010.

 

**NOTE 8****—****SELF-INSURED HEALTHCARE PLAN**

 

The Company has had a self-insured health plan for itsemployees, subject to certain limits, since January 1994.  The Bank is named the plan administrator forthis plan and has retained the services of an independent third partyadministrator to process claims and handle other duties for this plan.  The third party administrator does not assumeliability for benefits payable under this plan.

 

The Company assumes the responsibility for funding the plan benefitsout of general assets; however, employees cover some of the costs of coveredbenefits through contributions, deductibles, co-pays and participationamounts.  An employee is eligible forcoverage upon completion of 30 calendar days of regular employment.  The plan, which is on a calendar year basis,is intended to comply with, and be governed by, the Employee Retirement IncomeSecurity Act of 1974, as amended.

 

The accrual estimate forpending and incurred but not reported health claims is based upon a pendingclaims lag report provided by a third party provider.  Although management believes that it uses thebest information available to determine the accrual, unforeseen health claimscould result in adjustments and net earnings being significantly affected ifcircumstances differ substantially from the assumptions used in estimating theaccrual.  Net healthcare costs areinclusive of health claims expenses and administration fees offset by stop lossand employee reimbursement.  Thefollowing table is a summary of net healthcare costs by quarter:

 
| ** **                       | ** ** | **Fiscal Years Ended June 30,** | ** ** |
|----------------------------------|------------|--------------------------------------|------------|
| ** **                       | ** ** | **2010**                             | ** ** | **2009** | ** ** |
| ** **                       | ** ** | **(Dollars  in Thousands)**          | ** ** |
|                             |       |                                 |       |   |   |
| Quarter  ended September 30 |       | $                                    | 748        |   | $ | 358 |   |
| Quarter  ended December 31  |       | —                               |       | 945 |   |
| Quarter  ended March 31     |       | —                               |       | 704 |   |
| Quarter  ended June 30      |       | —                               |       | 555 |   |
| Net  healthcare costs            |       | $                                    | 748        |   | $ | 2,562 |   |

 

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**NOTE9—STOCK-BASED COMPENSATION PLANS**

 

The fair value of each incentive stock option and eachstock appreciation right grant is estimated at the grant date using theBlack-Scholes option-pricing model.  Thefollowing assumptions were used for grants in the three months ended September 30:

 
| ** **                | ** ** | **2009** | ** ** | **2008** | ** ** |
|---------------------------|------------|----------|------------|----------|------------|
|                      |       |     |       |     |       |
| Expected  volatility      |       | 22.00    | %          | 19.00    | %          |
| Expected  dividend yield  |       | 3.61     | %          | 3.06     | %          |
| Risk-free  interest rate  |       | 2.35     | %          | 2.87     | %          |
| Expected  term (in years) |       | 5        |       | 5        |       |

 

Stock option activity forthe three months ended September 30, 2009 is as follows:

 
| ** **              | ** ** | ** ** | ** ** | ** **   | ** ** | **Weighted**    | ** ** | ** **    | ** ** |
|-------------------------|------------|------------|------------|--------------|------------|-----------------|------------|---------------|------------|
| ** **              | ** ** | ** ** | ** ** | **Weighted** | ** ** | **Average**     | ** ** | ** **    | ** ** |
| ** **              | ** ** | ** ** | ** ** | **Average**  | ** ** | **Remaining**   | ** ** | **Aggregate** | ** ** |
| ** **              | ** ** | ** ** | ** ** | **Exercise** | ** ** | **Contractual** | ** ** | **Intrinsic** | ** ** |
| ** **              | ** ** | **Shares** | ** ** | **Price**    | ** ** | **Term**        | ** ** | **Value**     | ** ** |
|                    |       |       |       |         |       |            |       |          |       |
| Beginning  balance      |       | 139,919    |       | $            | 12.89      |            |       |          |       |   |
| Granted                 |       | —     |       | —       |       |            |       |          |       |
| Forfeited               |       | —     |       | —       |       |            |       |          |       |
| Exercised               |       | —     |       | —       |       |            |       |          |       |
|                    |       |       |       |         |       |            |       |          |       |
| Ending  balance         |       | 139,919    |       | $            | 12.89      |            | 3.77       |          | $          | 69,386 |   |
|                    |       |       |       |         |       |            |       |          |       |
| Vested  and exercisable |       | 139,919    |       | $            | 12.89      |            | 3.77       |          | $          | 69,386 |   |

 

Stock appreciation rights activity for the threemonths ended September 30, 2009 are as follows:

 
| ** **              | ** ** | ** ** | ** ** | ** **   | ** ** | **Weighted**    | ** ** | ** **    | ** ** |
|-------------------------|------------|------------|------------|--------------|------------|-----------------|------------|---------------|------------|
| ** **              | ** ** | ** ** | ** ** | **Weighted** | ** ** | **Average**     | ** ** | ** **    | ** ** |
| ** **              | ** ** | ** ** | ** ** | **Average**  | ** ** | **Remaining**   | ** ** | **Aggregate** | ** ** |
| ** **              | ** ** | ** ** | ** ** | **Exercise** | ** ** | **Contractual** | ** ** | **Intrinsic** | ** ** |
| ** **              | ** ** | **SARs**   | ** ** | **Price**    | ** ** | **Term**        | ** ** | **Value**     | ** ** |
|                    |       |       |       |         |       |            |       |          |       |
| Beginning  balance      |       | 87,650     |       | $            | 15.35      |            |       |          |       |   |
| Granted                 |       | 115,747    |       | 12.48        |       |            |       |          |       |
| Forfeited               |       | —     |       | —       |       |            |       |          |       |
| Exercised               |       | —     |       | —       |       |            |       |          |       |
|                    |       |       |       |         |       |            |       |          |       |
| Ending  balance         |       | 203,397    |       | $            | 13.72      |            | 9.24       |          | $          | — |   |
| ** **              | ** ** | ** ** |       |         |       |            |       |          |       |
| Vested  and exercisable |       | 36,356     |       | $            | 15.63      |            | 7.94       |          | $          | — |   |

 

The total intrinsic value of options exercised duringthe three months ended September 30, 2009 and 2008 were $0 and $41,000,respectively.  Cash received from theexercise of these options was $0 and $337,000, respectively, and the relatedtax benefit realized for the tax deductions from cashless option exercisestotaled $0 and $1,000, respectively.  Theweighted-average grant date fair value of stock appreciation rights (SARs)granted during the three months ended September 30, 2009 and 2008 was$1.75 and $2.06, respectively.  The totalunrecognized compensation cost related to nonvested SARs awards at September 30,2009 was $444,000.  The unrecognized costat September 30, 2009 is expected to be recognized over a weighted averageperiod of 35 months.

 

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Nonvested share activityfor the three months ended September 30 follows:

 
| ** **                    | ** ** | **2009**   | ** ** | **2008**       | ** ** |
|-------------------------------|------------|------------|------------|----------------|------------|
| ** **                    | ** ** | ** ** | ** ** | **Weighted**   | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                    | ** ** | ** ** | ** ** | **Average**    | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                    | ** ** | ** ** | ** ** | **Grant Date** | ** ** | ** ** | ** ** | **Grant Date** | ** ** |
| ** **                    | ** ** | **Shares** | ** ** | **Fair Value** | ** ** | **Shares** | ** ** | **Fair Value** | ** ** |
|                          |       |       |       |           |       |   |   |   |   |
| Nonvested  balance, beginning |       | 90,708     |       | $              | 15.81      |   | 121,746 |   | $ | 16.57 |   |
| Granted                       |       | 18,436     |       | 12.48          |       | 9,091 |   | 14.71 |   |
| Vested                        |       | (40,415    | )          | 16.31          |       | (48,455 | ) | 16.44 |   |
| Forfeited                     |       | —     |       | —         |       | (1,305 | ) | 16.95 |   |
|                          |       |       | ** ** | ** **     | ** ** |   |   |   |   |
| Nonvested  balance, ending    |       | 68,729     |       | $              | 14.62      |   | 81,077 |   | $ | 16.43 |   |

 

Pretax compensation expense recognized for nonvested shares for thethree months ended September 30, 2009, and 2008 was $92,000 and $115,000,respectively.  The tax benefit for thethree months ended September 30, 2009, and 2008 was $31,000 and $39,000,respectively.  As of September 30,2009, there was $512,000 of total unrecognized compensation cost related tononvested shares granted under the Company’s 2002 Stock Option and IncentivePlan, as amended (“the Plan”).  The costis expected to be recognized over a weighted-average period of 22 months.  The total fair value of shares vested duringthe three months ended September 30, 2009 and 2008 was $659,000 and$797,000, respectively.

 

In association with the 2002 Option Plan, awards of nonvested shares ofthe Company’s common stock are made to outside directors of the Company.  Each outside director is entitled to allvoting, dividend and distribution rights during the vesting period.  During the second quarter of fiscal 2009,14,511 shares of nonvested stock were awarded. Nonvested shares vest on the first anniversary of the date ofgrant.  As of September 30, 2009,there was $30,000 of total unrecognized compensation cost related to nonvestedshares, which are expected to be recognized over the remaining two months.  For the three months ended September 30,2009, amortization expense was recorded in the amount of $45,000.

 

These stock option and incentive plans are described more fully in Part II,Item 8 “Financial Statements and Supplementary Data” of the Company’s AnnualReport on Form 10-K for fiscal 2009, under Note 16 of “Notes toConsolidated Financial Statements.”

 

**NOTE10—SUBORDINATED DEBENTURES PAYABLE TO TRUSTS**

 

On December 19, 2002, the Company issued 5,000 shares totaling$5,000 of Company Obligated Mandatorily Redeemable Preferred Securities ofTrust III. Trust III was established and exists for the sole purpose of issuingtrust preferred securities and investing the proceeds in subordinateddebentures of the Company. These subordinated debentures constitute the soleasset of Trust III. The securities provide for cumulative cash distributionscalculated at a rate based on three-month LIBOR plus 3.35% adjusted quarterly.The Company may, at one or more times, defer interest payments on the capitalsecurities for up to 20 consecutive quarterly periods, but not beyond January 7,2033. At the end of the deferral period, all accumulated and unpaiddistributions must be paid. The capital securities must be redeemed on January 7,2033; however, the Company has the option to shorten the maturity date as thecall option date has passed. Holders of the capital securities have no votingrights, are unsecured, and rank junior in priority of the payment to all of theCompany’s indebtedness and senior to the Company’s capital stock.

 

On September 25, 2003, the Company issued 7,000 shares totaling$7,000 of Company Obligated Mandatorily Redeemable Preferred Securities ofTrust IV. Trust IV was established and exists for the sole purpose of issuingtrust preferred securities and investing the proceeds in subordinateddebentures of the Company. These subordinated debentures constitute the soleasset of Trust IV. The securities provide for cumulative cash distributionscalculated at a rate based on three-month LIBOR plus 3.10% adjusted quarterly.The Company may, at one or more times, defer interest payments on the capitalsecurities for up to 20 consecutive quarterly periods, but not beyond October 8,2033. At the end of the deferral period, all accumulated and unpaiddistributions must be paid. The capital securities must be redeemed on October 8,2033; however, the Company has the option to shorten the maturity date as thecall option date has passed. Holders of the capital securities have no votingrights, are unsecured, and rank junior in priority of the payment to all of theCompany’s indebtedness and senior to the Company’s capital stock.

 

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On December 7, 2006, the Company issued 10,000 shares totaling$10,000 of Company Obligated Mandatorily Redeemable Preferred Securities ofTrust V. Trust V was established and exists for the sole purpose of issuingtrust preferred securities and investing the proceeds in subordinateddebentures of the Company. These subordinated debentures constitute the soleasset of Trust V. The securities provide for cumulative cash distributionscalculated at a rate based on three-month LIBOR plus 1.83%, fixed for fiveyears at 6.61%; thereafter, adjusted quarterly. The Company may, at one or moretimes, defer interest payments on the capital securities for up to 20consecutive quarterly periods, but not beyond March 1, 2037. At the end ofthe deferral period, all accumulated and unpaid distributions must be paid. Thecapital securities must be redeemed on March 1, 2037; however, the Companyhas the option to shorten the maturity date to a date not earlier than March 1,2012. Holders of the capital securities have no voting rights, are unsecured,and rank junior in priority of the payment to all of the Company’s indebtednessand senior to the Company’s capital stock.

 

On July 5, 2007, the Company issued 5,000 shares totaling $5,000of Company Obligated Mandatorily Redeemable Preferred Securities of Trust VI.Trust VI was established and exists for the sole purpose of issuing trustpreferred securities and investing the proceeds in subordinated debentures ofthe Company. These subordinated debentures constitute the sole asset of TrustVI. The securities provide for cumulative cash distributions calculated at arate based on three- month LIBOR plus 1.65% adjusted quarterly. The Companymay, at one or more times, defer interest payments on the capital securitiesfor up to 20 consecutive quarterly periods, but not beyond October 1, 2037.At the end of the deferral period, all accumulated and unpaid distributionsmust be paid. The capital securities must be redeemed on October 1, 2037;however, the Company has the option to shorten the maturity date to a date notearlier than October 1, 2012. Holders of the capital securities have novoting rights, are unsecured, and rank junior in priority of the payment to allof the Company’s indebtedness and senior to the Company’s capital stock.

 

**NOTE 11****—****INTEREST RATE CONTRACTS**

 

Interest rate swap contracts are entered into primarily as anasset/liability management strategy of the Company to modify interest raterisk.  The primary risk associated withall swaps is the exposure to movements in interest rates and the ability of thecounterparties to meet the terms of the contract.  The Company is exposed to losses if thecounterparty fails to make its payments under a contract in which the Companyis in a receiving status. The Company minimizes its risk by monitoring thecredit standing of the counterparty.  TheCompany anticipates the counterparty will be able to fully satisfy itsobligations under the remaining agreements. These contracts are designated as cash flow hedges.

 

During the first quarter of fiscal 2008, the Company entered into aninterest rate swap agreement with a $5.0 million notional amount to convert thevariable-rate Trust Preferred VI security into a fixed-rate instrument for aterm of five years at a fixed rate of 6.69%. The fair value of the derivative was a $534,000 unrealized loss at September 30,2009.

 

During the fourth quarter of fiscal 2008, the Company entered into aninterest rate swap agreement with a $7.0 million notional amount to convert thevariable-rate Trust Preferred IV security into a fixed-rate instrument for a termof three years at a fixed rate of 6.19%. The fair value of the derivative was a $250,000 unrealized loss at September 30,2009.

 

During the first quarter of fiscal 2009, the Company entered into aninterest rate swap agreement with a $3.0 million notional amount to convert aportion of the variable-rate Trust Preferred III security into a fixed-rateinstrument for a term of three years at a fixed rate of 6.70%.  The Company also entered into an interestrate swap agreement with a $2.0 million notional amount to convert theremaining portion of variable rate Trust Preferred III security into a fixedrate instrument for a term of four years at a fixed rate of 6.91%.  The fair value of the $3.0 million notionalamount derivative was a $147,000 unrealized loss, while the fair value of the$2.0 million notional amount derivative was a $117,000 unrealized loss at September 30,2009.

 

No gain or loss was recognized in earnings for the three months ended September 30,2009, and 2008 related to interest rate swaps. No deferred net losses on interest rate swaps in other comprehensiveloss as of September 30, 2009, are expected to be reclassified intoearnings during the current fiscal year. See Note 12 “Accumulated Other Comprehensive Loss” for amounts reportedas other comprehensive loss.

 

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The Company posted $1.2 million in cash under collateral arrangementsas of September 30, 2009, to satisfy collateral requirements associatedwith our interest rate swap contracts.

 

The following table summarizes the derivative financial instrumentsutilized as of September 30, 2009:

 
| ** **                    | ** ** | **Balance**                          | ** ** | **Notional**                | ** ** | **Estimated  Fair Value** | ** ** |
|-------------------------------|------------|--------------------------------------|------------|-----------------------------|------------|---------------------------|------------|
| **Cash flow hedge**           | ** ** | **Sheet  Location**                  | ** ** | **Amount**                  | ** ** | **Gain**                  | ** ** | **Loss** | ** ** |
|                          |       |                                 |       | **(Dollars  in Thousands)** |       |
|                          |       |                                 |       |                        |       |                      |       |   |   |
| Interest  rate swap contracts |       | Accumulated other comprehensive loss |       | $                           | 17,000     |                      | $          | — |   | $ | (1,048 | ) |
|                               |            |                                      |            |                             |            |                           |            |  |  |  |  |  |

 

The following table details the derivative financial instruments, theaverage remaining maturities and the weighted-average interest rates being paidand received as of September 30, 2009:

 
| ** **                     | ** ** | ** **                  | ** ** | **Average**  | ** ** | ** ** | ** ** | ** **                 | ** ** | ** ** | ** ** |
|--------------------------------|------------|-----------------------------|------------|--------------|------------|------------|------------|----------------------------|------------|------------|------------|
| ** **                     | ** ** | **Notional**                | ** ** | **Maturity** | ** ** | **Fair**   | ** ** | **Weighted  Average Rate** | ** ** |
| **Liability conversion swaps** | ** ** | **Amount**                  | ** ** | **(years)**  | ** ** | **Value**  | ** ** | **Receive**                | ** ** | **Pay**    | ** ** |
| ** **                     | ** ** | **(Dollars  in Thousands)** | ** ** |
|                           |       |                        |       |         |       |       |       |                       |       |       |       |
| Interest  rate swap contracts  |       | $                           | 17,000     |         | 2.2        |       | $          | (1,048                     | )          | 3.31       | %          | 6.51 | % |
|                                |            |                             |            |              |            |            |            |                            |            |            |            |  |  |

 

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**NOTE 12****—****ACCUMULATED OTHER COMPREHENSIVELOSS**

 

Thecomponents of accumulated other comprehensive loss are as follows:

 
| ** **                                                                                         | ** ** | **Three Months Ended**      | ** ** |
|----------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                                         | ** ** | **September 30,**      | ** ** |
| ** **                                                                                         | ** ** | **2009**                    | ** ** | **2008** | ** ** |
| ** **                                                                                         | ** ** | **(Dollars  in Thousands)** | ** ** |
|                                                                                               |       |                        |       |   |   |
| Net  income                                                                                        |       | $                           | 855        |   | $ | 1,975 |   |
| Other  comprehensive income (loss), net of tax:                                                    |       |                        |       |   |   |
| Securities  available for sale:                                                                    |       |                        |       |   |   |
| Net  unrealized gains (losses) that are included in accumulated other  comprehensive income (loss) |       | 4,500                       |       | (584 | ) |
| Reclassification  adjustment for net gains realized in net income                                  |       | (533                        | )          | (80 | ) |
| Noncredit  component of impairment losses on other-than-temporary impaired securities,  net        |       | (1,858                      | )          | — |   |
| Income  tax benefit (expense)                                                                      |       | (802                        | )          | 253 |   |
|                                                                                               |       |                        |       |   |   |
| Other  comprehensive income (loss) on securities available for sale                                |       | 1,307                       |       | (411 | ) |
|                                                                                               |       |                        |       |   |   |
| Defined  benefit plan:                                                                             |       |                        |       |   |   |
| Net  unrealized (loss)                                                                             |       | —                      |       | — |   |
| Income  tax benefit                                                                                |       | —                      |       | — |   |
|                                                                                               |       |                        |       |   |   |
| Other  comprehensive (loss) on defined benefit plan                                                |       | —                      |       | — |   |
|                                                                                               |       |                        |       |   |   |
| Cash  flow hedging activities-interest rate swap contracts:                                        |       |                        |       |   |   |
| Net  unrealized (losses)                                                                           |       | (96                         | )          | (32 | ) |
| Income  tax benefit                                                                                |       | 32                          |       | 11 |   |
|                                                                                               |       |                        |       |   |   |
| Other  comprehensive (loss) on cash flow hedging activities-interest rate swap  contracts          |       | (64                         | )          | (21 | ) |
|                                                                                               |       |                        |       |   |   |
| Total  other comprehensive income (loss)                                                           |       | 1,243                       |       | (432 | ) |
|                                                                                               |       |                        |       |   |   |
| Comprehensive  income                                                                              |       | $                           | 2,098      |   | $ | 1,543 |   |
|                                                                                               |       |                        |       |   |   |
| Cumulative  other comprehensive (loss) balances were:                                              | ** ** | ** **                  | ** ** | ** ** | ** ** |
| ** **                                                                                         | ** ** |                        |       |   |   |
| Unrealized  (loss) on securities available for sale net of related tax effect of $308 and  $1,521  | ** ** | $                           | (504       | ) | $ | (2,479 | ) |
| Unrealized  (loss) on defined benefit plan net of related tax effect of $1,177 and $523            |       | (1,920                      | )          | (853 | ) |
| Unrealized  (loss) on cash flow hedging activities net of related tax effect of $356 and  $52      |       | (692                        | )          | (101 | ) |
|                                                                                               |       |                        |       |   |   |
|                                                                                               |       | $                           | (3,116     | ) | $ | (3,433 | ) |

 

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**NOTE 13****—****FINANCIAL INSTRUMENTS AND FAIRVALUE MEASUREMENT**

 

The Bank is a party to financial instruments with off-balance-sheetrisk in the normal course of business to meet the financing needs of itscustomers. These financial instruments include commitments to extend credit,standby letters of credit and financial guarantees. Those instruments involve,to varying degrees, elements of credit and interest-rate risk in excess ofamounts recognized in the consolidated statements of financial condition. Thecontract or notional amounts of those instruments reflect the extent of theBank’s involvement in particular classes of financial instruments.

 

The Bank’s exposure to credit loss in the event of nonperformance bythe other party to the financial instrument for commitments to extend credit,standby letters of credit, and financial guarantees written is represented bythe contractual notional amount of those instruments. The Bank uses the samecredit policies in making commitments and conditional obligations as it doesfor on-balance-sheet instruments.

 

Unless noted otherwise, the Bank does not require collateral or othersecurity to support financial instruments with credit risk.

 

The following methods and assumptions were used by the Company inestimating the fair value of its financial instruments:

 

Cash and cashequivalents—The carrying amounts reported in the statements of financialcondition for cash and cash equivalents approximate their fair values.

 

Securities—Fairvalues for investment securities are based on quoted market prices or whosevalue is determined using discounted cash flow methodologies, except for stockin the Federal Home Loan Bank for which fair value is assumed to equal cost.

 

Loans and leases,net—The fair values for loans are estimated using discounted cash flowanalyses, using interest rates currently being offered for loans with similarterms and credit quality. Leases are stated at cost which equals fair value.

 

Accrued interestreceivable—The carrying value of accrued interest receivable approximates itsfair value.

 

Servicingrights—Fair values are estimated using discounted cash flows based on currentmarket rates of interest.

 

Interest rate swapcontracts—Valuations of interest rate swap contracts are based on inputsobserved in active markets for similar instruments. Typical inputs include theLIBOR curve, option volatility and option skew.

 

Off-statement-of-financial-conditioninstruments—Fair values for the Company’s off-statement-of-financial-conditioninstruments (unused lines of credit and letters of credit), which are basedupon fees currently charged to enter into similar agreements taking intoaccount the remaining terms of the agreements and counterparties’ creditstanding, are not significant.

 

Deposits—The fairvalues for deposits with no defined maturities equal their carrying amounts,which represent the amount payable on demand. Fair values for fixed-ratecertificates of deposit are estimated using a discounted cash flow calculationthat applies interest rates currently being offered on a comparably termedwholesale funding alternative (i.e., FHLB borrowings).

 

Borrowed funds—Thecarrying amounts reported for variable rate advances approximate their fairvalues. Fair values for fixed-rate advances and other borrowings are estimatedusing a discounted cash flow calculation that applies interest rates currentlybeing offered on advances and borrowings with corresponding maturity dates.

 

Subordinateddebentures payable to trusts—Fair values for subordinated debentures areestimated using a discounted cash flow calculation that applies interest rateson comparable borrowing instruments with corresponding maturity dates.

 

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Accrued interestpayable and advances by borrowers for taxes and insurance—The carrying valuesof accrued interest payable and advances by borrowers for taxes and insuranceapproximate their fair values.

 

Estimated fair values of the Company’s financial instruments are asfollows:

 
| ** **                                                                  | ** ** | **September 30,  2009** | ** ** | **June 30,  2009** | ** ** |
|-----------------------------------------------------------------------------|------------|------------------------------|------------|-------------------------|------------|
| ** **                                                                  | ** ** | **Carrying**                 | ** ** | **Fair**                | ** ** | **Carrying** | ** ** | **Fair** | ** ** |
| ** **                                                                  | ** ** | **Amount**                   | ** ** | **Value**               | ** ** | **Amount** | ** ** | **Value** | ** ** |
| ** **                                                                  | ** ** | **(Dollars in Thousands)**   | ** ** |
| Financial  Assets                                                           |       |                         |       |                    |       |   |   |   |   |
| Cash  and cash equivalents                                                  |       | $                            | 18,717     |                    | $          | 18,717 |   | $ | 18,511 |   | $ | 18,511 |   |
| Securities                                                                  |       | 221,137                      |       | 221,137                 |       | 222,910 |   | 222,910 |   |
| Federal  Home Loan Bank Stock                                               |       | 12,476                       |       | 12,476                  |       | 12,476 |   | 12,476 |   |
| Loans  and leases                                                           |       | 848,113                      |       | 849,868                 |       | 857,693 |   | 863,453 |   |
| Accrued  interest receivable                                                |       | 9,370                        |       | 9,370                   |       | 7,598 |   | 7,598 |   |
| Servicing  rights                                                           |       | 11,998                       |       | 15,636                  |       | 11,768 |   | 15,055 |   |
| Interest  rate swap contracts                                               |       | (1,048                       | )          | (1,048                  | )          | (952 | ) | (952 | ) |
|                                                                        |       |                         |       |                    |       |   |   |   |   |
| Financial  liabilities                                                      |       |                         |       |                    |       |   |   |   |   |
| Deposits                                                                    |       | 830,241                      |       | 836,337                 |       | 837,868 |   | 844,243 |   |
| Borrowed  funds                                                             |       | 207,278                      |       | 213,634                 |       | 212,869 |   | 219,249 |   |
| Subordinated  debentures payable to trusts                                  |       | 27,837                       |       | 11,888                  |       | 27,837 |   | 9,990 |   |
| Accrued  interest payable and advances by borrowers for taxes and insurance |       | 21,889                       |       | 21,889                  |       | 17,421 |   | 17,421 |   |
|                                                                             |            |                              |            |                         |            |  |  |  |  |  |  |  |  |

 

*FairValue Measurement*

 

Effective July 1, 2009, FASB Staff Position 157-2, *Effective Date of SFAS No. 157(ASC Topic 820)*,the Company applied the provisions of this statement to non-financial assetsand liabilities.  The Company earlyadopted FASB Staff Position 157-4, in April 2009, *Determining Fair Value When the Volume and Level ofActivity for the Asset or Liability Have Significantly Decreased andIdentifying Transactions That Are Not Orderly(ASC 820-10-65)*.  ASC 820-10-65 defines fair value andestablishes a consistent framework for measuring fair value under GAAP andexpands disclosure requirements for fair value measurements. Fair valuesrepresent the estimated price that would be received from selling an asset orpaid to transfer a liability in an orderly transaction between marketparticipants at the measurement date under current market conditions. Thestandard describes three levels of inputs that may be used to measure fairvalue:

 

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

 

Level 2:  Significant otherobservable inputs other than Level 1 prices such as quoted prices forsimilar assets or liabilities; quoted prices in markets that are not active; orother inputs that are observable or can be corroborated by observable marketdata.

 

Level 3:  Significantunobservable inputs that reflect a company’s own assumptions about theassumptions that market participants would use in pricing an asset orliability. Level 3 assets and liabilities include financial instrumentswhose value is determined using pricing models, discounted cash flowmethodologies, or similar techniques, as well as instruments for which thedetermination of fair value requires significant management judgment orestimation.

 

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Thetable below presents the Company’s assets and liabilities measured at fairvalue on a recurring basis by level within the hierarchy at September 30,2009:

 
| ** **                     | ** ** | **Quoted  Prices**          | ** ** | **Significant  Other** | ** ** | **Significant**  | ** ** | ** **     | ** ** |
|--------------------------------|------------|-----------------------------|------------|------------------------|------------|------------------|------------|----------------|------------|
| ** **                     | ** ** | **In Active**               | ** ** | **Observable**         | ** ** | **Unobservable** | ** ** | ** **     | ** ** |
| ** **                     | ** ** | **Markets**                 | ** ** | **Inputs**             | ** ** | **Inputs**       | ** ** | **Total at**   | ** ** |
| ** **                     | ** ** | **(Level 1)**               | ** ** | **(Level 2)**          | ** ** | **(Level 3)**    | ** ** | **Fair Value** | ** ** |
| ** **                     | ** ** | **(Dollars  in Thousands)** | ** ** |
|                           |       |                        |       |                   |       |             |       |           |       |
| Securities  available for sale |       | $                           | 4          |                   | $          | 215,484          |       | $              | 5,649      |   | $ | 221,137 |   |
| Interest  rate swap contracts  |       | —                      |       | (1,048                 | )          | —           |       | (1,048         | )          |
| Total  assets                  |       | $                           | 4          |                   | $          | 214,436          |       | $              | 5,649      |   | $ | 220,089 |   |

 

TheCompany used the following methods and significant assumptions to estimate thefair value of items:

 

Securitiesavailable for sale: The fair values of securities available for sale aredetermined by obtaining quoted prices on nationally recognized securitiesexchanges (Level 1 inputs), or matrix pricing, which is a mathematicaltechnique widely used in the industry to value debt securities without relyingexclusively on quoted prices for the specific securities, but rather by relyingon the securities’ relationship to other benchmark quoted securities (Level 2inputs).  The Company outsources thisvaluation primarily to a third party provider which utilizes several sourcesfor valuing fixed-income securities. Sources utilized by the third party provider include pricing models thatvary based by asset class and include available trade, bid, and other marketinformation.  This methodology includesbroker quotes, proprietary models, descriptive terms and conditions databases,as well as extensive quality control programs. As further valuation sources, the third party provider uses aproprietary valuation model and capital markets trading staff.  This proprietary valuation model is used forvaluing municipal securities. This model includes a separate curve structurefor Bank-Qualified municipal securities. The grouping of municipal securitiesis further broken down according to insurer, credit support, state of issuance,and rating to incorporate additional spreads and municipal curves.

 

The securitiesshown in Level 3 relate to trust preferred securities which are currently partof an inactive market.  The inactivitywas evidenced first by a significant widening of the bid-ask spread in thebrokered markets in which these securities trade, and then by a significantdecrease in the volume of trades relative to historical levels.  The new issue market for pooled trustpreferred securities has been inactive since 2007.  Given conditions in the debt markets and theabsence of observable orderly transactions in the secondary and new issuemarkets, management determined that an income valuation approach technique(present value technique) that maximizes the use of relevant observable inputsand minimizes the use of unobservable inputs will be equally or morerepresentative of fair value than the market approach valuation technique.

 

Theresults of third party valuation and valuation derived by management cash flowscenarios were weighted each at 50% and used to measure fair value for eachsecurity. The approaches to determining fair value for the trust preferredsecurities included the following factors:

 

1.     The credit quality of the collateral isestimated using average probability of default values for each industry withinthe third part valuation.

 

2.     The loss given default was assumed to be100% (i.e. no recovery) for third party valuations.  Management utilized a range of loss givendefault based upon a review of the financial condition of underlying issuers ineach pool, under multiple scenarios for each security.

 

3.     The cash flows were forecasted for theunderlying collateral and applied to each tranche to determine the resultingdistribution among the securities.

 

4.     For third party valuation, the expectedcash flows for each scenario are discounted at 3-month Libor plus 300 basispoints.  Management scenarios of the bestestimates of expected cash flows were discounted to calculate the present valueof the security.  Management considered arange of discount rates based upon three factors:  (1) a risk-free rate based on the rateof return on government debt securities, (2) the credit spread for BBBBank Corporate Debt Indices, and (3) a liquidity or “risk premium” of 200basis points.

 

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5.               The third party calculations were modeled in severalthousand scenarios and the average price was used for the third partyvaluations.  Management utilized anaverage price derived from various cash flow scenarios.

 

Interestrate swaps:  The fair values of interestrate swaps relate to cash flow hedges of trust preferred debt securities issuedby the Company.  The fair value isestimated by a third party using inputs that are observable or that can becorroborated by observable market data and, therefore, are classified withinLevel 2 of the valuation hierarchy. These fair value estimations includeprimarily market observable inputs, such as yield curves, and include the valueassociated with counterparty credit risk.

 

The following table reconciles the beginning and ending balances ofsecurities available for sale that are measured at fair value on a recurringbasis using significant unobservable inputs:

 
| ** **                                    | ** ** | **Three  Months Ended**     | ** ** |
|-----------------------------------------------|------------|-----------------------------|------------|
| ** **                                    | ** ** | **September 30,**      | ** ** |
| ** **                                    | ** ** | **2009**                    | ** ** | **2008** | ** ** |
| ** **                                    | ** ** | **(Dollars  in Thousands)** | ** ** |
|                                          |       |                        |       |   |   |
| Beginning  balance                            |       | $                           | 6,051      |   | $ | — |   |
| Total  realized/unrealized gains (losses)     |       |                        |       |   |   |
| Included  in earnings                         |       | (1,858                      | )          | — |   |
| Included  in other comprehensive loss         |       | 1,449                       |       | — |   |
| Purchases,  issuances, (paydowns) and (sales) |       | 7                           |       | 1 |   |
| Transfers  into or (out) of Level 3           |       | —                      |       | 9,498 |   |
| Ending  balance                               |       | $                           | 5,649      |   | $ | 9,499 |   |

 

Thetable below presents the Company’s assets subject to the nonrecurring fairvalue measurements by level within the hierarchy at September 30, 2009:

 
| ** **                 | ** ** | **Quoted  Prices**          | ** ** | **Significant  Other** | ** ** | **Significant**  | ** ** | ** **       | ** ** |
|----------------------------|------------|-----------------------------|------------|------------------------|------------|------------------|------------|------------------|------------|
| ** **                 | ** ** | **In Active**               | ** ** | **Observable**         | ** ** | **Unobservable** | ** ** | **Fiscal  2010** | ** ** |
| ** **                 | ** ** | **Markets**                 | ** ** | **Inputs**             | ** ** | **Inputs**       | ** ** | **Incurred**     | ** ** |
| ** **                 | ** ** | **(Level 1)**               | ** ** | **(Level 2)**          | ** ** | **(Level 3)**    | ** ** | **Losses**       | ** ** |
| ** **                 | ** ** | **(Dollars  in Thousands)** | ** ** |
|                       |       |                        |       |                   |       |             |       |             |       |
| Loans  held for sale       |       | $                           | —     |                   | $          | 22,792           |       | $                | —     |   | $ | — |   |
| Impaired  loans            |       | —                      |       | 7,817                  |       | 274              |       | —           |       |
| Mortgage  servicing rights |       | —                      |       | —                 |       | 11,998           |       | —           |       |
| Foreclosed  assets         |       | —                      |       | —                 |       | 11               |       | —           |       |
|                            |            |                             |            |                        |            |                  |            |                  |            |  |  |  |  |

 

Loansheld for sale, which consist generally of current production of certainfixed-rate, first-lien residential mortgage loans and student loans, arecarried at the lower of cost or estimated fair value. The estimated fair valueis based on what secondary markets are currently offering for portfolios withsimilar characteristics, which the Company classifies as a Level 2nonrecurring fair value measurement.

 

Impairedloans are evaluated and valued at the time the loan is identified as impaired,at the lower of cost or market value. Market value is measured based onthe value of the collateral securing these loans.  Collateral isprimarily real estate and its fair value is generally determined based on realestate appraisals or other evaluations by qualified professionals and reportedas Level 2 inputs. When no appraisal or external valuation can be obtained, theCompany internally values these assets and reports these as Level 3inputs.  Impaired loans are reviewed andevaluated on at least a quarterly basis for additional impairment and adjustedaccordingly, based on the same factors identified above. Impaired loans thatare collateral dependent are written down to their fair value, less costs tosell, through the establishment of specific reserves or by recordingcharge-offs when the carrying value exceeds the fair value. Valuationtechniques consistent with the market approach, income approach, and/or costapproach were used to measure fair value and primarily included observableinputs such as recent sales of similar assets or observable market data foroperational or carrying costs.

 

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Foreclosedassets’ values are originally derived from the estimated value of thecollateral based asset upon repossession by the Bank.  During the period the foreclosed assetremains in the possession of the Bank, the asset is evaluated periodically forany valuation adjustments. Those foreclosed assets, for which a reduction inasset value is needed, are adjusted and determined to be an impaired asset ofthe Company.  These assets will remain animpaired asset until ultimately sold or disposed.

 

Mortgage servicing rights do not trade in an active, open market withreadily observable prices. While sales of mortgage servicing rights do occur,the precise terms and conditions typically are not readily available to allowfor a “quoted price for similar assets” comparison. Accordingly, the Companyrelies on an internal discounted cash flow model to estimate the fair value ofits mortgage servicing rights. The Company uses a valuation model to projectmortgage servicing rights cash flows based on the current interest ratescenario, which is then discounted to estimate an expected fair value of themortgage servicing rights. The valuation model considers portfoliocharacteristics of the underlying mortgages, contractually specified servicingfees, prepayment assumptions, discount rate assumptions, other ancillaryrevenue, costs to service, and other economic factors. The Company reassessesand periodically adjusts the underlying inputs and assumptions used in themodel to reflect market conditions and assumptions that a market participantwould consider in valuing the mortgage servicing rights asset. In addition, theCompany compares its fair value estimates and assumptions to observable marketdata for mortgage servicing rights, where available, and to recent marketactivity and actual portfolio experience. Due to the nature of the valuationinputs, mortgage servicing rights are classified within Level 3 of thefair value hierarchy. The Company uses the amortization method(i.e., lower of amortized cost or estimated fair value measured on anonrecurring basis), not fair value measurement accounting, for its mortgageservicing rights assets.

 

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

 

**Forward-Looking Statements**

 

This Quarterly Report on Form 10-Q (“Form 10-Q”), as well asother reports issued by HF Financial Corp. (the “Company”) include “forward-lookingstatements” within the meaning of Section 27A of the Securities Act of1933, as amended, and Section 21E of the Securities Exchange Act of 1934,as amended. In addition, the Company’s management may make forward-lookingstatements orally to the media, securities analyst, investors and others fromtime to time. Forward-looking statements can be identified by the fact thatthey do not relate strictly to historical or current facts. Words such as “optimism,”“look-forward,” “bright,” “believe,” “expect,” “anticipate,” “intend,” “hope,” “plan,”“estimate” or words of similar meaning, or future or conditional verbs such as “will,”“would,” “should,” “could” or “may,” are intended to identify theseforward-looking statements.

 

These forward-looking statements might include one or more of thefollowing:

 

·                  projections of income, loss, revenues, earnings or losses per share,dividends, capital expenditures, capital structure, tax benefit or otherfinancial items.

 

·                  descriptions of plans or objectives of management for futureoperations, products or services, transactions, investments and use ofsubordinated debentures payable to trusts.

 

·      forecasts of future economicperformance.

 

·      use and descriptions ofassumptions and estimates underlying or relating to such matters.

 

Forward-looking statements are subject to certain risks anduncertainties that could cause actual results to differ materially from ourhistorical experience and our present expectations or projections. Factors thatcould cause actual results to differ from those discussed in theforward-looking statements include, but are not limited to:

 

·                  adverse economic and market conditions of the financial servicesindustry in general, including, without limitation, the credit markets;

 

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·                  the effect of recent legislation to help stabilize the financialmarkets or the effect of the phase-out of existing recovery programs;

 

·      future losses on ourholdings of trust preferred securities;

 

·      increase of non-performingloans and additional provisions for loan losses;

 

·      the failure of assumptionsunderlying the establishment of reserves for loan losses and other estimates;

 

·      the failure to maintain ourreputation in our market area;

 

·      prevailing economic,political and business conditions in South Dakota;

 

·                  the effects of competition from a wide variety of local, regional,national and other providers of financial services;

 

·                  compliance with existing and future banking laws and regulations,including, without limitation, regulatory capital requirements and FDICinsurance coverages and costs;

 

·      changes in the availabilityand cost of credit and capital in the financial markets;

 

·      the effects of FDIC depositinsurance premiums and assessments;

 

·                  the risks of changes in market interest rates on the composition andcosts of deposits, loan demand, net interest income, and the values andliquidity of loan collateral, and our ability or inability to manage interestrate and other risks;

 

·                  changes in the prices, values and salesvolumes of residential and commercial real estate;

 

·                  an extended period of low commodity prices, significantly reducedyields on crops, reduced levels of governmental assistance to the agriculturalindustry, and reduced farmland values;

 

·      soundness of other financialinstitutions;

 

·                  the risks of future acquisitions and other expansion opportunities,including, without limitation, the related time and costs of implementing suchtransactions, integrating operations as part of these transactions and possiblefailures to achieve expected gains, revenue growth and expense savings fromsuch transactions;

 

·      security and operationsrisks associated with the use of technology;

 

·                  the loss of one or more of our key personnel, or the failure toattract, assimilate and retain other highly qualified personnel in the future;

 

·      changes in orinterpretations of accounting standards, rules or principles; and

 

·                  other factors and risks described under Part I, Item 2—“Management’sDiscussion and Analysis of Financial Condition and Results of Operations” andItem 3—“Quantitative and Qualitative Disclosures About Market Risk” in this Form 10-Q.

 

Forward-looking statements speak only as of the date they are made.Forward-looking statements are based upon management’s then-current beliefs andassumptions, but management does not give any assurance that such beliefs andassumptions will prove to be correct. We undertake no obligation to publiclyupdate or revise any forward-looking statements included or incorporated by referencein this Form 10-Q or to update the reasons why actual results could differfrom those contained in such statements, whether as a result of newinformation, future events or otherwise, except to the extent required byfederal securities laws. Based upon changing conditions, should any one or moreof the above risks or uncertainties materialize, or should any of ourunderlying beliefs or assumptions prove incorrect, actual results may varymaterially from those described in any forward-looking statement.

 

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References in thisForm 10-Q to “we,” “our,” “us” and other similar references are to theCompany, unless otherwise expressly stated or the context requires otherwise.

 

**ExecutiveSummary**

 

The Company’s netincome available to common shareholders for the first quarter of fiscal 2010was $855,000, or $0.21 in diluted earnings per common share, compared to $2.0million, or $0.49 in diluted earnings per common share, for the first quarterof fiscal 2009.  Return on common equity,based upon net income available to common shareholders divided by equity, was4.87% for the first three months of fiscal 2010 as compared to 12.12% in thecomparable period of the prior year.

 

Net interest income forthe first three months of fiscal 2010 was $8.8 million, an increase of $62,000,or 0.7%, over the same period a year ago. For the three months ended September 30, 2009, averageinterest-earning assets and average interest-bearing liabilities increased 4.0%and 2.2%, respectively, compared to the same period a year ago.  Yields on earning assets decreased to 5.33%in the first three months of fiscal 2010, compared to 5.99% a year ago, adecrease of 66 basis points.  For thesame period, interest-bearing cost of funds decreased to 2.42%, compared to3.01%, a decrease of 59 basis points.

 

The net interest marginon a fully taxable equivalent basis (“Net Interest Margin, TE”) for the threemonths ended September 30, 2009 was 3.24%, compared to 3.35% for the sameperiod a year ago, a decrease of 11 basis points. A sustained overall declinein the interest rate yield curve affected the yield for the interest-earningassets and the interest-bearing liabilities, while the average balances forthese categories increased over the prior year quarterly period.  Net Interest Margin, TE is a non-GAAPfinancial measure.  See “Analysis of NetInterest Income” for a calculation of this non-GAAP financial measure and forfurther discussion as to the reasons we believe this non-GAAP financial measureis useful.

 

The net interest marginratio may vary due to many factors, including Federal Reserve policies forshort-term interest rates, competitive and economic factors and customerpreferences for various products and services. In the second quarter of fiscal 2009, the Federal Reserve decreased theFed Funds Target Rate by a total of 175 basis points on three separateincrements, the first decrease in short-term interest rates since April 30,2008.

 

The allowance for loanand lease losses increased $33,000 to $8.5 million at September 30, 2009,compared to June 30, 2009.  Theratio of allowance for loan and lease losses to total loans and leases was0.99% as of September 30, 2009 compared to 0.98% at June 30,2009.  Total nonperforming assets at September 30,2009 were $13.8 million as compared to $12.6 million at June 30, 2009, anincrease of $1.2 million.  The ratio ofnonperforming assets to total assets increased to 1.18% at September 30,2009, compared to 1.07% at June 30, 2009. The allowance for loan and lease losses is calculated based on loan andlease levels, loan and lease loss history over 12, 36, and 60 month timeperiods, credit quality of the loan and lease portfolio, and environmentalfactors such as economic health of the region and management experience.  This risk rating analysis is designed to givethe Company a consistent and systematic methodology to determine proper levelsfor the allowance at a given time.

 

The Company held$10.0 million in trust preferred securities at September 30, 2009 that arecurrently impaired under applicable accounting rules.  These are comprised of pooled securitiesissued primarily by banks throughout the United States, and were downgraded byMoody’s during the 2009 fiscal year.  TheCompany performed analysis to determine if any of the securities had a creditloss by estimating if any of the cash flows are not expected to be received ascontracted.  Based upon the analysis, theCompany recognized total other-than-temporary impairment losses of $3.9 millionfor three trust preferred securities at September 30, 2009.  Thedifference between the present value of cash flows and the amortized cost basisfor each of the three securities was recorded as credit loss impairment andrecognized in earnings in the amount of $1.9 million. The amortized cost basisof the three securities was reduced by the amount of credit loss. The remainingimpairment amount related to other factors of $2.1 million was recognized inother comprehensive income, net of applicable taxes.

 

Total deposits at September 30,2009 were $830.2 million, a decrease of $7.6 million, or 0.9%, from June 30,2009.  During the three month period,public fund account balances decreased $33.3 million which are categorized inmultiple categories of deposits. In-market certificates of deposit increased a total of $23.4 millionfrom $401.3 million to $424.7 million for the three month period, due in partto customer preference for higher yielding term deposit products.  The primary factors affecting interestexpense was the decrease in the average rates paid on total deposits for thethree month period ended September 30, 2009 of 1.92% compared to 2.67% forthe three month period ended September 30, 2008.

 

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On October 26,2009, the Company announced it will pay a quarterly cash dividend of 11.25cents per common share for the first quarter of fiscal 2010.  The dividend will be paid on November 13,2009 to stockholders of record on November 6, 2009.

 

The total risk-basedcapital ratio of 11.27% at September 30, 2009, increased by 22 basispoints from 11.05% at June 30, 2009. This continues to place the Bank in the “well-capitalized” categorywithin OTS regulation at September 30, 2009 and is consistent with the “well-capitalized”OTS category in which the Company plans to operate.  The Company historically has been able tomanage the size of its assets through secondary market loan sales ofsingle-family mortgages and student loans.

 

Noninterestincome was $1.7 million for the quarter ended September 30, 2009 comparedto $3.0 million for the quarter ended September 30, 2008, a decrease of$1.4 million or 44.3%.  This decrease isdue primarily to net impairment credit losses recognized in earnings of $1.9million for the quarter ended September 30, 2009.   Net gain on sale of loans and net gain onsale of securities increased $245,000 and $453,000, respectively, to partiallyoffset the decrease for the comparable quarter.

 

Noninterestexpense was $8.9 million for the three months ended September 30, 2009 ascompared to $8.4 million for the three months ended September 30, 2008, anincrease of $546,000, or 6.5%.  Theincrease was primarily due to increases in healthcare costs included incompensation and employee benefits of $390,000, and from increased FDICinsurance premiums of $184,000.

 

The Bank is a member ofthe Deposit Insurance Fund (the “DIF”), which is administered by the FederalDeposit Insurance Corporation (“FDIC”). Deposits are insured up to the applicable limits by the FDIC and suchinsurance is backed by the full faith and credit of the United StatesGovernment.  As insurer, the FDIC imposesdeposit insurance premiums and is authorized to conduct examinations of and torequire reporting by FDIC-insured institutions. Recent bank failures have decreased the DIF to levels below its requiredreserve ratio.  In order to replenish theDIF, the FDIC has increased deposit insurance premiums to a level designed torestore the DIF to required levels within seven years, and the Company paid aone-time special assessment of $535,000 on September 30, 2009, based upondeposits at June 30, 2009.  Thisassessment was accrued in the fourth quarter of fiscal 2009.  On September 29,2009, the FDIC adopted a notice of proposed rulemaking which would requireprepayment of the quarterly assessments for the fourth quarter of calendar 2009,and the entire calendar years of 2010, 2011, and 2012 to be payable on December 30,2009.  The amount would be recorded as aprepaid asset and proportionally expensed over the periods.** **On November 12, 2009, the FDIC Boardapproved a rule requiring this prepayment. The amount estimated to be prepaid for the three years is approximately$4.5 million.  The FDIC may imposeadditional special assessments which would be recorded as they areincurred.  The FDIC also instituted theTransaction Account Guarantee Program (“TAGP”). The TAGP extended the FDIC’s insurance to full coverage of non-interestbearing transaction accounts for participating institutions through the end of2009 at an annualized rate of 10 basis points on deposit balances in excess ofthe $250,000 insurance limit currently in place.  The Bank is a participant in the TAGP, butdoes not expect this program to have a material impact on the FDICassessment.  The Bank had previously paidassessments under the Savings Association Insurance Fund (“SAIF”) and waseligible for certain credit against deposit insurance assessments when SAIF wasmerged into the DIF in 2005.  This credithad offset the majority of the Bank’s FDIC premium expense in past fiscalyears, but was fully utilized during the second quarter of fiscal 2009.  As a result of these factors, the Bank isanticipating an increase in deposit insurance premiums in the first threequarters of fiscal 2010 as compared to the same period of fiscal 2009.

 

**General**

 

The Company is afinancial services provider and, as such, has inherent risks that must bemanaged in order to achieve net income. Primary risks that affect net income include credit risk, liquidityrisk, operational risk, regulatory compliance risk and reputation risk.  The Company’s net income is derived bymanaging net interest margin, the ability to collect fees from servicesprovided, by controlling the costs of delivering services and the management ofloan and lease losses.  The primary sourceof revenues comes from the net interest margin, which represents the differencebetween income on interest-earning assets (i.e. loans and investmentsecurities) and expense on interest-bearing liabilities (i.e. deposits andborrowed funding).  The net interestmargin is affected by regulatory, economic and competitive factors thatinfluence interest rates, loan demand and deposit flows.  Fees earned include charges for depositservices, trust services and loan services. Personnel costs are the primary expenses required to deliver the servicesto customers.  Other costs includeoccupancy and equipment and general and administrative expenses.

 

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**Financial Condition Data**

 

At September 30,2009, the Company had total assets of $1.2 billion, and exhibited a decrease of$8.3 million from the level at June 30, 2009.  The decrease in assets in the first quarterof fiscal 2010 was due primarily to a net decrease in net loans and leasesreceivable of $17.5 million, and partially offset by an increase in loans heldfor sale of $7.9 million.  Totalliabilities decreased $10.1 million at September 30, 2009 as compared to June 30,2009.  This decrease was primarily due todecreases in deposits of $7.6 million and advances from the FHLB and otherborrowings of $5.6 million.  The decreasein liabilities was partially offset by an increase in stockholders’ equity of$1.8 million to $70.5 million at September 30, 2009 from $68.7 million at June 30,2009.  This increase was due primarily tothe net income available to common shareholders for the three months ended September 30,2009 of $855,000 and the net increase in accumulated other comprehensive(loss), net of related deferred tax effect, of $1.2 million.

 

The decrease in net loansand leases receivable of $17.5 million at September 30, 2009 as comparedto June 30, 2009, was primarily the result of decreases in commercialbusiness and real estate loans of $13.3 million and one-to four-family loans of$7.5 million.  These decreases werepartially offset by increases in agricultural loans of $5.8 million at September 30,2009 as compared to June 30, 2009. Loans held for sale increased $7.9 million at September 30, 2009,as compared to June 30, 2009, due primarily to seasonal fluctuation ofstudent loan activity and increased single family loan production activity.

 

Cash and cashequivalents increased $206,000 at September 30, 2009 as compared to June 30,2009.  See the Consolidated Statement ofCash Flows for an in-depth analysis in the change in cash and cash equivalentsfor the three months ended September 30, 2009.

 

Deposits decreased $7.6 million at September 30,2009 as compared to June 30, 2009 primarily due to a decrease in publicfunds of $33.3 million in multiple categories of deposits.  Public funds decreased from $182.5 million atJune 30, 2009 to $149.2 million at September 30, 2009, as a result ofseasonal fluctuations typical with these types of municipal deposits.  For the same period, in-market andout-of-market certificates of deposit increased $23.4 million and $4.8 million,respectively.  These increases wereoffset by decreases in money market accounts and savings accounts of $15.8million and $20.0 million, respectively, when compared to the totals at June 30,2009.

 

Advances from theFHLB and other borrowings decreased $5.6 million at September 30, 2009 ascompared to June 30, 2009. This decrease was primarily the result of a netdecrease in net loans and leases receivable of $9.6 million combined with anincrease in advances by borrowers for taxes and insurance of $4.1 million.   These changes increased the cash position by$13.7 million and were partially offset by a decrease in deposits of $7.6million, reducing the need for advances.

 

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The following tables showthe composition of the Company’s loan and lease portfolio and deposit accounts:

 

**Loanand Lease Portfolio Composition**

 
|                                     |   | **September 30, 2009**     | ** ** | **June 30, 2009** |       |
|------------------------------------------|--------|--------------------------------------|------------|-----------------------------|------------|
|                                     |   | **Amount**                           | ** ** | **Percent**                 | ** ** | **Amount** | ** ** | **Percent** |   |
|                                     |   | **(Dollars in Thousands)** |       |
|                                     |   |                                 |       |                        |       |   |   |   |   |
| One-to  four-family (1)                  |   | $                                    | 77,348     |                        | 9.28       | % | $ | 84,849 |   | 9.97 | % |
| Commercial  business and real estate (2) |   | 309,117                              |       | 37.07                       |       | 322,416 |   | 37.87 |   |
| Multi-family  real estate                |   | 48,016                               |       | 5.76                        |       | 48,342 |   | 5.68 |   |
| Equipment  finance leases                |   | 14,480                               |       | 1.74                        |       | 16,010 |   | 1.88 |   |
| Consumer  direct (3)                     |   | 119,184                              |       | 14.29                       |       | 116,777 |   | 13.72 |   |
| Consumer  indirect (4)                   |   | 17,307                               |       | 2.07                        |       | 21,394 |   | 2.51 |   |
| Agricultural                             |   | 237,121                              |       | 28.44                       |       | 231,315 |   | 27.17 |   |
| Construction                             |   | 11,251                               |       | 1.35                        |       | 10,179 |   | 1.20 |   |
| Total  loans and leases receivable (5)   |   | $                                    | 833,824    |                        | 100.00     | % | $ | 851,282 |   | 100.00 | % |

 

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(1) Excludes$13,775 and $8,888 loans held for sale at September 30, 2009 and June 30,2009, respectively.

(2) Includes$2,810 and $2,810 tax exempt leases at September 30, 2009 and June 30,2009, respectively.

(3) Excludes $9,017and $5,993 student loans held for sale at September 30, 2009 and June 30,2009, respectively.

(4) TheCompany announced Consumer Indirect originations ceased during the firstquarter of Fiscal 2008.

(5) Includesdeferred loan fees and discounts.

 

**DepositComposition**

 
| ** **                             | ** ** | **September 30, 2009**     | ** ** | **June 30, 2009** | ** ** |
|----------------------------------------|------------|--------------------------------------|------------|-----------------------------|------------|
| ** **                             | ** ** | **Amount**                           | ** ** | **Percent**                 | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| ** **                             | ** ** | **(Dollars in Thousands)** | ** ** |
|                                   |       |                                 |       |                        |       |   |   |   |   |
| Noninterest  bearing checking accounts |       | $                                    | 99,645     |                        | 12.00      | % | $ | 94,067 |   | 11.23 | % |
| Interest  bearing checking accounts    |       | 89,321                               |       | 10.76                       |       | 94,846 |   | 11.32 |   |
| Money  market accounts                 |       | 129,382                              |       | 15.58                       |       | 145,214 |   | 17.33 |   |
| Savings  accounts                      |       | 61,394                               |       | 7.40                        |       | 81,417 |   | 9.72 |   |
| In-market  certificates of deposit     |       | 424,664                              |       | 51.15                       |       | 401,291 |   | 47.89 |   |
| Out-of-market  certificates of deposit |       | 25,835                               |       | 3.11                        |       | 21,033 |   | 2.51 |   |
| Total  deposits                        |       | $                                    | 830,241    |                        | 100.00     | % | $ | 837,868 |   | 100.00 | % |

 

**Analysis of Net Interest Income**

 

Net interestincome represents the difference between income on interest-earning assets andexpense on interest-bearing liabilities. Net interest income depends upon the volume of interest-earning assetsand interest-bearing liabilities and the interest rates earned or paid on them.

 

*AverageBalances, Interest Rates and Yields.*  The followingtable presents for the periods indicated, the total dollar amount of interestincome from average interest-earning assets and the resulting yields, as wellas the interest expense on average interest-bearing liabilities, expressed bothin dollars and rates, and the net interest margin.  The table does not reflect any effect ofincome taxes, except where noted. Average balances consist of daily average balances for the Bank withsimple average balances for all other subsidiaries of the Company.  The average balances include nonaccruingloans and leases.  The yields on loansand leases include origination fees, net of costs, which are consideredadjustments to yield.

 

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| ** **                                     | ** ** | **Three Months Ended September 30,** | ** ** |
|------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                     | ** ** | **2009**                                  | ** ** | **2008** | ** ** |
| ** **                                     | ** ** | **Average**                               | ** ** | **Interest** | ** ** | ** ** | ** ** | **Average** | ** ** | **Interest** | ** ** | ** ** | ** ** |
| ** **                                     | ** ** | **Outstanding**                           | ** ** | **Earned/** | ** ** | **Yield/** | ** ** | **Outstanding** | ** ** | **Earned/** | ** ** | **Yield/** | ** ** |
| ** **                                     | ** ** | **Balance**                               | ** ** | **Paid** | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Paid** | ** ** | **Rate** | ** ** |
| ** **                                     | ** ** | **(Dollars in Thousands)**                | ** ** |
| Interest-earning  assets:                      |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Loans  and leases receivable (1) (3)      |       | $                                         | 851,419    |   | $ | 12,343 |   | 5.75 | % | $ | 805,722 |   | $ | 13,018 |   | 6.41 | % |
| Investment  securities (2) (3)            |       | 225,312                                   |       | 2,228 |   | 3.92 | % | 229,928 |   | 2,692 |   | 4.65 | % |
| FHLB  stock                                    |       | 12,476                                    |       | 62 |   | 1.97 | % | 12,090 |   | 121 |   | 3.97 | % |
|                                           |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Total  interest-earning assets                 |       | 1,089,207                                 |       | $ | 14,633 |   | 5.33 | % | 1,047,740 |   | $ | 15,831 |   | 5.99 | % |
| Noninterest-earning  assets                    |       | 71,444                                    |       |   |   |   |   | 66,263 |   |   |   |   |   |
| Total  assets                                  |       | $                                         | 1,160,651  |   |   |   |   |   | $ | 1,114,003 |   |   |   |   |   |
|                                           |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:                 |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Deposits:                                      |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Checking  and money market                     |       | $                                         | 228,639    |   | $ | 324 |   | 0.56 | % | $ | 246,147 |   | $ | 858 |   | 1.38 | % |
| Savings                                        |       | 66,592                                    |       | 62 |   | 0.37 | % | 70,538 |   | 261 |   | 1.47 | % |
| Certificates  of deposit                       |       | 432,573                                   |       | 3,138 |   | 2.88 | % | 364,434 |   | 3,458 |   | 3.76 | % |
| Total  interest-bearing deposits               |       | 727,804                                   |       | 3,524 |   | 1.92 | % | 681,119 |   | 4,577 |   | 2.67 | % |
| FHLB  advances and other borrowings            |       | 207,028                                   |       | 1,899 |   | 3.64 | % | 232,636 |   | 2,109 |   | 3.60 | % |
| Subordinated  debentures payable to trusts     |       | 27,837                                    |       | 459 |   | 6.54 | % | 27,837 |   | 456 |   | 6.50 | % |
|                                           |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Total  interest-bearing liabilities            |       | 962,669                                   |       | 5,882 |   | 2.42 | % | 941,592 |   | 7,142 |   | 3.01 | % |
| Noninterest-bearing  deposits                  |       | 98,213                                    |       |   |   |   |   | 78,730 |   |   |   |   |   |
| Other  liabilities                             |       | 30,143                                    |       |   |   |   |   | 29,041 |   |   |   |   |   |
| Total  liabilities                             |       | 1,091,025                                 |       |   |   |   |   | 1,049,363 |   |   |   |   |   |
| Equity                                         |       | 69,626                                    |       |   |   |   |   | 64,640 |   |   |   |   |   |
| Total  liabilities and equity                  |       | $                                         | 1,160,651  |   |   |   |   |   | $ | 1,114,003 |   |   |   |   |   |
|                                           |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Net  interest income; interest rate spread (4) |       |                                      |       | $ | 8,751 |   | 2.91 | % |   |   | $ | 8,689 |   | 2.98 | % |
|                                           |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Net  interest margin (4) (5)              |       |                                      |       |   |   | 3.19 | % |   |   |   |   | 3.29 | % |
|                                           |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Net  interest margin, TE (6)                   |       |                                      |       |   |   | 3.24 | % |   |   |   |   | 3.35 | % |

 

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(1)  Includesloan fees and interest on accruing loans and leases past due 90 days or more.

(2)  Includesfederal funds sold.

(3)  Yieldsdo not reflect the tax-exempt nature of loans, equipment leases and municipalsecurities.

(4)  Percentages forthe three months ended September 30, 2009 and September 30, 2008 havebeen annualized.

(5)  Netinterest income divided by average interest-earning assets.

(6)  Net interest margin expressed on a fullytaxable equivalent basis (“Net Interest Margin, TE”) is a non-GAAP financialmeasure.  The tax-equivalent adjustmentto net interest income recognizes the income tax savings when comparing taxableand tax-exempt assets and adjusting for federal and state exemption of interestincome and certain other permanent income tax differences.  We believe that it is a standard practice inthe banking industry to present net interest margin expressed on a fullytaxable equivalent basis, and accordingly believe industry to present netinterest margin expressed on a fully taxable equivalent basis, and accordinglybelieves the presentation of this non-GAAP financial measure may be useful forpeer comparison purposes.  As a non-GAAPfinancial measure, Net Interest Margin, TE should be considered supplemental toand not a substitute for or superior to, financial measures calculated inaccordance with GAAP.  As other companiesmay use different calculations for Net Interest Margin, TE, this presentationmay not be comparable to similarly titled measures reported by other companies.

 

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Thereconciliation of the net interest income (GAAP) to Net Interest Margin, TE(non-GAAP) is as follows:

** **
| ** **                       | ** ** | **Three Months Ended September 30,** | ** ** |
|----------------------------------|------------|-------------------------------------------|------------|
| ** **                       | ** ** | **2009**                                  | ** ** | **2008** | ** ** |
|                             |       |                                      |       |   |   |
| Net  interest income             |       | $                                         | 8,751      |   | $ | 8,689 |   |
| Taxable  equivalent adjustment   |       | 145                                       |       | 154 |   |
| Adjusted  net interest income    |       | 8,896                                     |       | 8,843 |   |
| Average  interest-earning assets |       | 1,089,207                                 |       | 1,047,740 |   |
| Net  Interest Margin, TE         |       | 3.24                                      | %          | 3.35 | % |
|                                  |            |                                           |            |  |  |  |  |

 

**Rate/VolumeAnalysis of Net Interest Income**

 

The following schedulepresents the dollar amount of changes in interest income and interest expensefor major components of interest-earning assets and interest-bearingliabilities.  It distinguishes betweenthe increases and decreases due to fluctuating outstanding balances due to thelevels and volatility of interest rates. For each category of interest-earning assets and interest-bearingliabilities, information is provided on changes attributable to (i) changesin volume (i.e., changes in volume multiplied by old rate) and (ii) changesin rate (i.e., changes in rate multiplied by old volume).

 

For purposes of thistable, changes attributable to both rate and volume, which cannot besegregated, have been allocated proportionately to the change due to volume andthe change due to rate.

 
| ** **                                 | ** ** | **Three Months Ended September 30,** | ** ** |
|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                 | ** ** | **2009 vs 2008**                          | ** ** |
| ** **                                 | ** ** | **Increase**                              | ** ** | **Increase** | ** ** | ** ** | ** ** |
| ** **                                 | ** ** | **(Decrease)**                            | ** ** | **(Decrease)** | ** ** | **Total** | ** ** |
| ** **                                 | ** ** | **Due to**                                | ** ** | **Due to** | ** ** | **Increase** | ** ** |
| ** **                                 | ** ** | **Volume**                                | ** ** | **Rate** | ** ** | **(Decrease)** | ** ** |
| ** **                                 | ** ** | **(Dollars in Thousands)**                | ** ** |
| Interest-earning  assets:                  |       |                                      |       |   |   |   |   |
| Loans  and leases receivable (1)           |       | $                                         | 739        |   | $ | (1,414 | ) | $ | (675 | ) |
| Investment  securities (2)                 |       | (53                                       | )          | (411 | ) | (464 | ) |
| FHLB  stock                                |       | 4                                         |       | (63 | ) | (59 | ) |
|                                       |       |                                      |       |   |   |   |   |
| Total  interest-earning assets             |       | 690                                       |       | (1,888 | ) | (1,198 | ) |
|                                       |       |                                      |       |   |   |   |   |
| Interest-bearing  liabilities:             |       |                                      |       |   |   |   |   |
| Deposits:                                  |       |                                      |       |   |   |   |   |
| Checking  and money market                 |       | (61                                       | )          | (473 | ) | (534 | ) |
| Savings                                    |       | (15                                       | )          | (184 | ) | (199 | ) |
| Certificates  of deposit                   |       | 643                                       |       | (963 | ) | (320 | ) |
| Total  interest-bearing deposits           |       | 567                                       |       | (1,620 | ) | (1,053 | ) |
| FHLB  advances and other borrowings        |       | (231                                      | )          | 21 |   | (210 | ) |
| Subordinated  debentures payable to trusts |       | —                                    |       | 3 |   | 3 |   |
|                                       |       |                                      |       |   |   |   |   |
| Total  interest-bearing liabilities        |       | 336                                       |       | (1,596 | ) | (1,260 | ) |
|                                       |       |                                      |       |   |   |   |   |
| Net  interest income increase              |       | $                                         | 354        |   | $ | (292 | ) | $ | 62 |   |

 

----

(1)  Includes loanfees and interest on accruing loans and leases past due 90 days or more.

(2)  Includesfederal funds sold.

 

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**Applicationof Critical Accounting Policies**

 

GAAP requires management to utilize estimates whenreporting financial results.  The Companyhas identified the policies discussed below as Critical Accounting Policiesbecause the accounting estimates require management to make certain assumptionsabout matters which may be uncertain at the time the estimate was made and adifferent method of estimating could have been reasonably made which could havea material impact on the presentation of the Company’s financial condition,changes in financial condition or results of operations.

 

*Allowance for Loan and Lease Losses.* GAAP requires the Company to set asidereserves or maintain an allowance against probable loan and lease losses in theloan and lease portfolio.  Managementmust develop a consistent and systematic approach to estimate the appropriatebalances to cover the probable losses. Due to the uncertainty of future events, the approach includes a processthat may differ significantly from other methodologies and still produce anestimate in accordance with GAAP.

 

The allowance is compiledby utilizing the Company’s loan and lease risk rating system, which is structuredto identify weaknesses in the loan and lease portfolio.  The risk rating system has evolved to aprocess whereby management believes the system will properly identify thecredit risk associated with the loan and lease portfolio.  Due to the stratification of loans and leasesfor the allowance calculation, the estimate of the allowance for loan and leaselosses could change materially if the loan and lease risk rating system wouldnot properly identify the strength of a large or a few large loan and leasecustomers.  Although management believesit uses the best information available to determine the allowance, unforeseenmarket or borrower conditions could result in adjustments and net earningsbeing significantly affected if circumstances differ substantially from theassumptions used in making the final determinations.

 

*MortgageServicing Rights (“MSR”)*.  The Company records aservicing asset for contractually separated servicing from the underlyingmortgage loans.   The asset is initiallyrecorded at fair value and represents an intangible asset backed by an incomestream from the serviced assets.  Theasset is amortized in proportion to and over the period of estimated netservicing income.

 

At each balance sheetdate, the MSRs are analyzed for impairment, which occurs when the fair value ofthe MSRs is lower than the amortized book value. The Company’s MSRs areprimarily servicing rights acquired on South Dakota Housing DevelopmentAuthority first time homebuyers program. Due to the lack of quoted markets for the Company’s servicing portfolio,the Company estimates the fair value of the MSRs using present value of futurecash flow analysis.  If the analysisproduces a fair value greater than or equal to the amortized book value of theMSRs, no impairment is recognized.  Ifthe fair value is less than the book value, an expense for the difference ischarged to earnings by initiating a MSR valuation account.  If the Company determines this impairment istemporary, any future changes in fair value are recorded as a change inearnings and the valuation.  If theCompany determines the impairment to be permanent, the valuation is written offagainst the MSRs, which results in a new amortized balance.

 

The Company has includedMSRs as a critical accounting policy because the use of estimates fordetermining fair value using present value concepts may produce results whichmay significantly differ from other fair value analysis perhaps even to thepoint of recording impairment.  The riskto earnings is when the underlying mortgages pay off significantly faster thanthe assumptions used in the previously recorded amortization.  Estimating future cash flows on theunderlying mortgages is a difficult analysis and requires judgment based on thebest information available.  The Companylooks at alternative assumptions and projections when preparing a reasonableand supportable analysis.  Based on theCompany’s quarterly analysis of MSRs, there was no impairment to the MSRs at September 30,2009.

 

*SecurityImpairment*.  Managementcontinually monitors the investment security portfolio for impairment on asecurity by security basis.  During thethird quarter of fiscal 2009, the Company early adopted FASB Staff Position (“FSP”)No. FAS 115-2(ASC Subtopic 320-10), *TheRecognition and Presentation of Other-Than-Temporary Impairments*,which changed the recognition and presentation of other-than-temporaryimpairment for securities.  Managementhas a process in place to identify securities that could potentially have acredit impairment that is other than temporary. This process involves the length of time and extent to which the fairvalue has been less than the amortized cost basis, review of availableinformation regarding the financial position of the issuer, monitoring the ratingof the security, cash flow projections, and the Company’s intent to sell asecurity or whether it is more likely than not the Company will be required tosell the security before the recovery of its amortized cost which, in somecases, may extend to maturity.  To theextent we determine that a security is deemed to be other-than-temporarilyimpaired, an impairment loss is recognized. If the Company intends to sell a security or it is more likely than notthat the Company would be required to sell a security before the recovery ofits amortized cost, less any current period credit loss, the Company recognizesan other-than-temporary impairment in earnings for the difference betweenamortized cost and fair value.  If we donot expect to recover the amortized cost basis, we do not plan to sell thesecurity and if it is not more likely than not that the Company would berequired to sell a security before the recovery of it amortized cost, less anycurrent period credit loss, the recognition of the other-than-temporaryimpairment is bifurcated.  For thosesecurities, the Company separates the total impairment into a credit losscomponent recognized in earnings, and the amount of the loss related to otherfactors is recognized in other comprehensive income net of taxes.

 

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Theamount of the credit loss component of a debt security impairment is estimatedas the difference between amortized cost and the present value of the expectedcash flows of the security.  The presentvalue is determined using the best estimate cash flows discounted at theeffective interest rate implicit to the security at the date of purchase or thecurrent yield to accrete an asset-backed or floating rate security.  Cash flow estimates for trust preferredsecurities are derived from scenario-based outcomes of forecasted defaultrates, loss severity, prepayment speeds and structural support.

 

*Level 3Fair Value Measurement.*  GAAP requires the Company tomeasure the fair value of financial instruments under a standard whichdescribes three levels of inputs that may be used to measure fair value.Level 3 measurement includes significant unobservable inputs that reflectthe Company’s own assumptions about the assumptions that market participantswould use in pricing an asset or liability. Level 3 assets and liabilitiesinclude financial instruments whose value is determined using pricing models,discounted cash flow methodologies, or similar techniques, as well asinstruments for which the determination of fair value requires significantmanagement judgment or estimation. Although management believes that it uses abest estimate of information available to determine fair value, due to theuncertainty of future events, the approach includes a process that may differsignificantly from other methodologies and still produce an estimate that is inaccordance with GAAP.

 

*Self-Insurance*. The Company has a self-insured healthcare plan for its employees up tocertain limits.  To mitigate a portion ofthese risks, the Company has a stop-loss insurance policy through a commercialinsurance carrier for coverage in excess of $65,000 per individual occurrencewith no maximum aggregate limitation. The estimate of self-insurance liability is based upon known claims andan estimate of incurred, but not reported (“IBNR”) claims.  IBNR claims are estimated using historicalclaims lag information received by a third party claims administrator.  Due to the uncertainty of health claims, theapproach includes a process which may differ significantly from othermethodologies and still produce an estimate in accordance with GAAP.  Although management believes it uses the bestinformation available to determine the accrual, unforeseen health claims couldresult in adjustments to the accrual. These adjustments could significantly affect net earnings ifcircumstances differ substantially from the assumptions used in estimating the accrual.

 

**AssetQuality and Potential Problem Loans and Leases**

 

Nonperforming assets(nonaccrual loans and leases, accruing loans and leases delinquent more than 90days and foreclosed assets) increased to $13.8 million at September 30,2009 from $12.6 million at June 30, 2009, an increase of $1.2 million, or9.8%.  The nonperforming asset figureswere significantly affected by one agricultural relationship which increasedthe amount of nonaccruing loans and leases at June 30, 2009.  Nonaccruing loans and leases decreased$733,000 from June 30, 2009 to September 30, 2009, to a total of $8.6million.  Accruing loans and leasesdelinquent more than 90 days increased $1.7 million to $3.8 million at September 30,2009 from $2.1 million at June 30, 2009, primarily attributable to onecredit relationship.  Foreclosed assetsincreased $231,000 to $1.3 million at September 30, 2009, from $1.1million at June 30, 2009.  Inaddition, the ratio of nonperforming assets to total assets, which is oneindicator of credit risk exposure, was 1.18% at September 30, 2009, whichis an increase from 1.07% as reported at June 30, 2009.

 

Nonaccruing loans andleases decreased $733,000 to $8.6 million at September 30, 2009 comparedto $9.4 million at June 30, 2009. One agricultural relationship comprised most of the total nonaccruingloans and leases.  It consists of oneloan totaling $32,000 secured by one- to four-family real estate, one loantotaling $740,000 secured by agricultural real estate, and four loans totaling$5.7 million secured by agricultural business assets.  The remaining loans and leases included innonaccruing loans and leases at September 30, 2009 were 10 loans totaling$398,000 secured by one- to four-family real estate, two loans totaling$177,000 secured by commercial real estate, eight loans totaling $454,000secured by commercial business assets, one agricultural business loan totaling$11,000, 26 leases totaling $759,000 secured by equipment, and 26 loanstotaling $389,000 secured by consumer assets.

 

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Accruing loans and leasesdelinquent more than 90 days increased 83.0% or $1.7 million, to $3.8 millionat September 30, 2009 compared to $2.1 million at June 30, 2009.  Included in accruing loans and leasesdelinquent more than 90 days at September 30, 2009 were two loans totaling$192,000 secured by commercial real estate, six loans totaling $751,000 securedby agricultural real estate, seven loans totaling $1.9 million secured bycommercial business assets, five loans totaling $513,000 secured byagricultural business assets, eight leases totaling $426,000 secured byequipment and seven loans totaling $50,000 unsecured overdraft and reserveaccounts.

 

The risk rating system inplace is designed to identify and manage the nonperforming loans andleases.  Commercial and agriculturalloans and equipment finance leases will have specific reserve allocations basedon collateral values or based on the present value of expected cash flows ifthe loans and leases are deemed impaired. Loans and leases that are not performing do not necessarily result in aloss.

 

As of September 30,2009, foreclosed assets increased by $231,000, or 21.3%, to $1.3 million ascompared to $1.1 million at June 30, 2009. The balance at September 30, 2009 consisted of $529,000 of one- tofour-family collateral owned, $226,000 of leased equipment owned, $482,000 ofagricultural collateral owned, and $79,000 of consumer collateral owned.

 

At September 30,2009, the Company had designated $25.8 million of its assets as special mentionand $20.3 million of its assets as classified that management has determinedneed to be closely monitored because of possible credit problems of theborrowers or the cash flows of the secured properties.  The Company also classified $10.0 million oftrust preferred securities in accordance with OTS debt security classificationguidelines.  At September 30, 2009the Company had $13.3 million in multi-family, commercial business, commercialreal estate and agricultural participation loans purchased, of which $1.6million were classified.  These loans andleases were considered in determining the adequacy of the allowance for loan andlease losses.  The allowance for loan andlease losses is established based on management’s evaluation of the risksprobable in the loan and lease portfolio and changes in the nature and volumeof loan and lease activity.  Suchevaluation, which includes a review of all loans and leases for which fullcollectability may not be reasonably assured, considers the estimated fairmarket value of the underlying collateral, present value of expected principaland interest payments, economic conditions, historical loss experience andother factors that warrant recognition in providing for an adequate loan andlease loss allowance.

 

Although the Company’s management believes the September 30,2009 recorded allowance for loan and lease losses was adequate to provide forprobable losses on the related loans and leases, there can be no assurance theallowance existing at September 30, 2009 will be adequate in the future.

 

In accordance with the Company’s internalclassification of assets policy, management evaluates the loan and leaseportfolio on a monthly basis to identify loss potential and determines theadequacy of the allowance for loan and lease losses quarterly.  Loans and leases are placed on nonaccrualstatus when the collection of principal and/or interest becomes doubtful.  Foreclosed assets include assets acquired insettlement of loans and leases.

 

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The following table sets forth the amounts andcategories of the Company’s nonperforming assets for the periods indicated.

 
| ** **                                                                      | ** ** | **Nonperforming Assets**    | ** ** |
|---------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                      | ** ** | **September 30, 2009** | ** ** | **June 30, 2009** | ** ** |
| ** **                                                                      | ** ** | **(Dollars in Thousands)**  |
| Nonaccruing  loans and leases:                                                  |       |                        |       |   |   |
| One-  to four-family                                                            |       | $                           | 430        |   | $ | 977 |   |
| Commercial  real estate                                                         |       | 177                         |       | 177 |   |
| Commercial  business                                                            |       | 454                         |       | 405 |   |
| Equipment  finance leases                                                       |       | 759                         |       | 272 |   |
| Consumer                                                                        |       | 389                         |       | 355 |   |
| Agricultural                                                                    |       | 6,439                       |       | 7,195 |   |
| Total                                                                           |       | 8,648                       |       | 9,381 |   |
|                                                                            |       |                        |       |   |   |
| Accruing  loans and leases delinquent more than 90 days:                        |       |                        |       |   |   |
| Commercial  real estate                                                         |       | 192                         |       | 277 |   |
| Commercial  business                                                            |       | 1,896                       |       | 349 |   |
| Equipment  finance leases                                                       |       | 426                         |       | 264 |   |
| Consumer                                                                        |       | 50                          |       | 8 |   |
| Agricultural                                                                    |       | 1,264                       |       | 1,194 |   |
| Total                                                                           |       | 3,828                       |       | 2,092 |   |
|                                                                            |       |                        |       |   |   |
| Foreclosed  assets:                                                             |       |                        |       |   |   |
| One-  to four-family                                                            |       | 529                         |       | 406 |   |
| Equipment  finance leases                                                       |       | 226                         |       | 105 |   |
| Consumer                                                                        |       | 79                          |       | 92 |   |
| Agricultural                                                                    |       | 482                         |       | 482 |   |
| Total  (1)                                                                      |       | 1,316                       |       | 1,085 |   |
|                                                                            |       |                        |       |   |   |
| Total  nonperforming assets (2)                                                 |       | $                           | 13,792     |   | $ | 12,558 |   |
|                                                                            |       |                        |       |   |   |
| Ratio  of nonperforming assets to total assets (3)                              |       | 1.18                        | %          | 1.07 | % |
|                                                                            |       |                        |       |   |   |
| Ratio  of nonperforming loans and leases to total loans and leases (4) (5) |       | 1.46                        | %          |  1.32 | % |

 

----

(1)  Total foreclosed assets do not include landor other real estate owned held for sale.

(2)  Nonperforming assets include nonaccruingloans and leases, accruing loans and leases delinquent more than 90 days andforeclosed assets.

(3)  Percentage is calculated based upon totalassets of the Company and its direct and indirect subsidiaries on aconsolidated basis.

(4)  Nonperforming loans and leases include bothnonaccruing and accruing loans and leases delinquent more than 90 days.

(5)  Totalloans and leases include loans held for sale.

 

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The following tablesets forth information with respect to activity in the Company’s allowance forloan and lease losses during the periods indicated.

 
| ** **                                                                                                 | ** ** | **Three Months Ended September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                 | ** ** | **2009**                                  | ** ** | **2008** | ** ** |
| ** **                                                                                                 | ** ** | **(Dollars in Thousands)**                | ** ** |
|                                                                                                       |       |                                      |       |   |   |
| Balance  at beginning of period                                                                            |       | $                                         | 8,470      |   | $ | 5,933 |   |
| Charge-offs:                                                                                               |       |                                      |       |   |   |
| One-  to four-family                                                                                       |       | (83                                       | )          | (1 | ) |
| Commercial  real estate                                                                                    |       | (4                                        | )          | — |   |
| Commercial  business                                                                                       |       | (5                                        | )          | — |   |
| Equipment  finance leases                                                                                  |       | (113                                      | )          | — |   |
| Consumer                                                                                                   |       | (150                                      | )          | (191 | ) |
| Total  charge-offs                                                                                         |       | (355                                      | )          | (192 | ) |
|                                                                                                       |       |                                      |       |   |   |
| Recoveries:                                                                                                |       |                                      |       |   |   |
| One-  to four-family                                                                                       |       | 3                                         |       | 2 |   |
| Commercial  business                                                                                       |       | —                                    |       | 1 |   |
| Consumer                                                                                                   |       | 42                                        |       | 52 |   |
| Total  recoveries                                                                                          |       | 45                                        |       | 55 |   |
|                                                                                                       |       |                                      |       |   |   |
| Net  recoveries (charge-offs)                                                                              |       | (310                                      | )          | (137 | ) |
|                                                                                                       |       |                                      |       |   |   |
| Additions  charged to operations                                                                           |       | 343                                       |       | 387 |   |
|                                                                                                       |       |                                      |       |   |   |
| Balance  at end of period                                                                                  |       | $                                         | 8,503      |   | $ | 6,183 |   |
|                                                                                                       |       |                                      |       |   |   |
| Ratio  of allowance for loan and lease losses to total loans and leases at end of  period (1)         |       | 0.99                                      | %          | 0.76 | % |
|                                                                                                       |       |                                      |       |   |   |
| Ratio  of allowance for loan and lease losses to nonperforming loans and leases at  end of period (2) |       | 68.15                                     | %          | 205.48 | % |
|                                                                                                       |       |                                      |       |   |   |
| Ratio  of net charge offs to average loans and leases for the year-to-date period (3)                 |       | 0.14                                      | %          | 0.07 | % |

 

----

(1)  Totalloans and leases include loans held for sale.

(2) Nonperforming loans and leases include both nonaccruing and accruing loans andleases delinquent more than 90 days.

(3) Percentages for the three months ended September 30, 2009 and September 30,2008 have been annualized.

 

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The distribution of the Company’s allowance for loanand lease losses and impaired loss summary as required by FASB Statement No. 114(ASC Topic 310), “Accounting by Creditors for Impairment of a Loan” aresummarized in the following tables.  Thecombination of FASB Statement No. 5 (ASC Topic 450) “Accounting forContingencies” and FASB Statement No. 114 calculations comprise theCompany’s allowance for loan and lease losses.

 
| ** **                | ** ** | **FAS 5**                            | ** ** | **FAS 114**                 | ** ** | **FAS 5**             | ** ** | **FAS 114**       | ** ** |
|---------------------------|------------|--------------------------------------|------------|-----------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                | ** ** | **Allowance**                        | ** ** | **Impaired Loan**           | ** ** | **Allowance**         | ** ** | **Impaired Loan** | ** ** |
| ** **                | ** ** | **for Loan and**                     | ** ** | **Valuation**               | ** ** | **for Loan and**      | ** ** | **Valuation**     | ** ** |
| ** **                | ** ** | **Lease Losses**                | ** ** | **Allowance**               | ** ** | **Lease Losses** | ** ** | **Allowance**     | ** ** |
| **Loan Type**        | ** ** | **September 30, 2009**     | ** ** | **June 30, 2009** | ** ** |
| ** **                | ** ** | **(Dollars in Thousands)** | ** ** |
|                      |       |                                 |       |                        |       |                  |       |              |       |
| One-  to four-family      |       | $                                    | 383        |                        | $          | —                |       | $                 | 416        |   | $ | — |   |
| Commercial  real estate   |       | 1,093                                |       | 15                          |       | 1,110                 |       | —            |       |
| Multi-family  real estate |       | 193                                  |       | —                      |       | 192                   |       | —            |       |
| Commercial  business      |       | 1,957                                |       | 163                         |       | 2,136                 |       | 153               |       |
| Equipment  finance leases |       | 384                                  |       | —                      |       | 409                   |       | —            |       |
| Consumer                  |       | 1,386                                |       | —                      |       | 1,280                 |       | —            |       |
| Agricultural              |       | 2,879                                |       | 50                          |       | 2,724                 |       | 50                |       |
| Total                     |       | $                                    | 8,275      |                        | $          | 228                   |       | $                 | 8,267      |   | $ | 203 |   |

 

**FAS 114 Impaired Loan Summary**

 
| ** **              | ** ** | ** **                  | ** ** | ** **             | ** ** | **Impaired**  | ** ** | ** **    | ** ** | ** **  | ** ** | **Impaired**  | ** ** |
|-------------------------|------------|-----------------------------|------------|------------------------|------------|---------------|------------|---------------|------------|-------------|------------|---------------|------------|
| ** **              | ** ** | **Number**                  | ** ** | ** **             | ** ** | **Loan**      | ** ** | **Number**    | ** ** | ** **  | ** ** | **Loan**      | ** ** |
| ** **              | ** ** | **of Loan**                 | ** ** | **Loan**               | ** ** | **Valuation** | ** ** | **of Loan**   | ** ** | **Loan**    | ** ** | **Valuation** | ** ** |
| ** **              | ** ** | **Customers**               | ** ** | **Balance**            | ** ** | **Allowance** | ** ** | **Customers** | ** ** | **Balance** | ** ** | **Allowance** | ** ** |
| **Loan Type**           | ** ** | **September 30, 2009** | ** ** | **June 30, 2009** | ** ** |
| ** **              | ** ** | **(Dollars in Thousands)**  | ** ** |
|                    |       |                        |       |                   |       |          |       |          |       |        |       |          |       |
| Commercial  real estate |       | 3                           |       | $                      | 192        |          | 15         |          | 3          |        | 177        |          | $          | — |   |
| Commercial  business    |       | 6                           |       | 432                    |       | 163           |       | 4             |       | 453         |       | 153           |       |
| Agricultural            |       | 4                           |       | 7,695                  |       | 50            |       | 2             |       | 7,997       |       | 50            |       |
| Total                   |       | 13                          |       | $                      | 8,319      |          | $          | 228           |       | 9           |       | $             | 8,627      |   | $ | 203 |   |
|                         |            |                             |            |                        |            |               |            |               |            |             |            |               |            |  |  |  |  |

 

The allowance for loanand lease losses was $8.5 million at September 30, 2009, as compared to$6.2 million at September 30, 2008. The ratio of the allowance for loan and lease losses to total loans andleases was 0.99% at September 30, 2009, compared to 0.76% at September 30,2008.  The Company’s management hasconsidered nonperforming loans and leases and potential problem loans andleases in establishing the allowance for loan and lease losses.  The Company continues to monitor itsallowance for probable loan and lease losses and make future additions orreductions in light of the level of loans and leases in its portfolio and aseconomic conditions dictate.  Thecurrent level of the allowance for loan and lease losses is a result ofmanagement’s assessment of the risks within the portfolio based on theinformation revealed in credit reporting processes. The Company utilizes arisk-rating system on all commercial business, agricultural, construction andmulti-family and commercial real estate loans, including purchased loans andleases.  A periodic credit review isperformed on all types of loans and leases to establish the necessary reservebased on the estimated risk within the portfolio. This assessment of risk takesinto account the composition of the loan and lease portfolio, historical lossexperience for each loan and lease category, previous loan and leaseexperience, concentrations of credit, current economic conditions and otherfactors that in management’s judgment deserve recognition.

 

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Real estate propertiesacquired through foreclosure are recorded at the lower of cost or fair value(less a deduction for disposition costs). Valuations are periodically updated by management and a specificprovision for losses on such properties is established by a charge tooperations if the carrying values of the properties exceed their estimated netrealizable values.

 

Althoughmanagement believes it uses the best information available to determine theallowances, unforeseen market conditions could result in adjustments and netearnings being significantly affected if circumstances differ substantiallyfrom the assumptions used in making the final determinations.  Future additions to the Company’s allowancesmay result from periodic loan, property or collateral reviews which cannot bepredicted in advance.

 

**Comparison of the Three MonthsEnded September 30, 2009, and September 30, 2008**

* *

*General*.  The Company’snet income available to common shareholders was $855,000, or $0.21 in basic and$0.21 in diluted earnings per common share for the three months ended September 30,2009, a $1.1 million decrease in earnings available to common shareholderscompared to $2.0 million, or $0.50 in basic and $0.49 in diluted earnings percommon share for the same period in the prior fiscal year.  For the three months ended September 30,2009, the return on average equity and the return on average assets were 4.87%and 0.29%, respectively, compared to 12.12% and 0.70%, respectively, for thesame period in the prior fiscal year.  Asdiscussed in more detail below, the decrease to earnings was due primarily tothe recording of net impairment credit losses of $1.9 million for the firstquarter of fiscal 2010.

 

*Interest, Dividend and Loan Fee Income.* Interest, dividend and loan fee income was $14.6 million for the threemonths ended September 30, 2009 as compared to $15.8 million for the sameperiod in the prior fiscal year, a decrease of $1.2 million or 7.6%.  This decrease was primarily the result ofdeclining average yields on the interest earning assets.  Loans and leases receivable had an averageyield of 5.75% for the three months ended September 30, 2009, which is 66basis points less than the average yield of 6.41% for the three months ended September 30,2008.  Investment securities also had adecline in average yield of 73 basis points when comparing the first quarter offiscal 2010 against the same period of the prior year.  The average interest-earning assets for loansand leases receivables increased $45.7 million, or 5.7% to $851.4 million forthe three months ended September 30, 2009, when compared to the threemonths ended September 30, 2008. Investment securities decreased in average balance $4.6 million, or 2.0%to $225.3 million for the first quarter of fiscal 2010, when compared to theaverage balance of the same quarter of the prior fiscal year.  The net revenue decrease attributable to theoverall declining yield and average volume was $411,000 and $53,000,respectively.

 

*Interest Expense.*  Interestexpense was $5.9 million for the three months ended September 30, 2009 ascompared to $7.1 million for the same period in the prior fiscal year, adecrease of $1.3 million or 17.6%.  A$1.6 million decrease in interest expense was the result of a decrease in theaverage rate paid of 1.92% on interest-bearing deposits for the three monthsended September 30, 2009 compared to an average rate paid of 2.67% for thethree months ended September 30, 2008. Average balance of interest-bearing deposits increased by $46.7 million,or 6.9%, while average balance of FHLB advances and other borrowings decreasedby $25.6 million, or 11.0% for the three month period ended September 30,2009, as compared to the three month period ended September 30, 2008.  This net increase in volume partially offsetthe overall decrease in interest expense for interest-bearing deposits by$336,000.  The average rate paid on totalinterest-bearing liabilities was 2.42% for the three months ended September 30,2009 as compared to 3.01% for the same period in fiscal 2009.

 

*Net Interest Income.* The Company’s net interestincome for the three months ended September 30, 2009 increased $62,000 or0.7%, to $8.8 million compared to $8.7 million for the same period in the priorfiscal year.  The net increase in volumesof interest-earning assets in excess of the increase volumes ofinterest-bearing liabilities resulted in a net increase in net interest incomeof $354,000 attributable to changes in volumes. This was offset by the net effect of the reduction of rates forinterest-earning assets in excess of the reduction of rates forinterest-bearing liabilities and resulted in a net decrease in net interestincome of $292,000 attributable to rates earned or paid.  The Company’s Net Interest Margin, TE was3.24% for the three months ended September 30, 2009 as compared to 3.35%for the three months ended September 30, 2008.  Net Interest Margin, TE is a non-GAAPfinancial measure.  See “Analysis of NetInterest Income” for a calculation of this non-GAAP financial measure and forfurther discussion as to the reasons we believe this non-GAAP financial measureis useful.

 

*Provision for Losses on Loans and Leases.*The allowance for loan and lease losses is maintained at a level which isconsidered by management to be adequate to absorb probable losses on existingloans and leases that may become uncollectible, based on an evaluation of thecollectability of loans and leases and prior loan and lease lossexperience.  The evaluation takes intoconsideration such factors as changes in the nature and volume of the loan andlease portfolio, overall portfolio quality, review of specific problem loansand leases, and current economic conditions that may affect the borrower’sability to pay.  The allowance for loanand lease losses is established through a provision for losses on loans andleases charged to expense.

 

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During the three months ended September 30, 2009, the Companyrecorded a provision for losses on loans and leases of $343,000 compared to$387,000 for the three months ended September 30, 2008.  See “Asset Quality and Potentially ProblemLoans and Leases” for further discussion.

 

*Noninterest Income.*  Noninterest income was $1.7 million for thequarter ended September 30, 2009 compared to $3.0 million for the quarterended September 30, 2008, a decrease of $1.4 million or 44.3%.  This decrease is due primarily to netimpairment credit losses recognized in earnings of $1.9 million for the quarterended September 30, 2009.   Net gainon sale of loans and net gain on sale of securities increased $245,000 and$453,000, respectively, to partially offset the decrease caused by the netimpairment losses.

 

Net impairment creditlosses recognized in earnings were $1.9 million for the quarter ended September 30,2009.  The Company determined that atotal of $3.9 million of losses due to other-than temporary impairments wereincurred, of which $2.1 million were recognized in other comprehensiveincome.  The resulting net $1.9 millionof credit loss was recognized as a reduction of other noninterest income.  Fees on deposits decreased $105,000 to $1.4million for the three months ended September 30, 2009 as compared to thethree months ended September 30, 2008, due largely to a decrease in NSFand overdraft fees of $224,000 and partially offset by an increase inpoint-of-sale interchange and ATM fee income of $139,000.  Loan servicing income decreased by $66,000 to$491,000 for the first quarter fiscal 2010 due primarily to increased servicingrights amortization expense recorded during the period based upon the Company’squarterly analysis of portfolio prepayment experience.  Net gain on sale of loans increased $245,000to $496,000 for the three months ended September 30, 2009 from $251,000for the three months ended September 30, 2008, primarily due to anincrease in mortgage loan activity and the related loan sales.  Gross proceeds from the securities sold at again were $11.1 million, resulting in a gain on sale of securities of $533,000for the three months ended September 30, 2009.  This compares to gross proceeds of $7.3million, resulting in a gain on sale of securities of $82,000 for the threemonths ended September 30, 2008. There were no securities sold at a loss for the three months ended September 30,2009 as compared to $2.3 million received in gross proceeds, which resulted ina net loss of $2,000 for the three months ended September 30, 2008.  The increase of gains on the sale ofsecurities was due to the bank restructuring the portfolio for higher rates.

 

*Noninterest Expense.*  Noninterest expense was $8.9 million for thethree months ended September 30, 2009 as compared to $8.4 million for thethree months ended September 30, 2008, an increase of $546,000, or6.5%.  The increase was primarily due toincreases in healthcare costs included in compensation and employee benefits of$390,000, occupancy and equipment of $107,000, FDIC insurance of $184,000, andprofessional fees of $92,000.  Theseincreases were partially offset by a decrease in net foreclosed real estate andother properties costs of $98,000.

 

Compensation and employeebenefits were $5.2 million for the three months ended September 30, 2009,an increase of $42,000 or 0.8% when compared to the three months ended September 30,2008.  Net healthcare costs, which are included in the totalfor compensation and employee benefits, increased $390,000, or 108.9% to$748,000 due to specific high dollar claims and general overallutilization.  Management currentlybelieves the self-insured structure is a reasonable alternative to traditionalhealthcare plans over the long term.  Thelevel of healthcare costs which the Company incurs may vary from year toyear.  Employee compensationincreased $313,000, or 10.0%, while variable pay relating to employeeincentives and commissions decreased $714,000, or 94.7%.  Employee compensation increased due to annualraises awarded and additional personnel since the three month period ended September 30,2008.  Variable pay relating to employeeincentive programs decreased due to a reduced change in performance outcomesthrough the first quarter of fiscal 2010.

 

Occupancy and equipment increased $107,000, or 11.0% to $1.1 million forthe first three months ended September 30, 2009 as compared to the sameperiod ended September 30, 2008. During fiscal 2009, a new facility in Watertown, South Dakota was builtand placed in service in July 2009. This new facility and purchases of information technology equipmentaccounted for an increase of $107,000 when compared to the first quarter offiscal 2009.

 

FDIC insurance premiumsincreased $184,000, to $325,000 for the first quarter of fiscal 2010, comparedto the same period of fiscal 2009.  Inthe first quarter of fiscal 2009, the Bank applied previously unused credits inthe payment of its insurance premiums.  The credits were fully utilized in the secondquarter of fiscal 2009.

 

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Professional fees increased $92,000, or 18.1% to $600,000 for the firstquarter of fiscal 2010, compared to the first quarter of fiscal 2009.  This increase is primarily attributed to increasedaudit, consulting and regulatory examination costs.

 

*Incometax expense.*  The Company’s income tax expensefor the three months ended September 30, 2009 decreased to $302,000compared to $973,000 for the same period in the prior fiscal year.  The effective tax rate was 26.10% and 33.01%for the three months ended September 30, 2009 and 2008, respectively.  Permanent tax differences were relativelyconstant when comparing the first quarters of fiscal 2010 and 2009, but thetaxable income was lower in the first quarter of fiscal 2010, which created alesser tax effective rate than anticipated.

 

**Liquidity and Capital Resources**

 

The Bank’s primary sources of funds are earnings,in-market deposits, FHLB advances and other borrowings, repayments of loanprincipal, residential mortgage-backed securities and callable agencysecurities and, to a lesser extent, sales of mortgage loans, sales andmaturities of securities, out-of-market deposits and short-terminvestments.  While scheduled loanpayments and maturing securities are relatively predictable, deposit flows andloan and security prepayments are more influenced by interest rates, generaleconomic conditions and competition. The Bank attempts to price its deposits tomeet its asset/liability objectives consistent with local marketconditions.  Excess balances are investedin overnight funds.

 

Liquiditymanagement is both a daily and long-term responsibility of management.  The Bank adjusts its investments in liquidassets based upon management’s assessment of (i) expected loan demand, (ii) projectedloan sales, (iii) expected deposit flows, (iv) yields available oninterest-bearing deposits, and (v) the objectives of its asset/liabilitymanagement program.  Excess liquidity isinvested generally in interest-bearing overnight deposits and other short-termgovernment and agency obligations.

 

Although in-market deposits is one of the Bank’s primary source offunds, the Bank’s policy has been to utilize borrowings where the funds can beinvested in either loans or securities at a positive rate of return or to usethe funds for short-term liquidity purposes. As of September 30, 2009, theBank had the following sources of additional borrowings:

 

·                  $15.0 million in an uncommitted, unsecured line of federal fundswith First Tennessee Bank, NA;

 

·                  $10.0 million in an uncommitted, unsecured line of federal fundswith Zion Bank;

 

·                  $64.5 million of available credit from the Federal Reserve Bank(after deducting outstanding borrowings with the Federal Reserve Bank); and

 

·                  $40.7 million of available credit from FHLB of Des Moines (afterdeducting outstanding borrowings with FHLB of Des Moines).

 

The Bank may also seek other sources of contingent liquidity includingadditional federal funds purchased lines with correspondent banks and lines ofcredit with the Federal Reserve Bank. There were no funds drawn on theuncommitted, unsecured line of federal funds with First Tennessee Bank, NA at September 30,2009. The Bank, as a member of the FHLB of Des Moines, is required to acquireand hold shares of capital stock in the FHLB of Des Moines equal to 0.12% ofthe total assets of the Bank at December 31 annually. The Bank is alsorequired to own activity-based stock, which is based on 4.45% of the Bank’soutstanding advances. These percentages are subject to change at the discretionof the FHLB Board of Directors.

 

In August 2009, the Bank executed an additional uncommitted,unsecured line of federal funds with Zions Bank. Currently, there are no fundsdrawn on this line of federal funds.

 

In addition to the above sources of additional borrowings, the Bank hasimplemented arrangements to acquire out-of-market certificates of deposit as anadditional source of funding. As of September 30, 2009, the Bank had$25.8 million in out-of-market certificates of deposit.

 

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The Company had aline of credit for $6.0 million with First Tennessee Bank, NA forliquidity needs, which was set to mature on September 30, 2009.  On September 30, 2009, the Company enteredinto a Loan Agreement (the “Loan Agreement”) with United Bankers’ Bank (the “Lender”)in order to refinance its outstanding borrowings of $5.966 million underits line of credit with First Tennessee Bank, NA (the “FTB Line of Credit”).Under the Loan Agreement, the Lender committed to lend to the Company anaggregate principal amount not to exceed $6.0 million. As of November 13,2009, the Company had outstanding borrowings of $6.0 million under theLoan Agreement. The loan is evidenced by a promissory note, accrues interest atthe United Bankers’ Bank Rate with a minimum interest rate of 4.75% per annum,and the principal balance (plus any accrued and unpaid interest) is due andpayable in full on October 1, 2010. As of September 30, 2009, theUnited Bankers’ Bank Rate was 3.25%.

 

In connection with entering into the Loan Agreement, the Company alsoentered into a Commercial Pledge Agreement with the Lender, granting the Lendera first security interest in all of the stock of the Bank.  The Loan Agreement contains customary eventsof default and affirmative covenants with which the Company and Bank were incompliance at September 30, 2009.

 

The Bank anticipates that it will have sufficient funds available tomeet current loan commitments. At September 30, 2009, the Bank hadoutstanding commitments to originate and purchase mortgage and commercial loansof $51.6 million and to sell mortgage loans of $33.5 million.Commitments by the Bank to originate loans are not necessarily executed by thecustomer. The Bank monitors the ratio of commitments to funding for use inliquidity management. At September 30, 2009, the Bank had one outstandingcommitment to purchase $100,000 investment securities available for sale and nocommitments to sell investment securities available for sale.

 

The Company usesits capital resources to pay dividends to its stockholders, to support organicgrowth, to make acquisitions, to service its debt obligations and to providefunding for investment into the Bank of Tier 1 (core) capital.

 

Savings institutions insured by the Federal DepositInsurance Corporation are required by the Financial Institutions Reform,Recovery and Enforcement Act of 1989 to meet three regulatory capitalrequirements.  If a requirement is notmet, regulatory authorities may take legal or administrative actions, includingrestrictions on growth or operations or, in extreme cases, seizure.  Institutions not in compliance may apply foran exemption from the requirements and submit a recapitalization plan.  At September 30, 2009, the Bank met allcurrent regulatory capital requirements.

 

The minimum OTS Tier 1(core) capital requirement for well-capitalized institutions is 5.00% of totaladjusted assets for thrifts.  The Bankhad Tier 1 (core) capital of 8.57% at September 30, 2009.  The minimum OTS total risk-based capitalrequirement for well-capitalized institutions is 10.00% of risk-weightedassets.  The Bank had total risk-basedcapital of 11.27% at September 30, 2009.

 

**Impact ofInflation and Changing Prices**

 

The unaudited consolidated financial statements andnotes thereto presented in this Quarterly Report on Form 10-Q have beenprepared in accordance with GAAP, which require the measurement of financialposition and operating results in terms of historical dollars withoutconsidering the change in the relative purchasing power of money over time dueto inflation.  The impact of inflation isreflected in the increased cost of the Bank’s operations.  Unlike most industrial companies, nearly allthe assets and liabilities of the Bank are monetary in nature.  As a result, interest rates have a greaterimpact on the Bank’s performance than do the effects of general levels ofinflation.  Interest rates do notnecessarily move in the same direction or to the same extent as the prices ofgoods and services.

 

**RecentAccounting Pronouncements**

** **

**FASBEstablishes Accounting Standards Codification**TM

 

In June 2009,the FASB issued Accounting Standards Update No. 2009-01, “GenerallyAccepted Accounting Principles” (ASC Topic 105) which establishes the FASBAccounting Standards Codification (“the Codification” or “ASC”) as the officialsingle source of authoritative U.S. generally accepted accounting principles (“GAAP”).All existing accounting standards are superseded. All other accounting guidancenot included in the Codification will be considered non-authoritative. TheCodification also includes all relevant Securities and Exchange Commission (“SEC”)guidance organized using the same topical structure in separate sections withinthe Codification.

 

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Following theCodification, the Board will not issue new standards in the form of Statements,FASB Staff Positions or Emerging Issues Task Force Abstracts. Instead, it willissue Accounting Standards Updates (“ASU”) which will serve to update theCodification, provide background information about the guidance and provide thebasis for conclusions on the changes to the Codification.

 

The Codificationis not intended to change GAAP, but it will change the way GAAP is organizedand presented. The Codification is effective for our first quarter fiscal 2010financial statements and the principal impact on our financial statements islimited to disclosures as all future references to authoritative accountingliterature will be referenced in accordance with the Codification. In order toease the transition to the Codification, we are providing the Codificationcross-reference alongside the references to the standards issued and adoptedprior to the adoption of the Codification.

 

**FairValue Accounting**

 

In 2006, the FASBissued SFAS No. 157, “Fair Value Measurements” (ASC Topic 820) whichdefines fair value, establishes a market-based framework or hierarchy formeasuring fair value and expands disclosures about fair value measurements.This guidance is applicable whenever another accounting pronouncement requiresor permits assets and liabilities to be measured at fair value. It does notexpand or require any new fair value measures; however the application of thisstatement may change current practice. The Company adopted this guidance forfinancial assets and liabilities effective July 1, 2008 and for nonfinancial assets and liabilities effective July 1, 2009.  The adoption did not have a material effecton the Company’s consolidated financial condition, results of operations orcash flow.

 

FSP FAS 107-1 andAPB 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (ASCTopic 320-10-65). This update requires fair value disclosures for financialinstruments that are not currently reflected on the balance sheet at fair valueon a quarterly basis.

 

TheCompany adopted this update effective June 30, 2009 and the adoption didnot have a material effect on the Company’s consolidated financial condition orresults of operations or cash flow.

 

In August 2009,FASB issued ASU No. 2009-05 which amends Fair Value Measurements andDisclosures — Overall (ASC Topic 820-10) to provide guidance on the fair valuemeasurement of liabilities. This update requires clarification for circumstancesin which a quoted price in an active market for the identical liability is notavailable, a reporting entity is required to measure fair value using one ormore of the following techniques: 1) a valuation technique that uses either thequoted price of the identical liability when traded as an asset or quotedprices for similar liabilities or similar liabilities when traded as an asset;or 2) another valuation technique that is consistent with the principles in ASCTopic 820 such as the income and market approach to valuation. The amendmentsin this update also clarify that when estimating the fair value of a liability,a reporting entity is not required to include a separate input or adjustment toother inputs relating to the existence of a restriction that prevents thetransfer of the liability. This update further clarifies that if the fair valueof a liability is determined by reference to a quoted price in an active marketfor an identical liability, that price would be considered a Level 1 measurementin the fair value hierarchy. Similarly, if the identical liability has a quotedprice when traded as an asset in an active market, it is also a Level 1 fairvalue measurement if no adjustments to the quoted price of the asset arerequired. This update is effective for the second quarter of fiscal 2010.

 

**BusinessCombinations and Noncontrolling Interests**

 

In 2007, the FASBissued SFAS No. 141 (revised 2007), “Business Combinations” (ASC Topic805). This guidance requires the acquiring entity in a business combination torecognize the full fair value of assets acquired and liabilities assumed in thetransaction (whether a full or partial acquisition); establishes theacquisition date fair value as the measurement objective for all assetsacquired and liabilities assumed; requires expensing of most transaction andrestructuring costs; and requires the acquirer to disclose the informationnecessary to evaluate and understand the nature and financial effect of thebusiness combination. The Company adopted this guidance effective July 1,2009 and the adoption did not have a material effect on the Company’sconsolidated financial condition, results of operations or cash flow.

 

In April 2009,the FASB issued Staff Position No. FSP FAS 141(R)-1, “Accounting forAssets Acquired and Liabilities Assumed in a Business Combination That Arisefrom Contingencies” (ASC Topic 805-20). This updated guidance amended theaccounting treatment for assets and liabilities arising from contingencies in abusiness combination and requires that pre-acquisition contingencies berecognized at fair value, if fair value can be reasonably determined. If fairvalue cannot be reasonably determined, measurement should be based on the bestestimate in accordance with SFAS No. 5, “Accounting for Contingencies”(ASC Topic 405). This updated guidance was effective July 1, 2009.

 

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In 2007, the FASBissued SFAS No. 160, “Noncontrolling Interests in Consolidated FinancialStatements—an amendment of Accounting Research Bulletin No. 51”, (ASCTopic 810-10-65). This guidance requires companies to present noncontrolling(minority) interests as equity (as opposed to a liability) and providedguidance on the accounting for transactions between an entity andnoncontrolling interests. In addition, it requires companies to report aconsolidated net income (loss) measure that includes the amount attributable tosuch noncontrolling interests.  TheCompany does not currently have any non-controlling interest in theconsolidated financial statements.  TheCompany adopted this guidance effective July 1, 2009.

** **

**OtherAccounting Changes**

 

On June 12,2009, the FASB issued SFAS No. 166, “Accounting for Transfers of FinancialAssets”, (ASC Topic 810). This updated guidance removed the concept of aqualifying special-purpose entity and removed the exception from applyingconsolidation guidance to these entities. This update also clarified therequirements for isolation and limitations on portions of financial assets thatare eligible for sale accounting. ASC Topic 810 is effective for interim andannual reporting periods beginning after November 15, 2009 and managementis currently evaluating the impact of adopting this update on the Company’sconsolidated financial condition, results of operations and cash flow.

 

On June 122009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No. 46(R),Consolidation of Variable Interest Entities” (ASC Topic 810-10). This updatedguidance requires an analysis to determine whether a variable interest givesthe entity a controlling financial interest in a variable interest entity. Italso requires an ongoing reassessment and eliminates the quantitative approachpreviously required for determining whether an entity is the primarybeneficiary.  This update is effectivefor interim and annual reporting periods beginning after November 15, 2009and management is currently evaluating the impact of adopting this update onthe Company’s consolidated financial condition, results of operations and cashflow.

 

In 2008, the FASBissued Staff Position No. FAS 132(R)-1, “Employers’ Disclosures aboutPostretirement Benefit Plan Assets” (ASC Topic 715-20-65). This guidance willexpand disclosure by requiring the following new disclosures: 1) how investmentallocation decisions are made by management; 2) major categories of planassets; and 3) significant concentrations of risk. Additionally, ASC 715-20-65will require an employer to disclose information about the valuation of planassets similar to that required in ASC Topic 820 Fair Value Measurements andDisclosures. ASC 715-20-65 is effective for annual reporting periods endingafter December 15, 2009 and the Company does not expect the adoption tohave a material effect on the Company’s consolidated financial condition,results of operations or cash flow.

 

During the firstquarter of fiscal 2010, the FASB has issued several ASU’s — ASU No. 2009-02through ASU No. 2009-15. Except for ASU No. 2009-05 discussed above,the ASU’s entail technical corrections to existing guidance or affect guidancerelated to specialized industries or entities and therefore have minimal, ifany, impact on the Company.

 

**Item 3.   *Quantitative and Qualitative Disclosures About Market Risk***

 

**InterestRate Risk Management**

 

The Company’s netincome is largely dependent on its net interest income.  Net interest income is susceptible tointerest rate risk to the degree that interest-bearing liabilities with short-and medium-term maturities mature or reprice more rapidly than itsinterest-earning assets.  Wheninterest-bearing liabilities mature or reprice more quickly thaninterest-earning assets in a given period, a significant increase in marketrates of interest could adversely affect net interest income.  Similarly, when interest-earning assetsmature or reprice more quickly than interest-bearing liabilities, fallinginterest rates could result in a decrease in net income.

 

In an attempt to manage its exposure to change in interest rates,management monitors the Company’s interest rate risk.  The Company’s Asset/Liability Committee meetsperiodically to review the Company’s interest rate risk position andprofitability, and to recommend adjustments for consideration by executivemanagement.  Management also reviews theBank’s securities portfolio, formulates investment strategies, and oversees thetiming and implementation of transactions to assure attainment of the Board’sobjectives in the most effective manner. In managing market risk and the asset/liability mix, the Bank has placedits emphasis on developing a portfolio in which, to the extent practicable,assets and liabilities reprice within similar periods.  Notwithstanding the Company’s interest raterisk management activities, the potential for changing interest rates is anuncertainty which may have an adverse effect on net income.

 

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The Companyadjusts its asset/liability position to mitigate the Company’s interest raterisk.  At times, depending on the levelof general interest rates, the relationship between long- and short-terminterest rates, market conditions and competitive factors, management mayincrease the Company’s interest rate risk position in order to increase its netinterest margin.  The Company’s resultsof operations and net portfolio values remain vulnerable to increases ininterest rates and to fluctuations in the difference between long- andshort-term interest rates.

 

As set forth below, the volatility of a rate change, the change in assetor liability mix of the Company or other factors may produce a decrease in netinterest margin in an upward moving rate environment even as the net portfoliovalue (“NPV”) estimate indicates an increase in net value.  The inverse situation may also occur.  One approach used by the Company to quantify interest rate risk is an NPVanalysis.  This analysis calculates thedifference between the present value of the liabilities and the present valueof expected cash flows from assets and off-balance sheet contracts.  The following tables set forth, at September 30,2009 and 2008, respectively, an analysis of the Company’s interest rate risk asmeasured by the estimated changes in NPV resulting from instantaneous andsustained parallel shifts in the yield curve. Management does not believe that the Company has experienced any materialchanges in its market risk position from that disclosed in the Company’s AnnualReport on Form 10-K for fiscal 2009 or that the Company’s primary marketrisk exposures and how those exposures were managed during the three monthsended September 30, 2009 changed significantly when compared to June 30,2009.

 

Even if interest rates change in the designated amounts, there can beno assurance that the Company’s assets and liabilities would perform as setforth below.  In addition, a change inU.S. Treasury rates in the designated amounts accompanied by a change in theshape of the Treasury yield curve would cause significantly different changesto the NPV than indicated below.

 
| **September 30,  2009** | ** ** |
|------------------------------|------------|
| ** **                   | ** ** | ** ** | ** ** | **Estimated  Increase** | ** ** |
| **Change in**                | ** ** | **Estimated** | ** ** | **(Decrease)  in NPV** | ** ** |
| **Interest  Rates**          | ** ** | **NPV Amount** | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| **Basis  Points**            | ** ** | **(Dollars  in Thousands)** | ** ** | ** ** | ** ** |
| +300                         |       | $ | 130,136 |   | $ | 10,102 |   | 8 | % |
| +200                         |       | 129,045 |   | 9,011 |   | 8 |   |
| +100                         |       | 125,825 |   | 5,791 |   | 5 |   |
| —                       |       | 120,034 |   | — |   | — |   |
| -100                         |       | 112,835 |   | (7,199 | ) | (6 | ) |
|                              |            |  |  |  |  |  |  |  |  |

 
| **September 30,  2008** | ** ** |
|------------------------------|------------|
| ** **                   | ** ** | ** ** | ** ** | **Estimated  Increase** | ** ** |
| **Change in**                | ** ** | **Estimated** | ** ** | **(Decrease)  in NPV** | ** ** |
| **Interest  Rates**          | ** ** | **NPV Amount** | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| **Basis Points**        | ** ** | **(Dollars in Thousands)** | ** ** | ** ** | ** ** |
| +300                         |       | $ | 100,985 |   | $ | (13,729 | ) | (12 | )% |
| +200                         |       | 107,505 |   | (7,209 | ) | (6 | ) |
| +100                         |       | 112,849 |   | (1,865 | ) | (2 | ) |
| —                       |       | 114,714 |   | — |   | — |   |
| -100                         |       | 110,129 |   | (4,585 | ) | (4 | ) |
|                              |            |  |  |  |  |  |  |  |  |

 

In managing market risk and the asset/liability mix,the Bank has placed an emphasis on developing a portfolio in which, to theextent practicable, assets and liabilities reprice within similar periods.  The goal of this policy is to provide arelatively consistent level of net interest income in varying interest ratecycles and to minimize the potential for significant fluctuations from periodto period.

 

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**Item 4.  *Controls and Procedures***

 

As of September 30, 2009, an evaluation was performed by theCompany’s management, including the Company’s Chairman, President and Chief ExecutiveOfficer and the Company’s Executive Vice President, Chief Financial Officer andTreasurer, of the effectiveness of the design and operation of the Company’sdisclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended) toprovide reasonable assurance that information required to be disclosed in thereports the Company files and submits under the Securities Exchange Act of1934, as amended, is recorded, processed, summarized and reported within thetime periods specified in the Securities and Exchange Commission’s rules andforms. Based upon that evaluation, the Company’s Chairman, President and ChiefExecutive Officer and the Company’s Executive Vice President, Chief FinancialOfficer and Treasurer concluded that the Company’s disclosure controls andprocedures were effective as of September 30, 2009.  There were no changes in the Company’sinternal control over financial reporting that occurred during the firstquarter ended September 30, 2009, that have materially affected, or arereasonably likely to materially affect, the Company’s internal control overfinancial reporting.

 

**PART II - OTHER INFORMATION**

 

**Item 1.  *Legal Proceedings***

 

The Company,the Bank and each of their subsidiaries are, from time to time, involved asplaintiff or defendant in various legal actions arising in the normal course oftheir businesses.  While the ultimateoutcome of any such proceedings cannot be predicted with certainty, it isgenerally the opinion of management, after consultation with counselrepresenting the Bank and the Company in any such proceedings, the resolutionof any such proceedings should not have a material effect on the Company’sconsolidated financial position or results of operations.  The Company, the Bank and each of theirsubsidiaries are not aware of any legal actions or other proceedingscontemplated by governmental authorities outside of the normal course ofbusiness.

 

**Item 1A.  *Risk Factors***

 

The discussion of our business and operationsshould be read together with the risk factors contained in Part I,Item 1A of our Annual Report on Form 10-K for the fiscal year ended June 30,2009, which describe various risks and uncertainties to which we are or maybecome subject.  These risks anduncertainties have the potential to affect our business, financial condition,results of operations, cash flows, strategies or prospects in a material andadverse manner.  Other than as set forthbelow, there have been no material changes to the risk factors set forth in theabove-referenced filing as of September 30, 2009.

 

***Recently enacted legislation may not help stabilize the U.S. financialsystem and the phase-out of existing recovery programs may adversely impact thesystem.***

 

Recent legislative and regulatory initiatives to address difficult marketand economic conditions may not stabilize the U.S. banking system. On October 3,2008, the President signed into law the Emergency Economic Stabilization Act of2008, or the Emergency Economic Stabilization Act, in response to the crisis inthe financial sector. The Treasury and various banking regulators haveimplemented a number of programs under this legislation to address capital andliquidity issues in the banking system. On February 17, 2009, thePresident signed into law the American Recovery and Reinvestment Act of 2009,or the American Recovery and Reinvestment Act. There can be no assurance,however, as to the actual impact that the Emergency Economic Stabilization Actor the American Recovery and Reinvestment Act, and the various programsimplemented in association with these legislative efforts, will have on thefinancial markets, including the extreme levels of volatility and limitedcredit availability currently being experienced within the sector. The failureof the Emergency Economic Stabilization Act or American Recovery andReinvestment Act and the associated programs to help stabilize the financialmarkets and a continuation or worsening of current financial market conditionscould have a material, adverse effect on our business, financial condition, resultsof operations, access to credit or the value of our securities. Similarly, thepremature termination, manner or timing of the phase-out of existing programsimplemented to assist the U.S. financial system in recovering from the recentfinancial crisis could have a material adverse impact on our business,financial condition, results of operations, access to credit or the value ofour securities.

 

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***The impact of pending legislation and regulatory changes on the U.S.financial services industry and the U.S. financial system may adversely affectour business.***

 

The U.S. Congress, the Obama Administration and various industry andpublic interest groups are currently debating many aspects of the existingstructure of the U.S. financial system, including regulatory restructuring;federal and national charter changes; issues involving systemic risk;appropriate capitalization levels; establishment of a new and independentConsumer Financial Protection Agency; permitting state regulators to supervise,oversee and/or enforce state laws on federal and nationally chartereddepository institutions; the ability of federal and nationally chartereddepository institutions to operate nationwide under a uniform set of federallaws; restrictions on mortgage lending, credit card lending and other areasaffecting bank lending operations; laws impacting loan securitization andsecondary mortgage lending activities; additional compliance laws that couldimpose new regulatory burdens on insured depository institutions; increasedassessments on depository institutions to pay for industry supervision andoversight; and changes in holding company oversight and supervision could allhave a material, adverse impact on the Bank’s and our business, financialcondition, results of operations, access to credit or the value of oursecurities.

*** ***

***We recorded other-than-temporary impairment (“OTTI”) charges in ourtrust preferred securities (“TRUPS”) portfolio in the third and fourth quartersof 2009 and in the first quarter of 2010, and we could record additional lossesin the future.***

 

We determine the fair value of our investment securities based on GAAPand three levels of informational inputs that may be used to measure fairvalue. The price at which a security may be sold in a market transaction couldbe significantly lower than the quoted market price for the security,particularly if the quoted market price is based on infrequent trading history,the market for the security is illiquid, or a significant amount of securitiesare being sold.

 

We held six TRUPS pools with an adjusted cost basis of $11.9 millionand a fair value of $6.1 million at June 30, 2009. Rating downgradeson these investments occurred during fiscal year 2009, placing each in a belowinvestment grade rating. Due to an inactive market for these securities,management utilized a “Level 3” fair value input according to Statement ofFinancial Accounting Standard No. 157, utilizing discounted cash flowmethodologies to determine fair value and OTTI. During fiscal 2009, wedetermined that three debt securities exhibited OTTI. The aggregate OTTI lossesrecorded for the three securities for the fiscal year 2009 were$3.9 million, of which $3.5 million was recognized on the balancesheet in other comprehensive income, with the balance being $397,000 of creditloss recognized through earnings. The remaining difference between amortizedcost basis and fair value of $2.3 million recognized in othercomprehensive income is primarily attributable to the three TRUPS for whichOTTI was not recognized for the fiscal year 2009.

 

At September 30, 2009, we carried the six TRUPS pools at an adjustedcost basis of $10.0 million and a fair value of $5.6 million. Wedetermined that three debt securities exhibited OTTI of $3.9 million, ofwhich $2.1 million was recognized on the balance sheet in other comprehensiveincome at September 30, 2009, with the balance being $1.9 million ofcredit loss recognized through earnings for the three-months ended September 30,2009.

 

The valuation of our TRUPS will continue to be influenced by externalmarket and other factors, including implementation of Securities and ExchangeCommission and Financial Accounting Standards Board guidance on fair valueaccounting, the financial condition of specific issuers within our pooledsecurities (including any credit deterioration thereof), deferral and defaultrates of specific issuer financial institutions, rating agency actions, and theprices at which observable market transactions occur. If we are required torecord additional OTTI charges on our TRUPS portfolio, we could experiencepotentially significant earnings losses as well as an adverse impact to ourcapital position.

*** ***

***Liquidity risks could affect operations and jeopardize our financialcondition.***

 

Liquidity is essential to our business. An inability to raise fundsthrough deposits, borrowings, the sale of loans and other sources toaccommodate our existing and future lending and investment activities couldhave a substantial negative effect on our liquidity and severely constrain ourfinancial flexibility. Our primary source of funding is retail depositsgathered through our network of branch offices. Our alternative funding sourcesinclude, without limitation, brokered certificates of deposit, federal fundspurchased, Federal Reserve Discount Window borrowings, Federal Home Loan Bankof Des Moines (FHLB) advances and short- and long-term debt.

 

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Until recently, the Bank has historically obtained funds principallythrough local deposits and it has a base of lower cost transaction deposits.Generally, we believe local deposits are a cheaper and more stable source offunds than other borrowings, because interest rates paid for local deposits aretypically lower than interest rates charged for borrowings from otherinstitutional lenders and reflect a mix of transaction and time deposits,whereas brokered deposits typically are higher cost time deposits.

 

Our costs of funds, profitability and liquidity will be adverselyaffected to the extent we have to rely upon higher cost borrowings from otherinstitutional lenders or brokers to fund loan demand or liquidity needs, andchanges in our deposit mix and growth could adversely affect our profitabilityand the ability to expand our loan portfolio.

 

On September 30, 2009, we entered into a Loan Agreement (the “LoanAgreement”) with United Bankers’ Bank (the “Lender”) in order to refinance ouroutstanding borrowings of $5.966 million under our line of credit withFirst Tennessee Bank, NA (the “FTB Line of Credit”). Our borrowings under theFTB Line of Credit were scheduled to mature on September 30, 2009. Underthe Loan Agreement, the Lender committed to lend to us an aggregate principalamount not to exceed $6 million. As of November 13, 2009, we hadoutstanding borrowings of $6.0 million under the Loan Agreement. The loanis evidenced by a promissory note, accrues interest at the United Bankers’ BankRate with a minimum interest rate of 4.75% per annum, and the principal balance(plus any accrued and unpaid interest) is due and payable in full on October 1,2010. As of September 30, 2009, the United Bankers’ Bank Rate was 3.250%.To the extent we have to borrow funds from other institutional lenders to repaythis indebtedness, our costs of funds, profitability and liquidity may beadversely affected.

 

We may look to sell production assets, such as mortgage loans, into thesecondary market as a means to manage the size of our balance sheet and managethe use of our capital. The demand for these products in the capital markets isnot driven by us and may not benefit us at the time we look to sell the loans.

 

Our liquidity, on a parent only basis, may be adversely affected bycertain restrictions on receiving dividends from the Bank without priorregulatory approval.

*** ***

***Higher FDIC deposit insurance premiums and assessments could adverselyaffect our financial condition.***

 

FDIC insurancepremiums have increased substantially in 2009 and we expect to paysignificantly higher FDIC premiums in the future. Market developments havesignificantly depleted the DIF and reduced the ratio of reserves to insureddeposits. The FDIC adopted a revised risk-based deposit insurance assessmentschedule on February 27, 2009, which raised deposit insurance premiums. OnMay 22, 2009, the FDIC also implemented a five basis point specialassessment of each insured depository institution’s assets minus Tier 1capital as of June 30, 2009, but no more than 10 basis points times theinstitution’s assessment base for the second quarter of 2009, that wascollected on September 30, 2009. In imposing the special assessment, theFDIC noted that additional special assessments may be imposed by the FDIC forfuture periods.

 

On November 12,2009, the FDIC adopted a final rule that requires insured depositoryinstitutions to prepay their quarterly risk-based assessments for the fourthquarter of 2009, and for all of 2010, 2011, and 2012, on December 30,2009, along with each institution’s risk-based deposit insurance assessment forthe third quarter of 2009. For purposes of calculating the prepaid amount, thebase assessment rate in effect at September 30, 2009 would be used for2010. That rate would be increased by an annualized 3 basis points for 2011 and2012 assessments. The prepayment calculation would also assume a 5 percentannual growth rate, increased quarterly, through the end of 2012. Under thefinal rule, an institution will account for the prepayment by recording theentire amount of its prepaid assessment as a prepaid expense (an asset) as of December 30,2009. Subsequently, each institution will record an expense (charge toearnings) for its regular quarterly assessment and an offsetting credit to theprepaid assessment until the asset is exhausted. Once the asset is exhausted,the institution would resume paying and accounting for quarterly depositinsurance assessments as they do currently. The FDIC will notify anyinstitution that the FDIC exempts, on its own initiative, from the prepaidassessment no later than November 23, 2009. In addition, an insuredinstitution may apply before December 1, 2009, to the FDIC for anexemption from the prepayment requirement if the prepayment would significantlyimpair the institution’s liquidity, or otherwise create extraordinary hardship.The Bank does not plan to apply for an exemption nor do we anticipate that theFDIC will provide an exemption on its own initiative. Under the final rule, theFDIC stated that its requirement for prepaid assessments does not preclude theFDIC from changing assessment rates or from further revising the risk-basedassessment system during 2009, 2010, 2011, 2012, or thereafter, pursuant tonotice-and-comment rulemaking procedures provided by statute, and therefore,continued actions by the FDIC could significantly increase the Bank’snoninterest expense in fiscal 2010 and for the foreseeable future.

 

The Bank participates in the FDIC’s Temporary Liquidity GuaranteeProgram, or TLGP, for noninterest-bearing transaction deposit accounts. Banksthat participate in the TLGP’s noninterest-bearing transaction accountguarantee program pay the FDIC an annual assessment of 10 basis points on theamounts in such accounts above the amounts covered by FDIC deposit insurance.The general termination date for the transaction account guarantee portion ofthe TLGP is December 31, 2009. To promote an orderly phase-out of theprogram, on August 26, 2009, the FDIC adopted a final rule extendingthe program for six months, through June 30, 2010. For institutions thatchoose to remain in the program, the fee will be raised and adjusted to reflectthe institution’s risk profile. Any institution participating in the programthat wished to opt out of the transaction account guarantee program extension wasrequired to submit its opt-out election to the FDIC on or before November 2,2009. The Bank has decided to remain in the program, and therefore will besubject to additional fees for the extended portion of the program. Continuedactions by the FDIC could significantly increase the Bank’s noninterest expensein fiscal 2010 and for the foreseeable future.

 

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**Item 2.  *Unregistered Sales ofEquity Securities and Use of Proceeds***

 

None

 

**Item 4.  *Submission of Matters to a Vote of Security Holders***

 

None

 

 

**Item 5.  *Other Information***

 

None

 

 

**Item 6.  *Exhibits***

 
| **Regulation S-K**

**Exhibit Number** | ** ** | **Document**                                                                                                                                                                                                                                                                                                                                                                                       |
|----------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                                    |       | Restated Certificate of Incorporation (incorporated  herein by reference to Exhibit 3.2 from the Company’s Current Report on  Form 8-K dated August 11, 2009, and filed with the SEC on  August 17, 2009, file no. 033-44383).                                                                                                                                       |
| 3.2                                    |       | Amended and Restated Bylaws of the Company  (incorporated herein by reference to Exhibit 3.1 from the Company’s  Current Report on Form 8-K dated October 15, 2008, and filed with  the SEC on October 17, 2008, file no. 033-44383).                                                                                                                                |
| 3.3                                    |       | Certificate of Elimination of Series A Junior  Participating Preferred Stock and Fixed Rate Cumulative Perpetual Preferred  Stock, Series A of HF Financial Corp. (incorporated herein by reference  to Exhibit 3.1 from the Company’s Current Report on Form 8-K dated  August 11, 2009, and filed with the SEC on August 17, 2009, file  no. 033-44383). |
| 10.1                                   |       | Loan Agreement, dated September 30, 2009, by  and between the Company and United Bankers’ Bank (incorporated herein by  reference to Exhibit 10.1 from the Company’s Current Report on  Form 8-K dated September 30, 2009, and filed with the SEC on  October 6, 2009, file no. 033-44383).                                                                |
| 10.2                                   |       | Promissory Note, dated September 30, 2009,  payable to United Bankers’ Bank (incorporated herein by reference to  Exhibit 10.2 from the Company’s Current Report on Form 8-K dated  September 30, 2009, and filed with the SEC on October 6, 2009, file  no. 033-44383).                                                                                   |
| 10.3                                   |       | Commercial Pledge Agreement, dated  September 30, 2009, by and between the Company and United Bankers’ Bank  (incorporated herein by reference to Exhibit 10.3 from the Company’s  Current Report on Form 8-K dated September 30, 2009, and filed with  the SEC on October 6, 2009, file no. 033-44383).                                                   |
| 31.1                                   |       | Certification of Chairman, President and Chief  Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002                                                                                                                                                                                                                                                                  |
| 31.2                                   |       | Certification of Executive Vice President, Chief  Financial Officer and Treasurer Pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                  |
| 32.1                                   |       | Certification of Chairman, President and Chief  Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of  2002                                                                                                                                                                                                                                                                  |
| 32.2                                   |       | Certification of Executive Vice President, Chief  Financial Officer and Treasurer Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                  |

 

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

 
|   |                   |   | HF Financial  Corp.                            |
|--------|------------------------|--------|------------------------------------------------|
|   |                   |   | (Registrant)                                   |
|   |                   |   |                                           |
|   |                   |   |                                           |
| Date:  | November 16, 2009 |   | By:                                            | /s/ Curtis L. Hage |
|   |                   |   | Curtis L. Hage,  Chairman, President           |
|   |                   |   | and Chief Executive  Officer                   |
|   |                   |   | (Principal Executive  Officer)                 |
|   |                   |   |                                           |
| Date:  | November 16, 2009 |   | By:                                            | /s/ Darrel L. Posegate |
|   |                   |   | Darrel L. Posegate,  Executive Vice President, |
|   |                   |   | Chief Financial Officer  and Treasurer         |
|   |                   |   | (Principal Financial  and Accounting Officer)  |

 

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**Exhibit Index**

** **
| **Exhibit Number** | ** ** | **Description** |
|--------------------|------------|-----------------|
|               |       |            |
| 31.1               |       |            | Certification of Chairman, President and Chief  Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002 |
| 31.2               |       |            | Certification of Executive Vice President, Chief  Financial Officer and Treasurer Pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002 |
| 32.1               |       |            | Certification of Chairman, President and Chief  Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of  2002 |
| 32.2               |       |            | Certification of Executive Vice President, Chief  Financial Officer and Treasurer Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |

 

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