**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

WASHINGTON, D.C. 20549

 

-----------------------------------------------------

 

**FORM 10-Q**

 

**[X]       QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE**

**SECURITIES EXCHANGE ACT OF 1934**

 

For the Quarterly Period ended December 31, 2007

 

Commission File Number: 0-19972

 

-----------------------------------------------------

 

**HF FINANCIAL CORP.**

*(Exact name of registrant asspecified in its charter.)*

 

| **Delaware**                               | ** ** | **46-0418532**                             |
|--------------------------------------------|------------|--------------------------------------------|
| *(State or other jurisdiction of*          | * *   | *(I.R.S. Employer Identification  Number)* |
| *incorporation or organization)*           |       |                                       |
|                                       |       |                                       |
| **225 South Main Avenue,**                 |       |                                       |
| **Sioux Falls, SD**                        | ** ** | **57104**                                  |
| *(Address of principal executive  office)* | * *   | *(ZIP Code)*                               |

 

**(605)   333-7556**

*(Registrant’s telephone number,including area code)*

 

Indicate by check mark whether the registrant  (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. YES  X     NO       

 

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

 

LARGE ACCELERATED FILER            ACCELERATED FILER            NON-ACCELERATED FILER   X  

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act). YES         NO X  

 

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

 

As of February 8, 2008 there were 3,966,345issued and outstanding shares of the Registrant’s Common Stock, with $.01 parvalue per share.

 

 

**HF FINANCIAL CORP.**

 

**Form 10-Q**

 

**Table of Contents**

 
|           |                                                                                                 | Page Number |
|----------------|------------------------------------------------------------------------------------------------------|------------------|
| ** **     | **PART I –  FINANCIAL INFORMATION**                                                        |             |
|           |                                                                                                 |             |
| Item 1.        | Financial Statements (Unaudited):                                                                    |             |
|           |                                                                                                 |             |
|           | Consolidated  Statements of Financial Condition  As of December 31, 2007 and June 30, 2007 | 1                |
|           |                                                                                                 |             |
|           | Consolidated  Statements of Income for the  Six Months Ended December 31, 2007 and 2006         | 2                |
|           |                                                                                                 |             |
|           | Consolidated  Statements of Cash Flows for the  Six Months Ended December 31, 2007 and 2006     | 3                |
|           |                                                                                                 |             |
|           | Notes to Consolidated  Financial Statements                                                          | 5                |
|           |                                                                                                 |             |
| Item  2.       | Management’s  Discussion and Analysis of Financial Condition  and Results of Operations         | 15               |
|           |                                                                                                 |             |
| Item 3.        | Quantitative  and Qualitative Disclosures about Market Risk                                          | 35               |
|           |                                                                                                 |             |
| Item 4         | Controls and  Procedures                                                                             | 37               |
|           |                                                                                                 |             |
|           |                                                                                                 |             |
| ** **     | **PART II – OTHER  INFORMATION**                                                           |             |
|           |                                                                                                 |             |
| Item 1.        | Legal Proceedings                                                                                    | 37               |
|           |                                                                                                 |             |
| Item  1A.      | Risk Factors                                                                                         | 37               |
|           |                                                                                                 |             |
| Item 2.        | Unregistered  Sales of Equity Securities and Use of Proceeds                                         | 38               |
|           |                                                                                                 |             |
| Item 4.        | Submission  of Matters to a Vote of Security Holders                                                 | 38               |
|           |                                                                                                 |             |
| Item  6.       | Exhibits                                                                                             | 39               |
|           |                                                                                                 |             |
| Form 10-Q | Signature Page                                                                                       | 40               |

 

 

**PART I  –  FINANCIAL INFORMATION**

 

**Item 1.             Financial Statements**

** **

**HF FINANCIAL CORP. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION**

**(Dollars in Thousands)**

 
| **ASSETS**                                                        | ** ** | **December 31,  2007** | ** ** | **June 30,  2007** | ** ** |
|-------------------------------------------------------------------|------------|-----------------------------|------------|-------------------------|------------|
|                                                              |       | (Unaudited)                 |       |                    | (Audited)  |   |
| Cash and cash  equivalents                                        |       |   $               | 24,042     |                    |       |   $ | 22,476 |   |
| Securities  available for sale                                    |       | 164,352                     |       |                    | 142,223    |   |
| Federal Home  Loan Bank stock                                     |       | 8,402                       |       |                    | 5,058      |   |
| Loans held for  sale                                              |       | 5,536                       |       |                    | 8,776      |   |
| Loans and leases  receivable                                      |       | 759,882                     |       |                    | 767,471    |   |
| Allowance for  loan and lease losses                              |       | (5,424                      | )          |                    | (5,872     | ) |
| Net loans and  leases receivable                                  |       | 754,458                     |       |                    | 761,599    |   |
|                                                              |       |                        |       |                    |       |   |
| Accrued interest  receivable                                      |       | 9,806                       |       |                    | 8,495      |   |
| Office  properties and equipment, net of accumulated depreciation |       | 15,869                      |       |                    | 15,830     |   |
| Foreclosed real  estate and other properties                      |       | 458                         |       |                    | 508        |   |
| Cash value of  life insurance                                     |       | 13,784                      |       |                    | 13,519     |   |
| Servicing rights                                                  |       | 11,311                      |       |                    | 10,871     |   |
| Goodwill, net                                                     |       | 4,951                       |       |                    | 4,951      |   |
| Other assets                                                      |       | 7,680                       |       |                    | 7,148      |   |
| Total assets                                                      |       |   $               | 1,020,649  |                    |       |   $ | 1,001,454 |   |

 
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                     | ** ** | ** **    | ** ** | ** ** | ** ** | ** **    |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------|------------|------------|------------|---------------|
| **LIABILITIES**                                                                                                                                                    | ** ** | ** **    | ** ** | ** ** | ** ** | ** **    |
| Deposits                                                                                                                                                           |       |   $ | 771,896    |       |       |   $ | 815,864 |   |
| Advances from Federal  Home Loan Bank  and other borrowings                                                                                                        |       | 130,457       |       |       | 68,600     |          |
| Subordinated  debentures payable to trusts                                                                                                                         |       | 27,837        |       |       | 27,837     |          |
| Advances by  borrowers for taxes and insurance                                                                                                                     |       | 10,953        |       |       | 10,337     |          |
| Accrued expenses and  other liabilities                                                                                                                            |       | 15,067        |       |       | 16,546     |          |
| Total  liabilities                                                                                                                                                 |       | 956,210       |       |       | 939,184    |          |
| **STOCKHOLDERS’  EQUITY**                                                                                                                                     | ** ** | ** **    | ** ** | ** ** | ** ** | ** **    |
| Preferred stock, $.01  par value, 500,000 shares authorized, none outstanding                                                                                      |       | - - - -       |       |       | - - - -    |          |
| Series A Junior  Participating Preferred Stock, $1.00 stated value, 50,000 shares authorized,  none outstanding                                               |       | - - - -       |       |       | - - - -    |          |
| Common stock, $.01 par  value, 10,000,000 shares authorized, 6,020,181 and 5,991,200 shares issued at  December 31, 2007 and June 30, 2007, respectively |       | 60            |       |       | 60         |          |
| Common stock subscribed  for but not issued, 5,146 shares at June 30, 2007                                                                                    |       | - - - -       |       |       | 81         |          |
| Additional  paid-in capital                                                                                                                                        |       | 21,637        |       |       | 20,898     |          |
| Retained  earnings, substantially restricted                                                                                                                       |       | 73,649        |       |       | 71,900     |          |
| Accumulated other  comprehensive income (loss), net of related deferred tax effect                                                                                 |       | (497          | )          |       | (1,502     | )             |
| Less cost of treasury  stock, 2,053,836 and 1,977,836 shares at December 31, 2007 and  June 30, 2007, respectively                                       |       | (30,410       | )          |       | (29,167    | )             |
| Total  stockholders’ equity                                                                                                                                   |       | 64,439        |       |       | 62,270     |          |
| Total  liabilities and stockholders’ equity                                                                                                                   |       |   $ | 1,020,649  |       |       |   $ | 1,001,454 |   |
|                                                                                                                                                                    |            |               |            |            |            |               |  |  |  |

 

*See accompanying notes to unaudited consolidatedfinancial statements.*

 

Page 1

 

**HF FINANCIAL CORP. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF INCOME**

**(Dollars in Thousands, Except Per Share Data)**

**(Unaudited)**

 
| ** **                                                               | ** ** | **Three  Months Ended  December 31,** | ** ** | **Six  Months Ended  December 31,** | ** **    |
|--------------------------------------------------------------------------|------------|--------------------------------------------|------------|------------------------------------------|---------------|
|                                                                     |       | 2007                                       |       | 2006                                     |          | 2007 |   | 2006 |   |
| Interest,  dividend and loan fee income:                                 |       |                                       |       |                                     |          |   |   |   |   |
| Loans and leases  receivable                                             |       |   $                              | 13,879     |                                     |   $ | 13,728 |   |   $ | 27,999 |   |   $ | 26,968 |   |
| Investment  securities and interest-earning deposits                     |       | 2,206                                      |       | 1,935                                    |          | 4,071 |   | 3,773 |   |
|                                                                     |       | 16,085                                     |       | 15,663                                   |          | 32,070 |   | 30,741 |   |
| Interest  expense:                                                       |       |                                       |       |                                     |          |   |   |   |   |
| Deposits                                                                 |       | 6,913                                      |       | 7,359                                    |          | 14,411 |   | 13,900 |   |
| Advances from  Federal Home Loan Bank and other borrowings               |       | 2,176                                      |       | 2,244                                    |          | 3,995 |   | 4,363 |   |
|                                                                     |       | 9,089                                      |       | 9,603                                    |          | 18,406 |   | 18,263 |   |
| **Net  interest income**                                                 |       | 6,996                                      |       | 6,060                                    |          | 13,664 |   | 12,478 |   |
| ** **                                                               | ** ** | ** **                                 | ** ** | ** **                               | ** **    | ** ** | ** ** | ** ** | ** ** |
| Provision for  losses on loans and leases                                |       | 295                                        |       | 461                                      |          | 620 |   | 752 |   |
|                                                                     |       |                                       |       |                                     |          |   |   |   |   |
| **Net  interest income after provision  for losses on loans and leases** | ** ** | 6,701                                      |       | 5,599                                    |          | 13,044 |   | 11,726 |   |
| ** **                                                               | ** ** | ** **                                 | ** ** | ** **                               | ** **    | ** ** | ** ** | ** ** | ** ** |
| Noninterest  income:                                                     |       |                                       |       |                                     |          |   |   |   |   |
| Gain on sale of  branches, net                                           |       | - - - -                                    |       | 2,763                                    |          | - - - - |   | 2,763 |   |
| Fees on deposits                                                         |       | 1,355                                      |       | 1,315                                    |          | 2,768 |   | 2,508 |   |
| Loan servicing  income                                                   |       | 542                                        |       | 441                                      |          | 1,047 |   | 770 |   |
| Gain on sale of  loans, net                                              |       | 439                                        |       | 260                                      |          | 698 |   | 456 |   |
| Trust income                                                             |       | 249                                        |       | 230                                      |          | 498 |   | 446 |   |
| Other                                                                    |       | 381                                        |       | 413                                      |          | 770 |   | 823 |   |
|                                                                     |       | 2,966                                      |       | 5,422                                    |          | 5,781 |   | 7,766 |   |
| Noninterest  expense:                                                    |       |                                       |       |                                     |          |   |   |   |   |
| Compensation and  employee benefits                                      |       | 4,788                                      |       | 4,478                                    |          | 9,231 |   | 8,634 |   |
| Occupancy and  equipment                                                 |       | 981                                        |       | 958                                      |          | 1,918 |   | 1,896 |   |
| Marketing                                                                |       | 299                                        |       | 704                                      |          | 562 |   | 1,147 |   |
| Check and data  processing expense                                       |       | 608                                        |       | 567                                      |          | 1,221 |   | 1,119 |   |
| Other                                                                    |       | 1,032                                      |       | 984                                      |          | 1,920 |   | 1,804 |   |
|                                                                     |       | 7,708                                      |       | 7,691                                    |          | 14,852 |   | 14,600 |   |
| ** **                                                               | ** ** | ** **                                 | ** ** | ** **                               | ** **    | ** ** | ** ** | ** ** | ** ** |
| **Income  before income taxes**                                          |       | 1,959                                      |       | 3,330                                    |          | 3,973 |   | 4,892 |   |
| ** **                                                               | ** ** | ** **                                 | ** ** | ** **                               | ** **    | ** ** | ** ** | ** ** | ** ** |
| Income tax  expense                                                      |       | 708                                        |       | 1,219                                    |          | 1,375 |   | 1,684 |   |
| **Net  income**                                                          |       |   $                              | 1,251      |                                     |   $ | 2,111 |   |   $ | 2,598 |   |   $ | 3,208 |   |
|                                                                     |       |                                       |       |                                     |          |   |   |   |   |
| **Comprehensive  income**                                                |       |   $                              | 1,539      |                                     |   $ | 2,254 |   |   $ | 3,603 |   |   $ | 4,586 |   |
| **Cash  dividends declared per share**                                   |       |   $                              | 0.1075     |                                     |   $ | 0.1050 |   |   $ | 0.2150 |   |   $ | 0.2075 |   |
| ** **                                                               | ** ** | ** **                                 | ** ** | ** **                               | ** **    | ** ** | ** ** | ** ** | ** ** |
| **Earnings  per share:**                                                 | ** ** | ** **                                 | ** ** | ** **                               | ** **    | ** ** | ** ** | ** ** | ** ** |
| Basic                                                                    |       |   $                              | 0.32       |                                     |   $ | 0.53 |   |   $ | 0.65 |   |   $ | 0.81 |   |
| Diluted                                                                  |       |   $                              | 0.31       |                                     |   $ | 0.52 |   |   $ | 0.64 |   |   $ | 0.79 |   |

 

*See accompanying notes to unaudited consolidatedfinancial statements.*

 

Page 2

 

**HFFINANCIAL CORP. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Dollarsin Thousands)**

**(Unaudited)**

 
| ** **                                                                                     | ** ** | **Six  Months Ended December 31,** | ** ** |
|------------------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                                     | ** ** | **2007**                           | ** ** | **2006** | ** ** |
| **Cash  flows from operating activities**                                                      |       |                               |       |   |   |   |
| Net income                                                                                     |       |   $                      | 2,598      |   |   |   $ | 3,208 |   |
| Adjustments to  reconcile net income to net cash provided by (used in) operating activities:   |       |                               |       |   |   |   |
| Provision for  losses on loans and leases                                                      |       | 620                                |       |   | 752 |   |
| Depreciation                                                                                   |       | 850                                |       |   | 803 |   |
| Amortization of  discounts and premiums on securities and other                                |       | 787                                |       |   | 971 |   |
| Stock based  compensation                                                                      |       | 375                                |       |   | 452 |   |
| Deferred income  taxes (credits)                                                               |       | - - - -                            |       |   | (572 | ) |
| Net change in  loans held for resale                                                           |       | 3,938                              |       |   | (4,888 | ) |
| (Gain) on sale  of loans, net                                                                  |       | (698                               | )          |   | (456 | ) |
| (Gain) on sale  of branches                                                                    |       | - - - -                            |       |   | (2,763 | ) |
| Losses and  provision for losses on sales of foreclosed real estate and other properties,  net |       | 15                                 |       |   | 32 |   |
| (Gain) loss on  disposal of office properties and equipment, net                               |       | - - - -                            |       |   | (7 | ) |
| Change in other  assets and liabilities                                                        |       | (4,436                             | )          |   | 5,334 |   |
| Net cash  provided by operating activities                                                     |       | 3,974                              |       |   | 2,866 |   |
|                                                                                           |       |                               |       |   |   |   |
| **Cash  flows from investing activities**                                                      |       |                               |       |   |   |   |
| Loan  participations purchased                                                                 |       | (4,911                             | )          |   | (18,815 | ) |
| Net change in  loans outstanding                                                               |       | 10,833                             |       |   | (3,919 | ) |
| Proceeds from  sale of loans associated with branch sales                                      |       | - - - -                            |       |   | 4,256 |   |
| Securities  available for sale:                                                                |       |                               |       |   |   |   |
| Sales and  maturities and repayments                                                           |       | 26,301                             |       |   | 18,668 |   |
| Purchases                                                                                      |       | (46,430                            | )          |   | (17,485 | ) |
| Purchase of  Federal Home Loan Bank stock                                                      |       | (4,493                             | )          |   | (2,658 | ) |
| Redemption of  Federal Home Loan Bank stock                                                    |       | 1,149                              |       |   | 2,830 |   |
| Proceeds from  sale of office properties and equipment                                         |       | - - - -                            |       |   | 9 |   |
| Proceeds from  sale of office properties and equipment associated with branch sales            |       | - - - -                            |       |   | 341 |   |
| Purchase of  office properties and equipment                                                   |       | (889                               | )          |   | (2,384 | ) |
| Purchase of  servicing rights                                                                  |       | (955                               | )          |   | (5,514 | ) |
| Proceeds from  sale of foreclosed real estate and other properties, net                        |       | 209                                |       |   | 581 |   |
| Net cash (used  in) investing activities                                                       |       | (19,186                            | )          |   | (24,090 | ) |
|                                                                                           |       |                               |       |   |   |
| *See  accompanying notes to unaudited consolidated financial statements.*                      |
|                                                                                                |            |                                    |            |  |  |  |  |  |

 

Page 3

 

**HFFINANCIAL CORP. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS (CONTINUED)**

**(Dollarsin Thousands)**

**(Unaudited) **

 
| ** **                                                  | ** ** | **Six  Months Ended December 31,** | ** ** |
|-------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                  | ** ** | **2007**                           | ** ** | ** ** | **2006** | ** ** |
|                                                        |       |                               |       |   |   |   |
| **Cash  flows from financing activities**                   |       |                               |       |   |   |   |
| Net increase  (decrease) in deposit accounts                |       |  $                            | (43,968    | ) |   |  $ | 73,397 |   |
| Proceeds of  advances from Federal Home Loan                |       |                               |       |   |   |   |
| Bank and other  borrowings                                  |       | 822,949                            |       |   | 492,902 |   |
| Payments on  advances from Federal Home Loan                |       |                               |       |   |   |   |
| Bank and other  borrowings                                  |       | (761,092                           | )          |   | (494,022 | ) |
| Proceeds from  issuance of subordinated debentures          |       | 5,000                              |       |   | 10,000 |   |
| Deposit account  disbursements associated with branch sales |       | - - - -                            |       |   | (33,563 | ) |
| Redemption of  subordinated debentures                      |       | (5,000                             | )          |   | (10,000 | ) |
| Increase  (decrease) in advances by borrowers               |       | 616                                |       |   | 3,040 |   |
| Purchase of  treasury stock                                 |       | (1,243                             | )          |   | - - - - |   |
| Proceeds from  issuance of common stock                     |       | 364                                |       |   | 325 |   |
| Cash dividends  paid                                        |       | (848                               | )          |   | (822 | ) |
| Net cash  provided by financing activities                  |       | 16,778                             |       |   | 41,257 |   |
|                                                        |       |                               |       |   |   |   |
| Increase  (decrease) in cash and cash equivalents           |       | 1,566                              |       |   | 20,033 |   |
|                                                        |       |                               |       |   |   |   |
| Cash and cash  equivalents                                  |       |                               |       |   |   |   |
| Beginning                                                   |       | 22,476                             |       |   | 27,037 |   |
| Ending                                                      |       |  $                            | 24,042     |   |   |  $ | 47,070 |   |
|                                                        |       |                               |       |   |   |   |
| Supplemental  Disclosures of Cash Flows Information         |       |                               |       |   |   |   |
| Cash payments  for interest                                 |       |  $                            | 18,426     |   |   |  $ | 17,013 |   |
| Cash payments  for income and franchise taxes, net          |       | 1,850                              |       |   | 396 |   |

 

*See accompanying notes to unaudited consolidatedfinancial statements.*

 

Page 4

 

**HF FINANCIAL CORP. AND SUBSIDIARIES**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

ForThe Six Months Ended December 31, 2007 and 2006

(Unaudited)

 

**NOTE 1.          SELECTEDACCOUNTING POLICIES**

 

*Basis ofpresentation:*

 

The consolidated financial information of HF FinancialCorp. (the “Company”) and its wholly-owned subsidiaries included in thisQuarterly Report on Form 10-Q is unaudited. However, in the opinion ofmanagement, adjustments (consisting of normal recurring adjustments) necessaryfor a fair presentation for the interim periods have been included. Results forany interim period are not necessarily indicative of results to be expected forthe fiscal year. Interim consolidated financial statements and the notesthereto 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, 2007 (“Fiscal 2007”), filed with theSecurities and Exchange Commission. The accounting and reporting policies ofthe Company and its subsidiaries conform to accounting principles generallyaccepted in the United States of America (“GAAP”) and to general practicewithin the industry.

 

The interim consolidated financial statements includethe accounts of the Company, its wholly-owned subsidiaries, Home Federal Bank(the “Bank”), HF Financial Group, Inc. (“HF Group”) and HomeFirst MortgageCorp. (the “Mortgage Corp.”), and the Bank’s wholly-owned subsidiaries, MidAmerica Capital Services, Inc. (“Mid America Capital”), Hometown Insurors, Inc.(“Hometown”), Home Federal Securitization Corp. (“HFSC”), Mid-America ServiceCorporation and PMD, Inc. All intercompany balances and transactions havebeen eliminated in consolidation.

 

 **NOTE 2.         REGULATORY CAPITAL**

 

The following table sets forth the Bank’scompliance with its minimum capital requirements for a well-capitalizedinstitution at December 31, 2007:

 
| ** **                                         | ** ** | **Amount**              |   | **Percent** |   |
|----------------------------------------------------|------------|-------------------------|--------|-------------|--------|
|                                               |       | (Dollars in  Thousands) |   |
| Tier I (core)  capital (to adjusted total assets): |       |                    |   |        |   |
| Required                                           |       | $50,735                 |   |        | 5.00   |   | % |
| Actual                                             |       | 85,109                  |   |        | 8.39   |   |   |
| Excess over  required                              |       | 34,374                  |   |        | 3.39   |   |   |
|                                               |       |                    |   |        |   |   |   |
| Risk-based  capital (to risk-weighted assets):     |       |                    |   |        |   |   |   |
| Required                                           |       | $80,990                 |   |        | 10.00  |   | % |
| Actual                                             |       | 90,403                  |   |        | 11.16  |   |   |
| Excess over  required                              |       | 9,413                   |   |        | 1.16   |   |   |
|                                                    |            |                         |        |             |        |  |  |  |

 

Page 5

 

**NOTE3.          EARNINGS PER SHARE**

 

Basic earnings per share is computed by dividingincome available to common stockholders (the numerator) by the weighted-averagenumber of common shares outstanding (the denominator) during the period. Sharesissued during the period and shares reacquired during the period are weightedfor the portion of the period they were outstanding. The weighted averagenumber of basic common shares outstanding for the three months ended December 31,2007 and 2006 was 3,955,388 and 3,968,451, respectively. The weighted averagenumber of basic common shares outstanding for the six months ended December 31,2007 and 2006 was 3,984,376 and 3,964,261, respectively.

 

Dilutive earnings per share is similar to thecomputation of basic earnings per share except the denominator is increased toinclude the number of additional common shares that would have been outstandingif the dilutive options outstanding had been exercised. The weighted averagenumber of common and dilutive potential common shares outstanding for the threemonths ended December 31, 2007 and 2006 was 4,009,060 and 4,046,493,respectively. The weighted average number of common and dilutive potentialcommon shares outstanding for the six months ended December 31, 2007 and2006 was 4,043,022 and 4,040,227, 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:

 
|                        |   | December 31,  2007      |    |
|-----------------------------|--------|-------------------------|---------|
|                        |   |                    |    | Gross |   | Gross |   |   |   |
|                        |   | Amortized               |    | Unrealized |   | Unrealized |   | Fair |   |
|                        |   | Cost                    |    | Gains |   | (Losses) |   | Value |   |
|                        |   | (Dollars in  Thousands) |    |
|                        |   |                    |    |   |   |   |   |   |   |
| Debt securities:            |   |                    |    |   |   |   |   |   |   |
| U.S. government  agencies   |   |  $                 | 10,054  |   |  $ | 122 |   |  $ | - - - - |   |  $ | 10,176 |   |
| Federal Home  Loan Bank     |   | 12,457                  |    | 215 |   | - - - - |   | 12,672 |   |
| Municipal bonds             |   | 11,147                  |    | 83 |   | (99 | ) | 11,131 |   |
| Preferred Term  Securities  |   | 10,931                  |    | - - - - |   | (505 | ) | 10,426 |   |
|                        |   | 44,589                  |    | 420 |   | (604 | ) | 44,405 |   |
|                        |   |                    |    |   |   |   |   |   |   |
| Equity  securities:         |   |                    |    |   |   |   |   |   |   |
| FNMA                        |   | 8                       |    | 8 |   | - - - - |   | 16 |   |
| Federal Ag  Mortgage        |   | 7                       |    | 2 |   | - - - - |   | 9 |   |
| Other  Investments          |   | 232                     |    | - - - - |   | - - - - |   | 232 |   |
|                        |   | 247                     |    | 10 |   | - - - - |   | 257 |   |
|                        |   |                    |    |   |   |   |   |   |   |
| Mortgage-backed  securities |   | 119,876                 |    | 860 |   | (1,046 | ) | 119,690 |   |
|                        |   |  $                 | 164,712 |   |  $ | 1,290 |   |  $ | (1,650 | ) |  $ | 164,352 |   |

 

Page 6

 
|                        |   | December 31,  2006      |    |
|-----------------------------|--------|-------------------------|---------|
|                        |   |                    |    | Gross |   | Gross |   |   |   |
|                        |   | Amortized               |    | Unrealized |   | Unrealized |   | Fair |   |
|                        |   | Cost                    |    | Gains |   | (Losses) |   | Value |   |
|                        |   | (Dollars in  Thousands) |    |
|                        |   |                    |    |   |   |   |   |   |   |
| Debt securities:            |   |                    |    |   |   |   |   |   |   |
| U.S. government  agencies   |   |  $                 | 12,061  |   |  $ | 25 |   |  $ | (89 | ) |  $ | 11,997 |   |
| Federal Home  Loan Bank     |   | 13,450                  |    | 14 |   | (82 | ) | 13,382 |   |
| Municipal bonds             |   | 7,925                   |    | 30 |   | (66 | ) | 7,889 |   |
| Preferred Term  Securities  |   | 11,019                  |    | 102 |   | (80 | ) | 11,041 |   |
| Other  Investments          |   | 5,274                   |    | 92 |   | - - - - |   | 5,366 |   |
|                        |   | 49,729                  |    | 263 |   | (317 | ) | 49,675 |   |
|                        |   |                    |    |   |   |   |   |   |   |
| Common Stock:               |   |                    |    |   |   |   |   |   |   |
| FNMA                        |   | 8                       |    | 16 |   | - - - - |   | 24 |   |
| Federal Ag  Mortgage        |   | 7                       |    | 3 |   | - - - - |   | 10 |   |
| Other Investments           |   | 100                     |    | - - - - |   | - - - - |   | 100 |   |
|                        |   | 115                     |    | 19 |   | - - - - |   | 134 |   |
|                        |   |                    |    |   |   |   |   |   |   |
| Mortgage-backed  securities |   | 98,273                  |    | 100 |   | (1,813 | ) | 96,560 |   |
|                        |   |  $                 | 148,117 |   |  $ | 382 |   |  $ | (2,130 | ) |  $ | 146,369 |   |

 

The following table presentsthe fair value and age of gross unrealized losses by investment category at December 31,2007 in accordance with FASB Staff Position (“FSP”) No. FAS 115-1, *The Meaning of Other-Than-Temporary Impairment andIts Application to Certain Investments.*

 
| ** **                  | ** ** | **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)** | ** ** |
|                        |       |                        |       |                   |       |       |       |   |   |   |   |   |   |
| Municipal bonds             |       | 2,192                       |       | (9                     | )          | 2,867      |       | (90 | ) | 5,059 |   | (99 | ) |
| Preferred term  securities  |       | 8,533                       |       | (380                   | )          | 1,893      |       | (125 | ) | 10,426 |   | (505 | ) |
| Mortgage-backed  securities |       | 22,579                      |       | (293                   | )          | 42,923     |       | (753 | ) | 65,502 |   | (1,046 | ) |
|                        |       |  $                     | 33,304     |                   |  $    | (682       | )          |  $ | 47,683 |   |  $ | (968 | ) |  $ | 80,987 |   |  $ | (1,650 | ) |
|                             |            |                             |            |                        |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Management does notbelieve any individual unrealized losses as of December 31, 2007 representan other-than-temporary impairment. The unrealized losses reported formortgage-backed securities relate to securities issued by the Federal NationalMortgage Association (“FNMA”), the Government National Mortgage Association (“GNMA”),and the Federal Home Loan Mortgage Corporation (“FHLMC”). These unrealizedlosses in total are primarily attributable to changes in interest rates and thecontractual cashflows of those investments are guaranteed by an agency of theU.S. government. As a group, the unrealized losses were less than 2.0% of theirrespective amortized cost basis at December 31, 2007. Because the declinein market value is attributable primarily to changes in interest rates and notcredit quality, and because the Company has the ability and intent to holdthose investments until a recovery of fair value, which may be at maturity, theCompany does not consider those investments to be other-than-temporarilyimpaired at December 31, 2007.

 

Page 7

 

**NOTE 5.          SEGMENTREPORTING**

 

Operating segments are defined as components of anenterprise for which separate financial information is available that isevaluated regularly by the chief operating decision makers in deciding how toallocate resources and in assessing performance. The Company’s reportablesegments 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 smallernonreportable segments, the Company and inter-segment eliminations.

 

The management approach is used as the conceptualbasis for identifying reportable segments and is based on the way thatmanagement organizes the segments within the enterprise for making operatingdecisions, allocating resources and monitoring performance, which is primarilybased on products.

 
| **Three  Months Ended December 31, 2007** | ** ** | **Banking**                 | ** ** | **Other** | ** ** | **Total** | ** ** |
|-------------------------------------------|------------|-----------------------------|------------|-----------|------------|-----------|------------|
| ** **                                | ** ** | **(Dollars  in Thousands)** | ** ** |
|                                      |       |                        |       |      |       |      |       |   |   |
| Net interest  income                      |       |  $                     | 7,503      |      |       |  $   | (507       | ) |   |  $ | 6,996 |   |
| Provision for  losses on loans and leases |       | (295                        | )          |      | - - - -    |      |       | (295 | ) |
| Noninterest  income                       |       | 2,923                       |       |      | 43         |      |       | 2,966 |   |
| Intersegment  noninterest income          |       | (22                         | )          |      | (22        | )         |       | (44 | ) |
| Noninterest  expense                      |       | (7,408                      | )          |      | (300       | )         |       | (7,708 | ) |
| Intersegment  noninterest expense         |       | - - - -                     |       |      | 44         |      |       | 44 |   |
| Income (loss)  before income taxes        |       |  $                     | 2,701      |      |       |  $   | (742       | ) |   |  $ | 1,959 |   |
|                                      |       |                        |       |      |       |      |       |   |   |
| Total assets at  December 31, 2007        |       |  $                     | 1,016,060  |      |       |  $   | 4,589      |   |   |  $ | 1,020,649 |   |

 
| **Three  Months Ended December 31, 2006** | ** ** | **Banking**                 | ** ** | **Other** | ** ** | **Total** | ** ** |
|-------------------------------------------|------------|-----------------------------|------------|-----------|------------|-----------|------------|
| ** **                                | ** ** | **(Dollars  in Thousands)** | ** ** |
|                                      |       |                        |       |      |       |      |       |   |   |
| Net interest  income                      |       |  $                     | 7,174      |      |       |  $   | (1,114     | ) |   |  $ | 6,060 |   |
| Intersegment  interest income             |       | (230                        | )          |      | 230        |      |       | - - - - |   |
| Provision for  losses on loans and leases |       | (461                        | )          |      | - - - -    |      |       | (461 | ) |
| Noninterest  income                       |       | 5,475                       |       |      | (53        | )         |       | 5,422 |   |
| Intersegment  noninterest income          |       | (201                        | )          |      | 201        |      |       | - - - - |   |
| Noninterest  expense                      |       | (7,463                      | )          |      | (228       | )         |       | (7,691 | ) |
| Intersegment  noninterest expense         |       | 3                           |       |      | (3         | )         |       | - - - - |   |
| Income (loss)  before income taxes        |       |  $                     | 4,297      |      |       |  $   | (967       | ) |   |  $ | 3,330 |   |
|                                      |       |                        |       |      |       |      |       |   |   |
| Total assets at  December 31, 2006        |       |  $                     | 1,009,944  |      |       |  $   | 2,074      |   |   |  $ | 1,012,018 |   |

 

Page 8

 
| **Six  Months Ended December 31, 2007**   | ** ** | **Banking**                 | ** ** | **Other** | ** ** | **Total** | ** ** |
|-------------------------------------------|------------|-----------------------------|------------|-----------|------------|-----------|------------|
| ** **                                | ** ** | **(Dollars  in Thousands)** | ** ** |
|                                      |       |                        |       |      |       |      |       |   |
| Net interest  income                      |       |  $                     | 14,797     |      |       |  $   | (1,133     | ) |   |  $ | 13,664 |   |
| Provision for  losses on loans and leases |       | (620                        | )          |      | - - - -    |      |       | (620 | ) |
| Noninterest  income                       |       | 5,692                       |       |      | 89         |      |       | 5,781 |   |
| Intersegment  noninterest income          |       | (54                         | )          |      | (34        | )         |       | (88 | ) |
| Noninterest  expense                      |       | (14,313                     | )          |      | (539       | )         |       | (14,852 | ) |
| Intersegment  noninterest expense         |       | - - - -                     |       |      | 88         |      |       | 88 |   |
| Income (loss)  before income taxes        |       |  $                     | 5,502      |      |       |  $   | (1,529     | ) |   |  $ | 3,973 |   |
|                                      |       |                        |       |      |       |      |       |   |   |
| Total assets at  December 31, 2007        |       |  $                     | 1,016,060  |      |       |  $   | 4,589      |   |   |  $ | 1,020,649 |   |

 
| **Six  Months Ended December 31, 2006**   | ** ** | **Banking**             | ** ** | **Other** | ** ** | **Total** | ** ** |
|-------------------------------------------|------------|-------------------------|------------|-----------|------------|-----------|------------|
|                                      |       | (Dollars in  Thousands) |       |
|                                      |       |                    |       |
| Net interest  income                      |       |  $                 | 14,453     |      |       |  $   | (1,975     | ) |   |  $ | 12,478 |   |
| Intersegment  interest income             |       | (477                    | )          |      | 477        |      |       | - - - - |   |
| Provision for losses  on loans and leases |       | (752                    | )          |      | - - - -    |      |       | (752 | ) |
| Noninterest  income                       |       | 7,901                   |       |      | (135       | )         |       | 7,766 |   |
| Intersegment  noninterest income          |       | (208                    | )          |      | 208        |      |       | - - - - |   |
| Noninterest  expense                      |       | (14,179                 | )          |      | (421       | )         |       | (14,600 | ) |
| Intersegment  noninterest expense         |       | 4                       |       |      | (4         | )         |       | - - - - |   |
| Income (loss)  before income taxes        |       |  $                 | 6,742      |      |       |  $   | (1,850     | ) |   |  $ | 4,892 |   |
|                                      |       |                    |       |      |       |      |       |   |   |
| Total assets at  December 31, 2006        |       |  $                 | 1,009,944  |      |       |  $   | 2,074      |   |   |  $ | 1,012,018 |   |

 

Page 9

 

**NOTE 6.          DEFINEDBENEFIT PLAN**

 

The Company has a noncontributory (cash balance)defined benefit pension plan covering all employees of the Company and itswholly-owned subsidiaries who have attained the age of 21 and have completed1,000 hours of service in a plan year. The benefits are based on 6% of eacheligible participant’s annual compensation, plus income earned in the accountsat a rate determined annually based on 30-year treasury note rates. The Company’sfunding policy is to make the minimum annual required contribution plus suchamounts as the Company may determine to be appropriate from time to time. Participantsare 100% vested after five years of service with a retirement age of the laterof age 65 or five years of participation. Information relative to thecomponents of net periodic benefit cost for the Company’s defined benefit planis presented below:

 
| ** **                         | ** ** | **Three  Months Ended  December 31,** | ** ** | ** ** | **Six  Months Ended  December 31,** | ** ** |
|------------------------------------|------------|---------------------------------------|------------|------------|-------------------------------------|------------|
| ** **                         | ** ** | **2007**                              | ** ** | **2006**   | ** **                          | ** ** | **2007** | ** ** | **2006** | ** ** |
|                               |       |                                  |       |       |                                |       |   |   |   |   |   |
| Service cost                       |       |  $                               | 111,830    |       |                                |  $    | 116,521 |   |   |  $ | 223,660 |   |   |  $ | 233,042 |   |
| Interest cost                      |       | 109,260                               |       |       | 97,748                              |       |   |  $ | 218,520 |   |   |  $ | 195,496 |   |
| Expected return  on plan assets    |       | (121,791                              | )          |       | (109,101                            | )          |   |  $ | (243,582 | ) |   |  $ | (218,202 | ) |
| Total costs  recognized in expense |       |  $                               | 99,299     |       |                                |  $    | 105,168 |   |   |  $ | 198,598 |   |   |  $ | 210,336 |   |

 

The Company previously disclosed in its consolidatedfinancial statements for Fiscal 2007, which are included in Part II, Item8 “Financial Statements and Supplementary Data” of the Company’s Annual Reporton Form 10-K for Fiscal 2007, that it contributed $621,000 to fund itsqualified pension plan. During the first quarter of the fiscal year ending June 30,2008 (“Fiscal 2008”), the Company made contributions of $532,000 to fund itsqualified pension plan. The Company anticipates no additional contributions forFiscal 2008.

 

**NOTE 7.          SELF-INSUREDHEALTHCARE PLAN**

 

The Company has had a self-insured health planfor its employees, subject to certain limits, since January 1994. The Bankis named the plan administrator for this plan and has retained the services ofan independent third party administrator to process claims and handle otherduties for this plan. The third party administrator does not assume liabilityfor benefits payable under this plan.

 

The Company assumes the responsibility for funding theplan benefits out of general assets; however, employees cover some of the costsof covered benefits through contributions, deductibles, co-pays andparticipation amounts. An employee is eligible for coverage upon completion of30 calendar days of regular employment. The plan, which is on a calendar yearbasis, is intended to comply with, and be governed by, the Employee RetirementIncome Security Act of 1974, as amended.

 

Page 10

 

Total net healthcare costs are inclusive ofhealth claims expenses and administration fees offset by stop loss and employeereimbursement. Reported below is a summary of net healthcare costs by quarterfor the fiscal years ended June 30, 2008 and 2007.

 
| ** **                  | ** ** | **Fiscal  Years Ended June 30,** | ** ** | ** ** |
|-----------------------------|------------|----------------------------------|------------|------------|
| ** **                  | ** ** | **2008**                         | ** ** | **2007**   | ** ** | ** ** |
|                        | ** ** | (Dollars in  Thousands)          | ** ** | ** ** |
|                        |       |                             |       |       |   |   |   |
| Quarter ended  September 30 |       |  $                          | 221        |       |   |  $ | 436 |   |   |
| Quarter ended  December 31  |       | 409                              |       |       | 357 |   |   |
| Quarter ended  March 31     |       | - - - -                          |       |       | 760 |   |   |
| Quarter ended  June 30      |       | - - - -                          |       |       | 596 |   |   |
| Net healthcare  costs       |       |  $                          | 630        |       |   |  $ | 2,149 |   |   |
|                             |            |                                  |            |            |  |  |  |  |  |  |

 

 

**NOTE 8.          STOCK-BASEDCOMPENSATION PLANS**

 

The fair value of each incentive stock optiongrant and stock appreciation right is estimated at the grant date using theBlack-Scholes option-pricing model. The following weighted average assumptionswere used for grants in the six months ended December 31, 2007 and 2006:

 
|                      |   | For the Six  Months Ended |   |
|---------------------------|--------|---------------------------|--------|
|                      |   | December 31,              |   |
|                      |   | 2007                      |   | 2006 |   |
|                      |   |                      |   |   |   |
| Expected  volatility      |   | 22.00                     | %      | 23.00 | % |
| Expected  dividend yield  |   | 2.61                      | %      | 2.63 | % |
| Risk-free  interest rate  |   | 4.10                      | %      | 4.61 | % |
| Expected term  (in years) |   |                      | 4      |   | 4 |

 

Page 11

 

Stockoption and stock appreciation right activity for the six months ended December 31follow:

 
|              |   | **Stock Options**             |   |
|-------------------|--------|-------------------------------|--------|
|              |   |                          |   |
|              |   | 2007                          |   | 2006 |   |
|              |   | Shares                        |   | Weighted  Average  Exercise  Price |   | Weighted  Average  Remaining  Contractual  Term |   | Aggregate  Intrinsic  Value |   | Shares |   | Weighted  Average  Exercise  Price |   | Weighted  Average  Remaining  Contractual  Term |   | Aggregate  Intrinsic  Value |   |
|              |   |                          |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Beginning Balance |   | 244,602                       |   | $ |  12.75 |   |   |   |   |   | 318,977 |   | $ |  12.77 |   |   |   |   |   |
| Granted           |   | - - - -                       |   | - - - - |   |   |   |   |   | - - - - |   | - - - - |   |   |   |   |   |
| Forfeited         |   | (1,870                        | )      | 17.27 |   |   |   |   |   | (11,002 | ) | 17.27 |   |   |   |   |   |
| Exercised         |   | (24,920                       | )      | 10.88 |   |   |   |   |   | (23,267 | ) | 12.69 |   |   |   |   |   |
|              |   |                          |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Ending Balance    |   | 217,812                       |   | $ |  12.60 |   | 6.06 |   | $ |  508 |   | 284,708 |   | $ |  12.85 |   | 5.76 |   | $ |  1,268 |   |
|              |   |                          |   |
|              |   |                          |   |
|              |   | **Stock Appreciation Rights** |   |
|              |   |                          |   |
|              |   | 2007                          |   | 2006 |   |
|              |   | SARs                          |   | Weighted  Average  Exercise  Price |   | Weighted  Average  Remaining  Contractual  Term |   | Aggregate  Intrinsic  Value |   | SARs |   | Weighted  Average  Exercise  Price |   | Weighted  Average  Remaining  Contractual  Term |   | Aggregate  Intrinsic  Value |   |
|              |   |                          |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Beginning Balance |   | 19,899                        |   | $ |  12.75 |   |   |   |   |   | - - - - |   | $ |  - - - - |   |   |   |   |   |
| Granted           |   | 29,204                        |   | 16.10 |   |   |   |   |   | 20,953 |   | 16.00 |   |   |   |   |   |
| Forfeited         |   | (3,534                        | )      | 16.05 |   |   |   |   |   | (1,054 | ) | 16.00 |   |   |   |   |   |
| Exercised         |   | - - - -                       |   | - - - - |   |   |   |   |   | - - - - |   | - - - - |   |   |   |   |   |
|              |   |                          |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Ending Balance    |   | 45,569                        |   | $ |  13.22 |   | 3.33 |   | $ |  83 |   | 19,899 |   | $ |  12.85 |   | 3.75 |   | $ |  81 |   |

 

The weighted-average grant date fair value of optionsand stock appreciation rights (SARs) granted during the six months ended December 31,2007 and 2006 was $2.89 and $3.11, respectively. The total intrinsic value ofoptions exercised during the six months ended December 31, 2007 and 2006was $106,000 and $107,000, respectively. As of December 31, 2007, therewas $6,000 of total unrecognized compensation cost related to nonvested stockoption awards. The cost is expected to be recognized over a period of sixmonths for stock option awards and over a weighted average period of four yearsfor SARs awards. Cash received from the exercise of options for the six monthsended December 31, 2007 and 2006 was $271,000 and $295,000, respectively. Thetax benefit realized for the tax deductions from cashless option exercisestotaled $2,600 and $30,000 for the six months ended December 31, 2007 and2006, respectively.

 

Page 12

 

Restrictedshare activity for the six months ended December 31 follows:

 
|                          |       | 2007       |       | 2006       |       |
|-------------------------------|------------|------------|------------|------------|------------|
|                          |       |       |       |       |       |   |   |   |   |   |   |   |
|                          |       |       |       |       | Weighted   |   |   |   |   |   | Weighted |   |
|                          |       |       |       |       | Average    |   |   |   |   |   | Average |   |
|                          |       |       |       |       | Grant Date |   |   |   |   |   | Grant Date |   |
|                          |       | Shares     |       |       | Fair Value |   |   | Shares |   |   | Fair Value |   |
|                          |       |       |       |       |       |   |   |   |   |   |   |   |
| Nonvested  Balance, beginning |       | 144,711    |       |       |  $    | 16.10 |   |   | 158,159 |   |   |  $ | 15.85 |   |
| Granted                       |       | 14,955     |       |       | 16.78      |   |   | 10,335 |   |   | 16.67 |   |
| Vested                        |       | (30,925    | )          |       | 14.47      |   |   | (16,447 | ) |   | 13.97 |   |
| Forfeited                     |       | (10,894    | )          |       | 16.46      |   |   | (5,733 | ) |   | 15.35 |   |
| ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Nonvested  Balance, ending    |       | 117,847    |       |       |  $    | 16.58 |   |   | 146,314 |   |   |  $ | 16.06 |   |

 

Pretax compensation expense recognized for restrictedshares for the six months ended December 31, 2007 and 2006 was $216,000and $234,000, respectively. The tax benefit for the six months ended December 31,2007 and 2006 was $73,000 and $80,000, respectively. As of December 312007, there was $1.2 million of total unrecognized compensation cost related torestricted shares granted under the Company’s 2002 Stock Option and IncentivePlan, as amended (“the Plan”). The cost is expected to be recognized over aweighted-average period of four years. The total fair value of shares vestedduring the six months ended December 31, 2007 and 2006 was $447,000 and$230,000, respectively.

 

Awards to directors of restricted shares of theCompany’s common stock are made to outside directors from the Company’s 2002Stock Option and Incentive Plan (2002 Option Plan). This plan was effective fordirectors as of January 1, 2007, when the prior plan, the “DirectorRestricted Stock Plan” expired on December 31, 2006. The DirectorRestricted Stock Plan provided awards of restricted shares of the Company’scommon stock and was in effect for a period of ten years.

 

These stock option and incentive plans are describedmore fully in Part II, Item 8 “Financial Statements and Supplementary Data”of the Company’s Annual Report on Form 10-K for Fiscal 2007, under Note 16of “Notes to Consolidated Financial Statements.”

 

**NOTE 9.          SUBORDINATEDDEBENTURES PAYABLE TO TRUSTS**

 

On July 5, 2007, the Company issued 5,000 sharestotaling $5.0 million of Company Obligated Mandatorily Redeemable PreferredSecurities of Trust VI. Trust VI was established and exists for the solepurpose of issuing trust preferred securities and investing the proceeds insubordinated debentures of the Company. These subordinated debenturesconstitute the sole asset of Trust VI. The securities provide for cumulativecash distributions calculated at a rate based on three-month LIBOR plus 1.65%,adjusted quarterly. Refer to Note 11 in regards to the interest rate swapagreement, which converted the variable-rate Trust Preferred VI security into afixed-rate security for a term of five years. The Company may, at one or moretimes, defer interest payments on the capital securities for up to 20consecutive quarterly periods, but not beyond October 1, 2037. At the endof the deferral period, all accumulated and unpaid distributions must be paid. Thecapital securities must be redeemed on October 1, 2037; however, theCompany has the option to shorten the maturity date to a date not earlier than October 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 exercised its optionto redeem $5.0 million of Company Obligated Mandatorily Redeemable PreferredSecurities of Trust II.

 

Page 13

 

**NOTE 10.       SALEOF BRANCHES**

** **

During the second quarter of Fiscal 2007, the Bankclosed on the sale of three branches and their associated book of business,along with one physical location. The Bank recognized a gain on sale of $2.8million that resulted in the sale of $4.2 million in loans and $33.6 million indeposits.

 

**NOTE 11.       INTEREST RATE CONTRACTS**

 

During the first quarter of Fiscal 2008, the Companyentered into an interest rate swap agreement with a $5.0 million notionalamount to convert the variable-rate Trust Preferred VI security into afixed-rate security for a term of five years at a fixed rate of 6.69%. Thisrate swap is designated as a cash flow hedge. For the six months ended December 31,2007, the Company recognized net interest income of $5,100 and this was used tooffset the interest expense for the subordinated debentures.

 

The Company is exposed to losses if the counterpartyfails to make its payments under a contract in which the Company is in areceiving status. The Company minimizes its risk by monitoring the creditstanding of the counterparty. The Company anticipates the counterparty will beable to fully satisfy its obligations under the remaining agreement.

 

**NOTE 12.       COMPREHENSIVE INCOME**

 

Comprehensive income consists of two components, netincome and other comprehensive income. Other comprehensive income refers torevenues, expenses and gains and losses under accounting principles generallyaccepted in the United States of America (“GAAP”) which are recorded as anelement of shareholders’ equity but are excluded from net income. Thecomponents of total comprehensive income follow:

 
| ** **                                                                                     | ** ** | ** ** | **Three  Months Ended  December 31,** | ** ** | ** ** | **Six  Months Ended  December 31,** | ** ** |
|------------------------------------------------------------------------------------------------|------------|------------|---------------------------------------|------------|------------|-------------------------------------|------------|
| ** **                                                                                     | ** ** | ** ** | **2007**                              | ** ** | **2006**   | ** **                          | ** ** | **2007** | ** ** | ** ** | **2006** | ** ** |
|                                                                                           |       |       |                                  |       |       |                                |       |   |   |   |   |   |
| Net Income                                                                                     |       |       |  $                               | 1,251      |       |                                |  $    | 2,111 |   |   |  $ | 2,598 |   |   |  $ | 3,208 |   |
| Other  comprehensive income:                                                                   |       |       |                                  |       |       |                                |       |   |   |   |   |   |   |
| Net change in  unrealized gain (loss) on securities available for sale, net of deferred  taxes |       |       | 430                                   |       |       | 143                                 |       |   | 1,181 |   |   | 1,378 |   |
| Net change in  interest rate swap fair value                                                   |       |       | (142                                  | )          |       | - - - -                             |       |   | (176 | ) |   | - - - - |   |
| Total other  comprehensive income                                                              |       |       | 288                                   |       |       | 143                                 |       |   | 1,005 |   |   | 1,378 |   |
|                                                                                           |       |       |                                  |       |       |                                |       |   |   |   |   |   |   |
| Total  comprehensive income                                                                    |       |       |  $                               | 1,539      |       |                                |  $    | 2,254 |   |   |  $ | 3,603 |   |   |  $ | 4,586 |   |

 

Page 14

 

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

 

**Forward-LookingStatements**

 

This Quarterly Report onForm 10-Q and other reports issued by the Company, including reports filedwith the Securities and Exchange Commission, contain “forward-lookingstatements” that deal with future results, expectations, plans and performance.In addition, the Company’s management may make forward-looking statementsorally to the media, securities analysts, investors or others. Theseforward-looking statements might include one or more of the following:

 

*      Projections of income, loss, revenues,earnings or losses per share, dividends, capital expenditures, capitalstructure, tax benefit or other financial items.

 

*      Descriptions of plans or objectives ofmanagement for future operations, products or services, transactions,investments and use of subordinated debentures payable to trusts.

 

*      Forecasts of future economic performance.

 

*      Use and descriptions of assumptions andestimates underlying or relating to such matters.

 

Forward-lookingstatements can be identified by the fact they do not relate strictly tohistorical or current facts. They often include words such as “optimism,” “look-forward,”“bright,” “believe,” “expect,” “anticipate,” “intend,” “plan,” “estimate” orwords of similar meaning, or future or conditional verbs such as “will,” “would,”“should,” “could” or “may.”

 

Forward-lookingstatements about the Company’s expected financial results and other plans aresubject to certain risks, uncertainties and assumptions. These include, but arenot limited to, the risks discussed in Part I, Item 1A “Risk Factors” inthe Company’s Annual Report on Form 10-K for Fiscal 2007 and thefollowing: possible legislative changes and adverse economic, business andcompetitive conditions and developments (such as shrinking interest margins andcontinued short-term rate environments); deposit outflows; reduced demand forfinancial services and loan products; changes in accounting policies orguidelines, or in monetary and fiscal policies of the federal government;changes in credit and other risks posed by the Company’s loan and lease portfolios;the ability or inability of the Company to manage interest rate and otherrisks; unexpected, continuing or excessive claims against the Company’sself-insured health plan; the Company’s use of trust preferred securities; theability or inability of the Company to successfully enter into a definitiveagreement for and close anticipated transactions; technological,computer-related or operational difficulties; adverse changes in securitiesmarkets; results of litigation; or other significant uncertainties.

 

Forward-lookingstatements speak only as of the date they are made. The Company does notundertake to update forward-looking statements to reflect circumstances orevents that occur after the date the forward-looking statements are made. Althoughthe Company believes its expectations are reasonable, it can give no assurancethat such expectations will prove to be correct. Based upon changingconditions, should any one or more of these risks or uncertainties materialize,or should any underlying assumptions prove incorrect, actual results may varymaterially from those described in any forward-looking statements.

 

**ExecutiveSummary**

 

The Company’s net incomefor the second quarter of Fiscal 2008 was $1.3 million, or $0.31 in dilutedearnings per share, compared to $2.1 million, or $0.52 in diluted earnings pershare, for the second quarter of Fiscal 2007. Fiscal year 2007 second quarternet income included a non-recurring after-tax gain on sale of branches of $1.7million, which represented $0.42 of diluted earnings per share. For the firstsix months of Fiscal 2008, net income was $2.6 million, or $0.64 in dilutedearnings per share, compared to $3.2 million, or $0.79 in diluted earnings pershare, for the first six months of Fiscal 2007. Return on average equity was8.18% at December 31, 2007 compared to 11.05% at December 31, 2006.

 

Page 15

 

The net interest margin on a fully taxable equivalentbasis for the six months ended December 31, 2007 was 2.96%, compared to2.76% for the same period a year ago, an increase of 20 basis points. Theincrease over the same period last year is primarily attributable to a highervolume of earning assets and higher yields on earning assets. During the firstquarter of Fiscal 2008, there was $125,000 expense of unamortized debt issuecosts related to the early redemption of the Trust II Trust PreferredSecurities. This caused a decrease of three basis points to the net interestmargin on a fully taxable equivalent basis for the six months ended December 31,2007. During the second quarter of Fiscal 2007, the Company expensed $290,000of unamortized debt issuance costs relating to the redemption of the Trust ITrust Preferred Securities. This caused a decrease of six basis points to thenet interest margin on a fully taxable equivalent basis for the six monthsended December 31, 2006.

 

Net interest income for the first six months of Fiscal2008 was $13.7 million, an increase of $1.2 million, or 9.5%, over the sameperiod a year ago. Net interest income increased $936,000, or 15.4%, to $7.0million for the three months ended December 31, 2007 from $6.1 million forthe same period in the prior fiscal year. For the six months ended December 31,2007, average interest-earning assets and average interest-bearing liabilitiesincreased 2.4% and 1.7%, respectively, compared to the same period a year ago. Yieldson earning assets increased to 6.81% in the first six months of Fiscal 2008,compared to 6.67% a year ago, an increase of 14 basis points. For the sameperiod, cost of funds decreased to 4.38%, compared to 4.40%, a decrease of twobasis points.

 

Net interest margin ratio may vary due to manyfactors, including Federal Reserve policies for short-term interest rates,competitive and economic factors and customer preferences for various productsand services. On September 18, 2007 the Federal Reserve decreased the FedFunds Target Rate by 50 basis points, the first decrease in short-term interestrates since June 25, 2003. This action was followed by another Fed Fundsrate cut of 25 basis points on October 31, 2007 and by a 25 basis pointcut on December 11, 2007.

 

The Company had previously issued trust preferredsecurities primarily to provide funding for stock repurchases and to repayother borrowings. Interest expense on the $27.8 million of trust preferredsecurities outstanding decreased to $1.2 million for the six months ended December 31,2007, compared to $1.6 million for the same period a year ago, a decrease of$358,000 or 23.0%. The average rate paid on these securities decreased 253basis points, from 11.10% at December 31, 2006 to 8.57% at December 31,2007. In July 2007, the Company refinanced $5.0 million of trust preferredsecurities, originally issued in July 2002. This new funding wascalculated at a rate based on three-month LIBOR plus 1.65%. This compares tothe original issuance which was based on three-month LIBOR plus 3.65%. In December 2006,the Company refinanced $10.0 million of trust preferred securities, originallyissued in November 2001. The new funding was calculated at a rate based onthree-month LIBOR plus 1.83%, fixed for five years and adjusted quarterlythereafter, compared to the original issuance of six-month LIBOR plus 3.75%. TheCompany will evaluate the suitability to refinance additional trust preferredsecurities outstanding over the next year depending upon yield curve spreadswhich exist at the time of refinancing.

 

The allowance for loan and lease losses decreased to$5.4 million at December 31, 2007, compared to $5.9 million at December 31,2006, a decrease of $448,000 or 7.6%. The ratio of allowance for loan and leaselosses to total loans and leases was 0.71% as of December 31, 2007compared to 0.77% at December 31, 2006. Total nonperforming assets at December 31,2007 were $3.4 million as compared to $4.5 million a year ago, a decrease of$1.1 million or 23.7%. The ratio of nonperforming assets to total assetsdecreased to 0.34% at December 31, 2007, compared to 0.44% at December 31,2006. The allowance for loan and lease losses is calculated based on loan andlease levels, loan and lease loss history, credit quality of the loan and leaseportfolio, and environmental factors such as economic health of the region andmanagement experience. This risk rating analysis is designed to give theCompany a consistent and systematic methodology to determine proper levels forthe allowance at a given time.

 

The Company made a strategic decision during the firstquarter of Fiscal 2008 to stop originating indirect automobile loans, and willcontinue to service the existing portfolio. As of December 31, 2007, theConsumer Indirect loan portfolio balance was $62.9 million, a decrease of $20.2million from June 30, 2007. The Company entered this line of business inthe 1990’s as part of an interest rate risk reduction strategy, as well as forfurther diversification of the balance sheet.

 

Page 16

 

Total deposits at December 31, 2007 were $771.9million, a decrease of $36.9 million, or 4.6%, from December 31, 2006. In-marketdeposits increased from $693.6 million at December 31, 2006 to $752.8million at December 31, 2007, an increase of $59.2 million, or 8.5%. Forthe same period, out-of-market deposits decreased from $115.3 million to $19.1million, respectively. Public funds have increased, from $122.1 million at December 31,2006 to $151.8 million at December 31, 2007. Interest expense on depositswas $14.4 million for the six months ended December 31, 2007, an increaseof $511,000, or 3.7%, over the same period a year ago. The primary factoraffecting interest expense on deposits was the increase in average fiscalyear-to-date volume of certificates of deposits by $8.6 million, or 2.4%, from December 2006to December 2007. Interest expense for certificates of deposit increasedby $951,000, or 11.7%, in the first six months of Fiscal 2008, compared to thesame period in the prior fiscal year, driving its average cost of funds to4.91% from 4.48%.

 

In October 2007, the Company announced anincrease in its quarterly cash dividend, from 10.50 cents per share to 10.75cents per share, resulting in an annualized increase of 2.4%.

 

The total risk-based capital ratio of 11.16% at December 31,2007 is above the 10.85% at December 31, 2006, an increase of 31 basispoints. This continues to place the Bank in the “well capitalized” categorywithin OTS regulation at December 31, 2007 and is consistent with the “wellcapitalized” OTS category in which the Company plans to operate. The Companyhistorically has been able to manage the size of its assets through secondarymarket loan sales of single-family mortgages and student loans.

 

On December 31, 2007, the Company had in effect astock buyback program in which up to 10% of the common stock of the Companyoutstanding on May 1, 2007 could be acquired through April 30, 2008. TheCompany utilized its stock buyback program during the second quarter,repurchasing 6,000 shares.  For fiscal year 2008, the Company hasrepurchased a total of 76,000 shares. Under the current program, the Company isauthorized to repurchase up to 323,141 additional shares of common stockthrough April 30, 2008.

 

Non-interest income was $3.0 million for the quarterended December 31, 2007 compared to $5.4 million at December 31,2006, a decrease of $2.5 million or 45.3%. The quarter ending December 31,2006 included a one-time gain on sale of branches of $2.8 million. Excludingthis gain, non-interest income for the quarter ended December 31, 2006would have been $2.7 million. The primary factors affecting non-interest incomewere increases of $179,000 in net gain on sale of loans and $101,000 in loanservicing income.

 

Non-interest expense was $7.7 million for the quarterended December 31, 2007 compared to $7.7 million at December 31,2006, an increase of $17,000 or 0.2%. Compensation and employee benefit expenseincreased $310,000 and other non-interest expense increased $48,000, offset bya decrease in marketing expense of $405,000. The increase in compensation andemployee benefit expense was primarily due to increases in variable payrelating to employee incentives of $118,000, regular employee compensation of$80,000 and net healthcare costs of $52,000. The increase in other non-interestexpense was primarily due to an increase in legal expenses of $138,000. Thedecrease in marketing expense was attributed to additional expenses in Fiscal2007 for several deposit package programs.

 

**General**

 

The Company is a financial servicesprovider and, as such, has inherent risks that must be managed in order toachieve net income. Primary risks that affect net income include credit risk,liquidity risk, operational risk, regulatory compliance risk and reputationrisk. The Company’s net income is derived by managing net interest margin, theability to collect fees from services provided, by controlling the costs ofdelivering services and the management of loan and lease losses. The primarysource of revenues comes from the net interest margin, which represents thedifference between income on interest-earning assets (i.e. loans and investmentsecurities) and expense on interest-bearing liabilities (i.e. deposits andborrowed funding). The net interest margin is affected by regulatory, economicand competitive factors that influence interest rates, loan demand and depositflows. Fees earned include charges for deposit services, trust services andloan services. Personnel costs are the primary expenses required to deliver theservices to customers. Other costs include occupancy and equipment and generaland administrative expenses.

 

Page 17

 

**FinancialCondition Data**

 

At December 31, 2007, the Companyhad total assets of $1.0 billion, an increase of $19.2 million from the levelat June 30, 2007. The increase in assets was due primarily to increases insecurities available for sale of $22.1 million, and FHLB stock of $3.3 million,offset by decreases in loans and leases receivable of $7.6 million and loansheld for sale of $3.2 million. The increase in liabilities of $17.0 millionfrom June 30, 2007 to December 31, 2007 was primarily due toincreases in advances from the FHLB and other borrowings of $61.9 million,offset by a decrease in out-of-market deposits of $52.4 million. In addition,stockholders’ equity increased $2.2 million to $64.4 million at December 31,2007 from $62.3 million at June 30, 2007, primarily due to net income of$2.6 million.

 

The increase in securities available for sale of $22.1million was primarily the result of purchases of $46.4 million exceeding sales,maturities and repayments of $26.3 million. The purchases of $46.4 millionincluded fixed-rate, mortgage-backed securities of $20.1 million. The increasein FHLB stock of $3.3 million was the result of higher outstanding balances ofadvances.

 

The decrease in net loans and leases receivable of$7.6 million was due primarily to the previous announcement on the decision tostop indirect automobile loan origination. The balances on consumer indirectloans decreased $20.2 million from June 30, 2007 to December 31, 2007.This was offset by the increase in other loan and lease receivables of $12.6million for the same period. In addition, net deferred (fees), costs anddiscounts decreased $425,000 from the levels at June 30, 2007 to $157,000at December 31, 2007. Loans held for sale decreased $3.2 million primarilydue to the lower level of one- to four-family loans held.

 

Advances from the FHLB and other borrowings increased$61.9 million. The overall increase in FHLB borrowings was primarily the resultof a decrease in public funds of $15.5 million and a decrease in out-of-marketcertificates of deposit of $52.4 million.

 

The $44.0 million decrease in deposits was dueto decreases in out-of-market certificates of deposit of $52.4 million, moneymarket accounts of $29.7 million and savings accounts of $8.6 million. Thedecrease in out-of-market certificates of deposit is attributed to a decisionto pursue other sources of lower cost wholesale funds in the period. Publicfund deposits decreased $15.5 million during the first six months of Fiscal2008 due to seasonal fluctuations typical for these accounts, primarilyaffecting the savings and money market account balances. These decreases wereoffset by increases within in-market certificates of deposit of $42.3 million,non-interest-bearing checking accounts of $2.8 million and interest-bearingchecking accounts of $1.6 million.

 

During the period of fiscal years 2002 through 2004,the Company issued a total of $27.8 million in subordinated debentures payableto trusts at various times through its trust subsidiaries. Each of theissuances included an option to shorten the maturity date at a specific time asstated in the contract. The issuance of $5.0 million of Company ObligatedMandatorily Redeemable Preferred Securities of Trust II on July 11, 2002included an option to shorten the maturity date to July 5, 2007. TheCompany exercised this option to redeem $5.0 million of trust preferredsecurities. Also during the first quarter of Fiscal 2008, the Company issued$5.0 million of Company Obligated Mandatorily Redeemable Preferred Securitiesof Trust VI. The new funding is calculated at a rate based on three-month LIBORplus 1.65%, compared to the original issuance which was based on three-monthLIBOR plus 3.65%. The unamortized amount of $125,000 deferred debt issuancecosts related to the original issuance was expensed.

 

Page 18

 

The following tables show the composition of theCompany’s loan and lease portfolio and deposit accounts:

 
| **Loan  and Lease Portfolio Composition**    |       |                      |       |                  |       |       |       |        |       |
|----------------------------------------------|------------|---------------------------|------------|-----------------------|------------|------------|------------|-------------|------------|
| ** **                                   | ** ** | **At  December 31, 2007** | ** ** | **At June  30, 2007** | ** ** |
| ** **                                   | ** ** | **Amount**                | ** ** | **Percent**           | ** ** | **Amount** | ** ** | **Percent** | ** ** |
|                                         |       | (Dollars in  Thousands)   |       |
|                                         |       |                      |       |                  |       |       |       |        |       |   |   |   |
| One-to  four-family (1)                      |       |  $                   | 108,142    |                  |       | 14.23      | %          |        |  $    | 116,544 |   |   | 15.18 | % |
| Commercial  business and real estate (2) (3) |       | 284,712                   |       |                  | 37.47      | %          |       | 275,646     |       |   | 35.92 | % |
| Multi-family  real estate                    |       | 42,862                    |       |                  | 5.64       | %          |       | 34,047      |       |   | 4.44 | % |
| Equipment  finance leases                    |       | 21,081                    |       |                  | 2.77       | %          |       | 22,307      |       |   | 2.91 | % |
| Consumer Direct  (4)                         |       | 103,487                   |       |                  | 13.62      | %          |       | 104,647     |       |   | 13.63 | % |
| Consumer  Indirect (5)                       |       | 62,914                    |       |                  | 8.28       | %          |       | 83,094      |       |   | 10.83 | % |
| Agricultural                                 |       | 126,213                   |       |                  | 16.61      | %          |       | 116,710     |       |   | 15.21 | % |
| Construction and  development                |       | 10,471                    |       |                  | 1.38       | %          |       | 14,476      |       |   | 1.88 | % |
| Total Loans and  Leases Receivable (6)       |       |  $                   | 759,882    |                  |       | 100.00     | %          |        |  $    | 767,471 |   |   | 100.00 | % |

 

(1) Excludes $3,765 and $8,290 loans held for sale atDecember 31, 2007 and June 30, 2007, respectively.

(2) Includes $3,109 and $3,297 tax exempt leases atDecember 31, 2007 and June 30, 2007, respectively.

(3) Excludes $223 commercial loans held for sale atDecember 31, 2007 and June 30, 2007.

(4) Excludes $1,547 and $263 student loans held forsale at December 31, 2007 and June 30, 2007, respectively.

(5) The Company announced Consumer Indirectoriginations ceased during the first quarter of Fiscal 2008.

(6) Includes deferred loan fees and discounts andundisbursed portion of loans in process.

 
| **Deposit  Composition**               |       |                      |       |                  |       |       |       |        |       |
|----------------------------------------|------------|---------------------------|------------|-----------------------|------------|------------|------------|-------------|------------|
| ** **                             | ** ** | **At  December 31, 2007** | ** ** | **At June  30, 2007** | ** ** |
| ** **                             | ** ** | **Amount**                | ** ** | **Percent**           | ** ** | **Amount** | ** ** | **Percent** | ** ** |
|                                   |       | (Dollars in  Thousands)   |       |
|                                   |       |                      |       |                  |       |       |       |        |       |   |   |   |
| Noninterest  bearing checking accounts |       |  $                   | 89,496     |                  |       | 11.60      | %          |        |  $    | 86,679 |   |   | 10.62% |   |
| Interest bearing  checking accounts    |       | 88,677                    |       |                  | 11.49      | %          |       | 87,030      |       |   | 10.67% |   |
| Money market  accounts                 |       | 182,809                   |       |                  | 23.68      | %          |       | 212,546     |       |   | 26.05% |   |
| Savings accounts                       |       | 57,664                    |       |                  | 7.47       | %          |       | 66,235      |       |   | 8.12% |   |
| In-Market  Certificates of deposit     |       | 334,169                   |       |                  | 43.29      | %          |       | 291,858     |       |   | 35.77% |   |
| Out-of-Market  Certificates of deposit |       | 19,081                    |       |                  | 2.47       | %          |       | 71,516      |       |   | 8.77% |   |
| Total Deposits                         |       |  $                   | 771,896    |                  |       | 100.00     | %          |        |  $    | 815,864 |   |   | 100.00% |   |

 

Page 19

 

**Analysisof Net Interest Income**

 

Net interest income represents the differencebetween income on interest-earning assets and expense on interest-bearingliabilities. Net interest income depends upon the volume of interest-earningassets and interest-bearing liabilities and the interest rates earned or paidon them.

 

*Average Balances, Interest Rates and Yields.*The following table presents for theperiods indicated, the total dollar amount of interest income from averageinterest-earning assets and the resulting yields, as well as the interestexpense on average interest-bearing liabilities, expressed both in dollars andrates, and the net interest margin. The table does not reflect any effect ofincome taxes, except where noted. Average balances consist of daily averagebalances for the Bank with simple average balances for all other subsidiariesof the Company. The average balances include nonaccruing loans and leases. Theyields on loans and leases include origination fees, net of costs, which areconsidered adjustments to yield.

 
| ** **                                     | ** ** | **Three  Months Ended December 31,** | ** ** |
|------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                     | ** ** | **2007**                             | ** ** | **2006** | ** ** |
| ** **                                     | ** ** | **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)           |       | $                                    | 775,089    |   |   | $ | 13,879 |   |   | 7.12 | % |   |  $ | 762,367 |   |   | $ | 13,728 |   |   | 7.14%   |   |
| Investment  securities (2) (3)                 |       | 162,701                              |       |   | 2,119 |   |   | 5.18 | % |   | 157,222 |   |   | 1,860 |   |   | 4.69%   |   |
| FHLB stock                                     |       | 7,703                                |       |   | 87 |   |   | 4.48 | % |   | 6,657 |   |   | 75 |   |   | 4.47%   |   |
|                                           |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  interest-earning assets                 |       | 945,493                              |       |   | $ | 16,085 |   |   | 6.77 | % |   | 926,246 |   |   | $ | 15,663 |   |   | 6.71%   |   |
| Noninterest-earning  assets                    |       | 72,793                               |       |   |   |   |   |   |   |   | 71,653 |   |   |   |   |   |   |   |
| Total assets                                   |       | $                                    | 1,018,286  |   |   |   |   |   |   |   |   |  $ | 997,899 |   |   |   |   |   |   |   |
|                                           |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:                 |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Deposits:                                      |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Checking and  money market                     |       | $                                    | 265,510    |   |   | $ | 2,077 |   |   | 3.11 | % |   |  $ | 277,185 |   |   | $ | 2,676 |   |   | 3.83%   |   |
| Savings                                        |       | 47,416                               |       |   | 274 |   |   | 2.30 | % |   | 38,123 |   |   | 207 |   |   | 2.15%   |   |
| Certificates of  deposit                       |       | 371,511                              |       |   | 4,562 |   |   | 4.89 | % |   | 383,073 |   |   | 4,476 |   |   | 4.64%   |   |
| Total  interest-bearing deposits               |       | 684,437                              |       |   | 6,913 |   |   | 4.02 | % |   | 698,381 |   |   | 7,359 |   |   | 4.18%   |   |
| FHLB advances and  other borrowings            |       | 135,817                              |       |   | 1,642 |   |   | 4.81 | % |   | 111,084 |   |   | 1,332 |   |   | 4.76%   |   |
| Subordinated  debentures payable to trusts (4) |       | 27,837                               |       |   | 534 |   |   | 7.63 | % |   | 27,837 |   |   | 912 |   |   | 13.00%   |   |
| Total  interest-bearing liabilities            |       | 848,091                              |       |   | 9,089 |   |   | 4.26 | % |   | 837,302 |   |   | 9,603 |   |   | 4.55%   |   |
| Noninterest-bearing  deposits                  |       | 80,806                               |       |   |   |   |   |   |   |   | 77,757 |   |   |   |   |   |   |   |
| Other liabilities                              |       | 25,674                               |       |   |   |   |   |   |   |   | 23,836 |   |   |   |   |   |   |   |
| Total liabilities                              |       | 954,571                              |       |   |   |   |   |   |   |   | 938,895 |   |   |   |   |   |   |   |
| Equity                                         |       | 63,715                               |       |   |   |   |   |   |   |   | 59,004 |   |   |   |   |   |   |   |
| Total liabilities  and equity                  |       | $                                    | 1,018,286  |   |   |   |   |   |   |   |   |  $ | 997,899 |   |   |   |   |   |   |   |
|                                           |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest  income; interest rate spread (5) |       |                                 |       |   | $ | 6,996 |   |   | 2.51 | % |   |   |   |   | $ | 6,060 |   |   | 2.16%   |   |
|                                           |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest  margin (5) (6)                   |       |                                 |       |   |   |   |   | 2.94 | % |   |   |   |   |   |   |   | 2.60%   |   |
|                                           |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest  margin, TE (7)                   |       |                                 |       |   |   |   |   | 3.00 | % |   |   |   |   |   |   |   | 2.66%   |   |
|                                           |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |

 

(1) Includes loan fees and interest on accruing loansand leases past due 90 days or more.

(2) Includes federal funds sold.

(3) Yields do not reflect the tax-exempt nature ofloans, equipment leases and municipal securities.

(4) Includes $290 expense in December 2006 forunamortized debt issuance costs.

(5) Percentages for the three months ended December31, 2007 and December 31, 2006 have been annualized.

(6) Net interest margin is net interest income dividedby average interest-earning assets.

(7) Net interest margin expressed on a fully taxableequivalent basis.

 

Page 20

 
| ** **                                     | ** ** | **Six  Months Ended December 31,** | ** ** |
|------------------------------------------------|------------|------------------------------------|------------|
| ** **                                     | ** ** | **2007**                           | ** ** | **2006** | ** ** |
| ** **                                     | ** ** | **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)           |       | $                                  | 775,583    |   |   | $ | 27,999 |   |   | 7.18 | % |   | $ | 753,432 |   |   | $ | 26,968 |   |   | 7.10%   |   |
| Investment  securities (2) (3)                 |       | 153,949                            |       |   | 3,923 |   |   | 5.07 | % |   | 154,397 |   |   | 3,619 |   |   | 4.65%   |   |
| FHLB stock                                     |       | 6,660                              |       |   | 148 |   |   | 4.41 | % |   | 6,816 |   |   | 154 |   |   | 4.48%   |   |
|                                           |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  interest-earning assets                 |       | 936,192                            |       |   | $ | 32,070 |   |   | 6.81 | % |   | 914,645 |   |   | $ | 30,741 |   |   | 6.67%   |   |
| Noninterest-earning  assets                    |       | 70,686                             |       |   |   |   |   |   |   |   | 67,087 |   |   |   |   |   |   |   |
| Total assets                                   |       | $                                  | 1,006,878  |   |   |   |   |   |   |   |   | $ | 981,732 |   |   |   |   |   |   |   |
|                                           |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:                 |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Deposits:                                      |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Checking and  money market                     |       | $                                  | 275,962    |   |   | $ | 4,658 |   |   | 3.36 | % |   | $ | 278,628 |   |   | $ | 5,314 |   |   | 3.78%   |   |
| Savings                                        |       | 51,096                             |       |   | 684 |   |   | 2.66 | % |   | 40,939 |   |   | 468 |   |   | 2.27%   |   |
| Certificates of  deposit                       |       | 367,672                            |       |   | 9,069 |   |   | 4.91 | % |   | 359,060 |   |   | 8,118 |   |   | 4.48%   |   |
| Total  interest-bearing deposits               |       | 694,730                            |       |   | 14,411 |   |   | 4.13 | % |   | 678,627 |   |   | 13,900 |   |   | 4.06%   |   |
| FHLB advances and  other borrowings            |       | 114,057                            |       |   | 2,796 |   |   | 4.88 | % |   | 116,476 |   |   | 2,806 |   |   | 4.78%   |   |
| Subordinated  debentures payable to trusts (4) |       | 27,837                             |       |   | 1,199 |   |   | 8.57 | % |   | 27,837 |   |   | 1,557 |   |   | 11.10%   |   |
|                                           |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  interest-bearing liabilities            |       | 836,624                            |       |   | 18,406 |   |   | 4.38 | % |   | 822,940 |   |   | 18,263 |   |   | 4.40%   |   |
| Noninterest-bearing  deposits                  |       | 79,743                             |       |   |   |   |   |   |   |   | 78,596 |   |   |   |   |   |   |   |
| Other liabilities                              |       | 27,349                             |       |   |   |   |   |   |   |   | 22,124 |   |   |   |   |   |   |   |
| Total liabilities                              |       | 943,716                            |       |   |   |   |   |   |   |   | 923,660 |   |   |   |   |   |   |   |
| Equity                                         |       | 63,162                             |       |   |   |   |   |   |   |   | 58,072 |   |   |   |   |   |   |   |
| Total liabilities  and equity                  |       | $                                  | 1,006,878  |   |   |   |   |   |   |   |   | $ | 981,732 |   |   |   |   |   |   |   |
|                                           |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest  income; interest rate spread (5) |       |                               |       |   | $ | 13,664 |   |   | 2.43 | % |   |   |   |   | $ | 12,478 |   |   | 2.27%     |   |
|                                           |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest  margin (5) (6)                   |       |                               |       |   |   |   |   | 2.90 | % |   |   |   |   |   |   |   | 2.71%   |   |
|                                           |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest  margin, TE (7)                   |       |                               |       |   |   |   |   | 2.96 | % |   |   |   |   |   |   |   | 2.76%   |   |

 

(1) Includes loan fees and interest on accruing loansand leases past due 90 days or more.

(2) Includes federal funds sold.

(3) Yields do not reflect the tax-exempt nature ofloans, equipment leases and municipal securities.

(4) Includes $125 and $290 expense in July 2007 andDecember 2006, respectively, for unamortized debt issuance costs.

(5) Percentages for the six months ended December 31,2007 and December 31, 2006 have been annualized.

(6) Net interest margin is net interest income dividedby average interest-earning assets.

(7) Net interest margin expressed on a fully taxableequivalent basis.

 

Page 21

 

**Rate/Volume Analysis of Net Interest Income**

 

The following schedule presents thedollar amount of changes in interest income and interest expense for majorcomponents of interest-earning assets and interest-bearing liabilities. Itdistinguishes between the increases and decreases due to fluctuatingoutstanding balances due to the levels and volatility of interest rates. Foreach category of interest-earning assets and interest-bearing liabilities,information is provided on changes attributable to (i) changes in volume(i.e., changes in volume multiplied by old rate) and (ii) changes in rate(i.e., changes in rate multiplied by old volume). For purposes of this table,changes attributable to both rate and volume, which cannot be segregated, havebeen allocated proportionately to the change due to volume and the change dueto rate.

 
| ** **                                 | ** ** | **Three  Months Ended December 31,** | ** ** | **Six  Months Ended December 31,** | ** ** |
|--------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                 | ** ** | **2007 vs  2006**                    | ** ** | **2007 vs  2006**                  | ** ** |
| ** **                                 | ** ** | ** **                           | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                 | ** ** | **Increase**                         | ** ** | **Increase**                       | ** ** | ** ** | ** ** | **Increase** | ** ** | **Increase** | ** ** | ** ** | ** ** |
| ** **                                 | ** ** | **(Decrease)**                       | ** ** | **(Decrease)**                     | ** ** | **Total** | ** ** | **(Decrease)** | ** ** | **(Decrease)** | ** ** | **Total** | ** ** |
| ** **                                 | ** ** | **Due to**                           | ** ** | **Due to**                         | ** ** | **Increase** | ** ** | **Due to** | ** ** | **Due to** | ** ** | **Increase** | ** ** |
| ** **                                 | ** ** | **Volume**                           | ** ** | **Rate**                           | ** ** | **(Decrease)** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **(Decrease)** | ** ** |
| ** **                                 | ** ** | (Dollars in  Thousands)              | ** ** |
|                                       |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-earning  assets:                  |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans and leases  receivable (1)           |       | $                                    | 210        |                               |       | $ | (59 | ) |   | $ | 151 |   |   | $ | 754 |   |   | $ | 277 |   |   | $ | 1,031 |   |
| Investment  securities (2)                 |       | 63                                   |       |                               | 196        |   |   | 259 |   |   | (15 | ) |   | 319 |   |   | 304 |   |
| FHLB stock                                 |       | 12                                   |       |                               | - - - -    |   |   | 12 |   |   | (4 | ) |   | (2 | ) |   | (6 | ) |
|                                       |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  interest-earning assets             |       | $                                    | 285        |                               |       | $ | 137 |   |   | $ | 422 |   |   | $ | 735 |   |   | $ | 594 |   |   | $ | 1,329 |   |
|                                       |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:             |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Deposits:                                  |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Checking and  money market                 |       | $                                    | (116       | )                                  |       | $ | (483 | ) |   | $ | (599 | ) |   | $ | (58 | ) |   | $ | (599 | ) |   | $ | (657 | ) |
| Savings                                    |       | 50                                   |       |                               | 17         |   |   | 67 |   |   | 116 |   |   | 101 |   |   | 217 |   |
| Certificates of  deposit                   |       | (141                                 | )          |                               | 227        |   |   | 86 |   |   | 183 |   |   | 768 |   |   | 951 |   |
| Total  interest-bearing deposits           |       | (207                                 | )          |                               | (239       | ) |   | (446 | ) |   | 241 |   |   | 270 |   |   | 511 |   |
| FHLB advances  and other borrowings        |       | 294                                  |       |                               | 16         |   |   | 310 |   |   | (62 | ) |   | 52 |   |   | (10 | ) |
| Subordinated  debentures payable to trusts |       | - - - -                              |       |                               | (378       | ) |   | (378 | ) |   | - - - - |   |   | (358 | ) |   | (358 | ) |
|                                       |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  interest-bearing liabilities        |       | $                                    | 87         |                               |       | $ | (601 | ) |   | $ | (514 | ) |   | $ | 179 |   |   | $ | (36 | ) |   | $ | 143 |   |
|                                       |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest  income increase              |       |                                 |       |                               |       |   |   | $ | 936 |   |   |   |   |   |   |   |   | $ | 1,186 |   |
|                                       |

 

(1) Includes loan fees and interest on accruing loansand leases past due 90 days or more.

(2) Includes federal funds sold.

 

Page 22

 

** **

**Applicationof Critical Accounting Policies**

 

GAAPrequires management to utilize estimates when reporting financial results.  The Company has identified the policiesdiscussed below as Critical Accounting Policies because the accountingestimates require management to make certain assumptions about matters whichmay be uncertain at the time the estimate was made and a different method ofestimating could have been reasonably made which could have a material impacton the presentation of the Company’s financial condition, changes in financialcondition or results of operations.

 

*Allowance for Loan and Lease Losses*– GAAP requires the Company to set aside reserves or maintain an allowanceagainst probable loan and lease losses in the loan and lease portfolio.  Management must develop a consistent andsystematic approach to estimate the appropriate balances to cover the probablelosses.  Due to the uncertainty of futureevents, the approach includes a process that may differ significantly fromother methodologies and still produce an estimate in accordance with GAAP.

 

The allowance is compiled by utilizing the Company’s loan and leaserisk rating system, which is structured to identify weaknesses in the loan andlease portfolio.  The risk rating systemhas evolved to a process whereby management believes the system will properlyidentify the credit 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.

 

*Mortgage Servicing Rights (“MSR”)* – The Company records a servicing asset for contractuallyseparated servicing from the underlying mortgage loans.   The asset is initially recorded at fairvalue and represents an intangible asset backed by an income stream from theserviced assets.  The asset is amortizedin proportion to and over the period of estimated net servicing income.

 

At each balance sheet date, the MSRs are analyzed for impairment, whichoccurs when the fair value of the MSRs is lower than the amortized book value.The Company’s MSRs are primarily servicing rights acquired on South DakotaHousing Development Authority first time homebuyers program.  Due to the lack of quoted markets for theCompany’s servicing portfolio, the Company estimates the fair value of the MSRsusing present value of future cash flow analysis.  If the analysis produces a fair value greaterthan or equal to the amortized book value of the MSRs, no impairment isrecognized.  If the fair value is lessthan the book value, an expense for the difference is charged to earnings byinitiating a MSR valuation account.  Ifthe Company determines this impairment is temporary, any future changes in fairvalue are recorded as a change in earnings and the valuation.  If the Company determines the impairment to bepermanent, the valuation is written off against the MSRs, which results in anew amortized balance.

 

The Company has included MSRs as a critical accounting policy becausethe use of estimates for determining fair value using present value conceptsmay produce results which may significantly differ from other fair valueanalysis perhaps even to the point of recording impairment.  The risk to earnings is when the underlyingmortgages pay off significantly faster than the assumptions used in thepreviously recorded amortization. Estimating future cash flows on the underlying mortgages is a difficultanalysis and requires judgment based on the best information available.  The Company looks at alternative assumptionsand projections when preparing a reasonable and supportable analysis.  Based on the Company’s quarterly analysis ofMSRs, there was no impairment to the MSRs at December 31, 2007.

 

*Self-Insurance*- The Company has a self-insuredhealthcare plan for its employees up to certain limits.  To mitigate a portion of these risks, theCompany has a stop-loss insurance policy through a commercial insurance carrierfor coverage in excess of $65,000 per individual occurrence with a maximumaggregate limitation of $2.0 million. 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 theaccrual.

 

Page 23

 

**AssetQuality and Potential Problem Loans and Leases**

 

Nonperformingassets (nonaccrual loans and leases, accruing loans and leases delinquent morethan 90 days and foreclosed assets) decreased to $3.4 million at December 31,2007 from $4.0 million at June 30, 2007, a decrease of $580,000, or14.5%.  Nonaccruing loans and leasesdecreased $350,000 to $1.8 million at December 31, 2007 from $2.2 millionat June 30, 2007.  In addition, theratio of nonperforming assets to total assets, which is one indicator of creditrisk exposure, decreased to 0.34% at December 31, 2007 from 0.40% at June 30,2007.

 

Nonaccruing loansand leases decreased 16.0%, or $350,000, to $1.8 million at December 31,2007 compared to $2.2 million at June 30, 2007.  Included in nonaccruing loans and leases at December 31,2007 were five loans totaling $256,000 secured by one- to four-family realestate, 11 loans totaling $684,000 secured by commercial business, six loanstotaling $326,000 secured by agriculture, two leases totaling $106,000 and 27consumer loans totaling $468,000.

 

The risk ratingsystem in place 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 December 31,2007, the Company had $458,000 of foreclosed assets.  The balance of foreclosed assets at December 31,2007 consisted of $256,000 of single-family collateral owned, $4,000 ofequipment finance leases and $198,000 of consumer collateral owned.

 

At December 31, 2007, the Company had designated $12.8 million of its assets asspecial mention and classified $7.3 million of its assets that management has determined need to be closely monitoredbecause of possible credit problems of the borrowers or the cash flows of thesecured properties.  At December 31,2007 the Company had $22.9 million in multi-family, commercial business,commercial real estate and agricultural participation loans purchased, of which$243,000 were classified as of December 31, 2007.  These loans and leases were considered indetermining the adequacy of the allowance for loan and lease losses.  The allowance for loan and lease losses isestablished based on management’s evaluation of the risks probable in the loanand lease portfolio and changes in the nature and volume of loan and leaseactivity.  Such evaluation, whichincludes a review of all loans and leases for which full collectability may notbe reasonably assured, considers the estimated fair market value of theunderlying collateral, present value of expected principal and interestpayments, economic conditions, historical loss experience and other factorsthat warrant recognition in providing for an adequate loan and lease lossallowance.

 

Althoughthe Company’s management believes the December 31, 2007 recorded allowancefor loan and lease losses was adequate to provide for probable losses on therelated loans and leases, there can be no assurance the allowance existing at December 31,2007 will be adequate in the future.

 

Page 24

 

Inaccordance with the Company’s internal classification of assets policy,management evaluates the loan and lease portfolio on a monthly basis toidentify loss potential and determines the adequacy of the allowance for loanand lease losses quarterly.  Loans andleases are placed on nonaccrual status when the collection of principal and/orinterest becomes doubtful.  Foreclosedassets include assets acquired in settlement of loans and leases.  The following table sets forth the amountsand categories of the Company’s nonperforming assets for the periods indicated.

 
| ** **                                                                                                                      | ** ** | **Nonperforming Assets As Of** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                                                      | ** ** | **December 31,  2007**                   | ** ** | **June 30,  2007** | ** ** |
|                                                                                                                            |       | (Dollars in Thousands)                        |       |
| Nonaccruing loans and leases:                                                                                                   |       |                                          |       |   |   |   |
| One- to  four-family                                                                                                            |       |   $                                 | 256        |   |   |  $ | 228  |   |
| Commercial real  estate                                                                                                         |       | - - - -                                       |       |   | 25  |   |
| Commercial  business                                                                                                            |       | 684                                           |       |   | 1,441  |   |
| Equipment  finance leases                                                                                                       |       | 106                                           |       |   | 118  |   |
| Consumer                                                                                                                        |       | 468                                           |       |   | 378  |   |
| Agricultural                                                                                                                    |       | 326                                           |       |   | - - - -  |   |
| Total                                                                                                                           |       | 1,840                                         |       |   | 2,190  |   |
|                                                                                                                            |       |                                          |       |   |   |   |
| Accruing loans and leases delinquent more than 90  days:                                                                        |       |                                          |       |   |   |   |
| One- to  four-family                                                                                                            |       | 265                                           |       |   | 470  |   |
| Commercial real  estate                                                                                                         |       | 354                                           |       |   | 178  |   |
| Commercial  business                                                                                                            |       | 271                                           |       |   | 213  |   |
| Equipment  finance leases                                                                                                       |       | 238                                           |       |   | 88  |   |
| Consumer                                                                                                                        |       | - - - -                                       |       |   | 1  |   |
| Agricultural                                                                                                                    |       | - - - -                                       |       |   | 358  |   |
| Total                                                                                                                           |       | 1,128                                         |       |   | 1,308  |   |
|                                                                                                                            |       |                                          |       |   |   |   |
| Foreclosed assets: (1)                                                                                                          |       |                                          |       |   |   |   |
| One- to  four-family                                                                                                            |       | 256                                           |       |   | 158  |   |
| Equipment  finance leases                                                                                                       |       | 4                                             |       |   | 180  |   |
| Consumer                                                                                                                        |       | 198                                           |       |   | 170  |   |
| Total                                                                                                                           |       | 458                                           |       |   | 508  |   |
|                                                                                                                            |       |                                          |       |   |   |   |
| Total nonperforming assets                                                                                                      |       |   $                                 | 3,426      |   |   |  $ | 4,006  |   |
|                                                                                                                            |       |                                          |       |   |   |   |
| Ratio of nonperforming assets to total assets                                                                                   |       | 0.34%                                         |       |   | 0.40%  |   |
|                                                                                                                            |       |                                          |       |   |   |   |
| Ratio of nonperforming loans and leases to total loans and leases (2) (3)                                                       |       | 0.39%                                         |       |   | 0.45%  |   |
|                                                                                                                            |
|                                                                                                                            |
| (1)  Total  foreclosed assets do not include land or other real estate owned held for  sale.                               |
| (2)  Nonperforming  loans and leases include both nonaccruing and accruing loans and leases  delinquent more than 90 days. |
| (3)  Total  loans and leases include loans held for sale.                                                                  |

 

Page 25

 

Thefollowing table sets forth information with respect to activity in the Company’sallowance for loan and lease losses during the periods indicated.

 
| ** **                                                                                                 | ** ** | **Six Months Ended December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                                                                                 | ** ** | **2007**                                              | ** ** | **2006** | ** ** |
| ** **                                                                                                 |       | **(Dollars  in Thousands**)                           |       |
|                                                                                                       |       |                                                  |       |   |   |
| Balance at  beginning of period                                                                            |       |  $                                               | 5,872      |   |  $ | 5,657 |   |
| Charge-offs:                                                                                               |       |                                                  |       |   |   |
| One- to  four-family                                                                                       |       | (3                                                    | )          | - - - - |   |
| Commercial  business                                                                                       |       | (620                                                  | )          | (216 | ) |
| Equipment  finance leases                                                                                  |       | (171                                                  | )          | (115 | ) |
| Consumer                                                                                                   |       | (421                                                  | )          | (370 | ) |
| Total  charge-offs                                                                                         |       | (1,215                                                | )          | (701 | ) |
|                                                                                                       |       |                                                  |       |   |   |
| Recoveries:                                                                                                |       |                                                  |       |   |   |
| One- to  four-family                                                                                       |       | - - - -                                               |       | 3 |   |
| Commercial  business                                                                                       |       | 8                                                     |       | - - - - |   |
| Consumer                                                                                                   |       | 134                                                   |       | 101 |   |
| Agricultural                                                                                               |       | 5                                                     |       | 57 |   |
| Total recoveries                                                                                           |       | 147                                                   |       | 161 |   |
|                                                                                                       |       |                                                  |       |   |   |
| Net  (charge-offs)                                                                                         |       | (1,068                                                | )          | (540 | ) |
|                                                                                                       |       |                                                  |       |   |   |
| Additions  charged to operations                                                                           |       | 620                                                   |       | 752 |   |
|                                                                                                       |       |                                                  |       |   |   |
| Balance at end  of period                                                                                  |       |  $                                               | 5,424      |   |  $ | 5,869 |   |
|                                                                                                       |       |                                                  |       |   |   |
| Ratio of net  (charge-offs) during the period to average loans and leases outstanding  during the period   |       | (0.14                                                 | )%         | (0.07)% |   |
|                                                                                                       |       |                                                  |       |   |   |
| Ratio of  allowance for loan and lease losses to total loans and leases at end of  period (1)              |       | 0.71                                                  | %          | 0.77% |   |
|                                                                                                       |       |                                                  |       |   |   |
| Ratio of  allowance for loan and lease losses to nonperforming loans and leases at end  of period (2) |       | 182.75                                                | %          | 145.89% |   |
|                                                                                                       |
|                                                                                                            |            |                                                       |            |  |  |  |  |  |

 

(1)  Total loans and leases include loans held forsale.

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

 

Page 26

 

The distributionof the Company’s allowance for loan and lease losses and impaired loss summaryas required by FASB Statement No. 114, “Accounting by Creditors forImpairment of a Loan” are summarized in the following tables.  The combination of FASB Statement No. 5 “Accountingfor Contingencies” and FASB Statement No. 114 calculations comprise theCompany’s allowance for loan and lease losses.

 
|                                   |   | **Allowance  for Loan and  Lease Losses** |              | **Impaired  Loan  Valuation  Allowance** |            | **Allowance  for Loan and  Lease Losses** |   | **Impaired  Loan  Valuation  Allowance** |            |
|----------------------------------------|--------|-------------------------------------------|-------------------|------------------------------------------|-----------------|-------------------------------------------|--------|------------------------------------------|-----------------|
| **Loan and Lease Type** |   | **At December 31, 2007**   |              | **At June  30, 2007**                    |            |
|                                   |   | (Dollars in  Thousands)                   |              |
|                                   |   |                                      |              |                                     |            |                                      |   |                                     |            |
| One- to four-family                    |   | $                                         | 380     |                                     | $               | - - - -                         |   | $                                        | 342   |   | $ | - - - -   |   |
| Commercial real estate                 |   | 586                             |              | - - - -                        |            | 524                             |   | - - - -                        |            |
| Multi-family real estate               |   | 130                             |              | - - - -                        |            | 123                             |   | - - - -                        |            |
| Commercial business                    |   | 1,809                           |              | - - - -                        |            | 1,974                           |   | 335                            |            |
| Equipment finance leases               |   | 399                             |              | - - - -                        |            | 486                             |   | - - - -                        |            |
| Consumer                               |   | 1,125                           |              | - - - -                        |            | 1,178                           |   | - - - -                        |            |
| Agricultural                           |   | 865                             |              | 130                            |            | 860                             |   | 50                             |            |
|                                   |   |                                      |              |                                     |            |                                      |   |                                     |            |
| Total                                  |   | $                                         | 5,294   |                                     | 130   |                                      | $      | 5,487                          |            | 385   |   |
|                                        |        |                                           |                   |                                          |                 |                                           |        |                                          |                 |  |  |  |  |

 

**Impaired Loan Summary**

 
| ** **                             | ** ** | **Number  of Loan  Customers**          | ** ** | **Loan  Balance**                   | ** **        | **Impaired  Loan  Valuation  Allowance** | ** **          | **Number  of Loan  Customers** | ** **    | **Loan  Balance** | ** ** | **Impaired  Loan  Valuation  Allowance** | ** ** |
|----------------------------------------|------------|-----------------------------------------|------------|-------------------------------------|-------------------|------------------------------------------|---------------------|--------------------------------|---------------|-------------------|------------|------------------------------------------|------------|
| **Loan and Lease Type** | ** ** | **At December 31, 2007** | ** ** | **At June 30, 2007** | ** **        |
|                                   |       |                                    |       |                                |              |
|                                   |       | (Dollars in  Thousands)                 |       | (Dollars in  Thousands)             |              |
|                                   |       |                                    |       |                                |              |                                     |                |                           |          |              |       |                                     |       |
| Commercial business                    |       | 5                             |       |  $                             | 607     |                                     | - - - -   |                           | 7   |              |  $    | 1,360                          |       | 335   |   |
| Agricultural                           |       | 2                             |       | 424                       |              | 130                            |                | 1                    |          | 121     |       | 50                             |       |
| Total                                  |       | 7                             |       |  $                             | 1,031   |                                     | 130       |                           | 8   |              |  $    | 1,481                          |       | 385   |   |

 

Page 27

 

The allowance forloan and lease losses was $5.4 million at December 31, 2007 as compared to$5.9 million at December 31, 2006. The ratio of the allowance for loan and lease losses to total loans andleases was 0.71% at December 31, 2007 compared to 0.77% at December 31,2006.  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.

 

Realestate properties acquired throughforeclosure are recorded at the lower of cost or fair value (less a deductionfor disposition costs).  Valuations areperiodically updated by management and a specific provision for losses on suchproperties is established by a charge to operations if the carrying values ofthe properties exceed their estimated net realizable values.

 

Although management believes it uses the best informationavailable to determine the allowances, unforeseen market conditions couldresult in adjustments and net earnings being significantly affected ifcircumstances differ substantially from the assumptions used in making thefinal determinations.  Future additions tothe Company’s allowances may result from periodic loan, property or collateralreviews which cannot be predicted at this time.

 

Page 28

 

**Comparison of the Three MonthsEnded December 31, 2007 and December 31, 2006**

 

*General*.  The Company’s net income was $1.3 million, or$0.32 in basic and $0.31 in diluted earnings per share for the three monthsended December 31, 2007, an $860,000 decrease in earnings compared to $2.1million, or $0.53 in basic and $0.52 in diluted earnings per share for the sameperiod in the prior fiscal year.  For thethree months ended December 31, 2007, the return on average equity was7.81% compared to 14.31% for the same period in the prior fiscal year.  For the three months ended December 31,2007, the return on average assets was 0.49% compared to 0.85% for the sameperiod in the prior fiscal year.  Asdiscussed in more detail below, the decreases were due to a variety of keyfactors, including an increase in interest income of $422,000 and decreases ininterest expense of $514,000 and provision for losses on loans and leases of$166,000 offset by a decrease in non-interest income of $2.5 million.

 

*Interest,Dividend and Loan Fee Income.* Interest, dividend and loan fee income was $16.1 million for the threemonths ended December 31, 2007 as compared to $15.7 million for the sameperiod in the prior fiscal year, an increase of $422,000 or 2.7%.  A $210,000increase in interest, dividend and loan fee income was due to a 1.7% increasein the average volume of loans and leases receivable and a $196,000 increase ininterest, dividend and loan fee income was the result of an increase in theaverage yield on investment securities from 4.69% for the three months ended December 31,2006 to 5.18% for the three months ended December 31, 2007.  The average yield on total interest-earningassets was 6.77% for the three months ended December 31, 2007 as comparedto 6.71% for the same period in the prior fiscal year.

 

*InterestExpense.*  Interest expense was $9.1 million for thethree months ended December 31, 2007 as compared to $9.6 million for thesame period in the prior fiscal year, a decrease of $514,000 or 5.4%.  A $239,000 decrease in interest expense wasthe result of a decrease in the average rate paid on interest-bearing depositsfrom 4.18% for the three months ended December 31, 2006 to 4.02% for thethree months ended December 31, 2007. An interest expense decrease of $290,000 was due to the unamortized debtissuance costs relating to the early redemption of a Trust Preferred Securityin Fiscal 2007 and $88,000 in interest expense was the result of a decrease inthe average rate paid on subordinated debentures payable to trusts.  The average rate paid on totalinterest-bearing liabilities was 4.26% for the three months ended December 31,2007 as compared to 4.55% for the same period in the prior fiscal year.

 

*NetInterest Income.* The Company’s netinterest income for the three months ended December 31, 2007 increased$936,000, or 15.4%, to $7.0 million compared to $6.1 million for the sameperiod in the prior fiscal year.  Theincrease in net interest income was due primarily to increases in the averageyield on interest-earning assets and average volume of interest-earning assetsand by decreases in the average rate paid on interest-bearing liabilities andaverage volume of interest-bearing liabilities for the three months ended December 31,2007 compared to the same period in the prior fiscal year.  The Company’s net interest margin on a fullytaxable equivalent basis was 3.00% for the three months ended December 31,2007 as compared to 2.66% for the same period in the prior fiscal year.

 

*Provisionfor Losses on Loans and Leases.*Theallowance 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.

 

During the threemonths ended December 31, 2007, the Company recorded a provision forlosses on loans and leases of $295,000 compared to $491,000 for the three monthsended December 31, 2006, a decrease of $166,000.  See “Asset Quality” for further discussion.

 

*Non-interestIncome.* Non-interest income was $3.0 million for the three months ended December 31,2007 as compared to $5.4 million for the same period in the prior fiscal year,a decrease of $2.5 million, or 45.3%. The decrease in non-interest income was primarily attributable toa one-time gain on sale of branches recorded in Fiscal 2007 of $2.8million.  In addition, there wereincreases in net gain on sale of loans of $179,000 and loan servicing income of$101,000 for the three months ended December 31, 2007 as compared to thesame period in the prior fiscal year.

 

Page 29

 

Net gain on saleof loans increased $179,000, from $260,000 for the three months ended December 31,2006 to $439,000 for the three months ended December 31, 2007, primarilydue to an increase in the amount of loans sold.

 

Loanservicing income increased $101,000 from $441,000 for the three months ended December 31,2006 to $542,000 for the three months ended December 31, 2007 primarilydue to an increase of $80.4 million in the balances of loans serviced by theBank from $946.2 million at December 31, 2006 to $1.027 billion at December 31,2007.

 

*Non-interestExpense.*  Non-interest expense was $7.7 million for thethree months ended December 31, 2007 as compared to $7.7 million for thethree months ended December 31, 2006, an increase of $17,000, or0.2%.  The increase in non-interestexpense was primarily due to increases in compensation and employee benefits of$310,000 and other non-interest expense of $48,000 offset by a decrease inmarketing of $405,000.

 

Compensation andemployee benefits increased $310,000, or 6.9%, from $4.5 million for the threemonths ended December 31, 2006 to $4.8 million for the three months ended December 31,2007.  Variable pay related to employeeincentives increased $118,000, regular employee pay increased $80,000 and nethealthcare costs increased $52,000.

 

Other non-interestexpense increased $48,000, or 4.9%, from $984,000 for the three months ended December 31,2006 to $1.0 million for the three months ended December 21, 2007,primarily due to an increase in legal expenses of $138,000.

 

Marketingdecreased $405,000, or 57.5%, from $704,000 for the three months ended December 31,2006 to $299,000 for the three months ended December 31, 2007.  Fiscal 2007 included additional expensesrelating to several deposit package programs.

 

*Income tax expense.*  The Company’s income tax expense for thethree months ended December 31, 2007 decreased $511,000 or 41.9% to$708,000 compared to $1.2 million for the same period in the prior fiscalyear.  The effective tax rate was 36.15%and 36.61% for the three months ended December 31, 2007 and 2006,respectively.

 

**Comparison of the Six MonthsEnded December 31, 2007 and December 31, 2006**

 

*General*.  The Company’s net income was $2.6 million, or$0.65 in basic and $0.64 in diluted earnings per share for the six months endedDecember 31, 2007, a $610,000 decrease in earnings compared to $3.2million, or $0.81 in basic and $0.79 in diluted earnings per share for the sameperiod in the prior fiscal year.  For thesix months ended December 31, 2007, the return on average equity was 8.18%compared to 11.05% for the same period in the prior fiscal year.  For the six months ended December 31,2007, the return on average assets was 0.51% compared to 0.65% for the sameperiod in the prior fiscal year.  Asdiscussed in more detail below, the decreases were due to a variety of keyfactors, including an increase in interest income of $1.3 million offset by adecrease in non-interest income of $2.0 million.

 

*Interest, Dividend and Loan Fee Income.*  Interest, dividend and loan fee income was$32.1 million for the six months ended December 31, 2007 as compared to$30.7 million for the same period in the prior fiscal year, an increase of $1.3million or 4.3%.  A $754,000 increase ininterest, dividend and loan fee income was due to a 2.9% increase in theaverage volume of loans and leases receivable. A $277,000 increase in interest, dividend and loan fee income was theresult of an increase in the average yield on loans and leases receivable from7.10% for the six months ended December 31, 2006 to 7.18% for the sixmonths ended December 31, 2007, and a $319,000 increase in interest,dividend and loan fee income was the result of an increase in the average yieldon investment securities from 4.65% for the six months ended December 31,2006 to 5.07% for the six months ended December 31, 2007.  The average yield on total interest-earningassets was 6.81% for the six months ended December 31, 2007 as compared to6.67% for the same period in the prior fiscal year.

 

Page 30

 

*InterestExpense.*  Interest expense was $18.4 million for thesix months ended December 31, 2007 as compared to $18.3 million for thesame period in the prior fiscal year, an increase of $143,000 or 0.8%.  A $270,000 increase in interest expense wasthe result of an increase in average rate paid on interest-bearing depositsfrom 4.06% for the six months ended December 31, 2006 to 4.13% for the sixmonths ended December 31, 2007, and a $241,000 increase in interestexpense was the result of an increase in the average volume of interest-bearingdeposits of 2.4%.  A net interest expensedecrease of $165,000 was due to the unamortized debt issuance costs relating tothe early redemption of two Trust Preferred Securities and $193,000 in interestexpense was the result of a decrease in the average rate paid on subordinateddebentures payable to trusts moving from 11.10% for the six months ended December 31,2006 to 8.57% for the six months ended December 31, 2007.  An increase of $179,000 in interest expensewas the result of an increase in the average volume of total interest-bearingliabilities of 1.7%.

 

*NetInterest Income.* The Company’s netinterest income for the six months ended December 31, 2007 increased $1.2million, or 9.5%, to $13.7 million compared to $12.5 million for the sameperiod in the prior fiscal year.  Theincrease in net interest income was due primarily to increases in the averageyield on interest-earning assets and average volume of interest-earning assetsand by decreases in the average rate paid on subordinated debentures payable totrusts offset by increases in the average rate paid on interest-bearingdeposits and average volume of interest-bearing deposits for the six monthsended December 31, 2007 compared to the same period in the prior fiscalyear.  The Company’s net interest marginon a fully taxable equivalent basis was 2.96% for the six months ended December 31,2007 as compared to 2.76% for the same period in the prior fiscal year.

 

*Provisionfor Losses on Loans and Leases.*Theallowance 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.

 

During the sixmonths ended December 31, 2007, the Company recorded a provision forlosses on loans and leases of $620,000 compared to $752,000 for the six monthsended December 31, 2006, a decrease of $132,000.  See “Asset Quality” for further discussion.

 

*Non-interestIncome.* Non-interest income was $5.8 million for the six months ended December 31,2007 as compared to $7.8 million for the same period in the prior fiscal year,a decrease of $2.0 million, or 25.6%. The decrease in non-interest income was primarily attributable to aone-time gain on sale of branches of $2.8 million in Fiscal 2007.  In addition, there were increases in loanservicing income of $277,000, fees on deposits of $260,000 and net gain on saleof loans of $242,000 for the six months ended December 31, 2007 ascompared to the same period in the prior fiscal year.

 

Loan servicingincome increased $277,000 from $770,000 for the six months ended December 31,2006 to $1.0 million for the six months ended December 31, 2007 primarilydue to an increase of $80.4 million in the balances of loans serviced by theBank from $946.2 million at December 31, 2006 to $1.027 billion at December 31,2007.

 

Fees on depositsincreased $260,000 to $2.8 million for the six months ended December 31,2007 from $2.5 million the same period in the prior fiscal year primarily dueto an increase in higher activity and increased service pricing.

 

Netgain on sale of loans increased $242,000 from $456,000 for the six months endedDecember 31, 2006 to $698,000 for the six months ended December 31,2007 primarily due to an increase in the amount of loans sold.

 

Page 31

 

*Non-interestExpense.*  Non-interest expense was $14.9 million forthe six months ended December 31, 2007 as compared to $14.6 million forthe six months ended December 31, 2006, an increase of $252,000, or1.7%.  The increase in non-interestexpense was primarily due to increases in compensation and employee benefits of$597,000, other non-interest expense of $116,000 and check and data processingexpenses of $102,000 offset by a decrease in marketing of $585,000.

 

Compensation andemployee benefits increased $597,000, or 6.9%, from $8.6 million for the sixmonths ended December 31, 2006 to $9.2 million for the six months ended December 31,2007.

 

Other non-interestexpense increased $116,000 for the six months ended December 31, 2007compared to the same period in the prior fiscal year, primarily due to anincrease of $154,000 in legal expenses for the six months ended December 31,2007 compared to the same period in the prior fiscal year.

 

Check and dataprocessing expenses increased $102,000 for the six months ended December 31,2007 compared to the same period in the prior fiscal year, primarily due toincreases in data processing expenses of $75,000 for the six months ended December 31,2007 compared to the six months ended December 31, 2006.

 

Marketing expensedecreased $585,000, or 51.0%, from $1.1 million for the six months ended December 31,2006 to $562,000 for the six months ended December 31, 2007 primarily dueto several deposit packages introduced during Fiscal 2007.

 

*Income tax expense.*  The Company’s income tax expense for the sixmonths ended December 31, 2007 decreased $309,000, or 18.3%, to $1.4million compared to $1.7 million for the same period in the prior fiscalyear.  The effective tax rate was 34.60%and 34.42% for the six months ended December 31, 2007 and 2006,respectively.

 

**Liquidityand Capital Resources**

 

TheBank’s primary sources of funds are earnings, in-market deposits, FHLB advancesand other borrowings, repayments of loan principal, mortgage-backed securitiesand callable agency securities and, to a lesser extent, sales of mortgageloans, sales and maturities of securities, out-of-market deposits andshort-term investments.  While scheduledloan payments and maturing securities are relatively predictable, deposit flowsand loan and security prepayments are more influenced by interest rates,general economic conditions and competition. The Bank attempts to price itsdeposits to meet 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.

 

The Bankanticipates it will have sufficient funds available to meet current loancommitments.  At December 31, 2007,the Bank had outstanding commitments to originate mortgage loans of $27.8million and non-mortgage loans of $8.4 million. In addition, the Bank had outstanding commitments to sell residentialmortgage loans of $9.3 million, commercial real estate loans of $2.0 million,commercial business loans of $223,000 and consumer student loans of $1.5million.  Commitments by the Bank tooriginate loans are not necessarily executed by the customer.  The Bank monitors the ratio of commitments tofunding for use in liquidity management.  At December 31, 2007, the Bank had nocommitments to purchase securities available for sale and no commitments tosell securities available for sale.

 

Page 32

 

Althoughin-market deposits are the Bank’s primary source of funds, the Bank’s policyhas been to utilize borrowings where the funds can be invested in either loansor securities at a positive rate of return or to use the funds for short-termliquidity purposes.  The Bank hasunsecured federal funds accommodations totaling $25.0 million withcorrespondent banks.  In addition, theCompany has a revolving line of credit totaling $6.0 million with acorrespondent bank.  There were no fundsdrawn on either line of credit at December 31, 2007.  Additionally, as of December 31, 2007,the Bank had $19.1 million in out-of-market certificates of deposit.  The Bank may also seek other sources ofcontingent liquidity including additional federal funds purchased lines withcorrespondent banks and lines of credit with the Federal Reserve Bank.

 

TheCompany uses its capital resources to pay dividends to its stockholders, torepurchase Company stock pursuant to Board of Directors approved plans, tosupport organic growth, to make acquisitions, to service its debt obligationsand to provide funding for investment into the Bank of Tier 1 (core) capital.

 

OnDecember 31, 2007, the Company had in effect a stock buyback program inwhich up to 10% of the common stock of the Company outstanding on May 1,2007 could be acquired through April 30, 2008.  As of December 31, 2007, 76,000 sharesof common stock had been purchased pursuant to the program.  See Part II, Item 2 “Unregistered Salesof Equity Securities and Use of Proceeds” of this Form 10-Q.

 

Savingsinstitutions insured by the Federal Deposit Insurance Corporation are requiredby the Financial Institutions Reform, Recovery and Enforcement Act of 1989 tomeet three regulatory capital requirements. If a requirement is not met, regulatory authorities may take legal oradministrative actions, including restrictions on growth or operations or, inextreme cases, seizure.  Institutions notin compliance may apply for an exemption from the requirements and submit arecapitalization plan.  At December 31,2007, the Bank met all current regulatory capital requirements.

 

The minimum OTSTier 1 (core) capital requirement for well-capitalized institutions is 5.00% oftotal adjusted assets for thrifts.  TheBank had Tier 1 (core) capital of 8.39% at December 31, 2007.  The minimum OTS total risk-based capitalrequirement for well-capitalized institutions is 10.00% of risk-weightedassets.  The Bank had total risk-basedcapital of 11.16% at December 31, 2007.

 

Page 33

 

**Impact ofInflation and Changing Prices**

 

Theunaudited consolidated financial statements and notes thereto presented in thisQuarterly Report on Form 10-Q have been prepared in accordance with GAAP,which require the measurement of financial position and operating results interms of historical dollars without considering the change in the relativepurchasing power of money over time due to inflation.  The impact of inflation is reflected in theincreased cost of the Bank’s operations. Unlike most industrial companies,nearly all the 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**

 

In March 2006,FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets,”which amends SFAS No. 140.  SFAS No. 156requires the recognition of all separately recognized servicing assets andservicing liabilities to be initially measured at fair value utilizing theamortization method or fair market value method. SFAS 156 is effective thebeginning of the first fiscal year that begins after September 15,2006.  The Company adopted this newaccounting standard effective July 1, 2007.  Under the amortization method, an entityshall amortize the value of servicing assets or liabilities in proportion toand over the period of estimated net servicing income or net servicing loss andassess servicing assets or liabilities for impairment or increased obligationbased on fair value at each reporting date. Under the fair value method, anentity shall measure servicing assets or liabilities at fair value at each reportingdate and report changes in fair value in earnings in the period in which thechanges occur. The adoption of SFAS No. 156 has not had a material affecton the Company’s financial statements.

 

In June 2006,FASB issued FIN 48, “Accounting for Uncertainty in Income Taxes - aninterpretation of FASB Statement No. 109” to create a single model toaddress accounting for uncertainty in tax positions.  FIN 48 clarifies that a tax position must bemore likely than not of being sustained before being recognized in thefinancial statements.  As required, theCompany adopted FIN 48 effective July 1, 2007.  The adoption of FIN 48 did not have amaterial impact on the Company’s financial statements.

 

In September 2006,FASB issued Statement of Financial Accounting Standards No. 157 (SFAS157), “Fair Value Measurements” and is effective for financial statementsissued for fiscal years beginning after November 15, 2007.  SFAS 157 provides a common definition of fairvalue and a framework for measuring assets and liabilities at fair values whena particular standard prescribes it.  Inaddition, the Statement expands disclosures about fair value measurements.  As required by SFAS 157, the Company willadopt this new accounting standard effective July 1, 2008.  Management is currently reviewing the impactof SFAS 157 on the Company’s financial statements.

 

In September 2006, FASB issued Statement ofFinancial Accounting Standards No. 158 (SFAS 158), “Employers’ Accountingfor Defined Benefit Pension and Other Postretirement Plans — an amendment ofFASB Statements No. 87, 88, 106 and 132R.” SFAS 158 requires recognition of the overfunded or underfunded status ofpension and other postretirement benefit plans on the balance sheet.  Under SFAS 158, gains and losses, prior servicecosts and credits and any remaining transition amounts under SFAS 87 and SFAS106 that have not yet been recognized through net periodic benefit cost will berecognized in accumulated other comprehensive income, net of tax effects, untilthey are amortized as a component of net periodic cost.  Also, the measurement date — the date atwhich the benefit obligation and plan assets are measured — is required to bethe company’s fiscal year-end.  Asrequired by SFAS 158, the Company adopted the balance sheet recognitionprovisions at June 30, 2007 and will adopt the year-end measurement datein 2009.

 

In February 2007, FASB issued Statement of Financial AccountingStandards No. 159 (SFAS 159), “The Fair Value Option for Financial Assetsand Financial Liabilities — Including an Amendment of FASB Statement No. 115.”  SFAS 159 is effective as of the beginning ofan entity’s first fiscal year after November 15, 2007.  SFAS 159 allows companies the choice tomeasure many financial instruments and certain other items at fair value.  This gives a company the opportunity tomitigate volatility in reported earnings caused by measuring related assets andliabilities differently without having to apply complex hedge accounting provisions.  The Company will adopt this new accountingstandard effective July 1, 2008. Management is currently reviewing the impact of SFAS 159 on ourfinancial statements.

 

Page 34

 

In December 2007, FASB issued Statement of Financial Accounting StandardsNo. 141(R) (SFAS 141R), “Business Combinations.”  SFAS 141 (R) is effective for fiscalyears beginning after December 15, 2008. SFAS 141 (R) improves reporting by creating greater consistency inthe accounting and financial reporting of business combinations, resulting inmore complete, comparable, and relevant information for investors and otherusers of financial statements. Management has reviewed SFAS 141 (R) and does not expect theadoption of this statement to have a material impact on the Company’sconsolidated financial condition, results of operations or cash flow.

 

In December 2007,FASB issued Statement of Financial Accounting Standards No. 160 (SFAS160), “Noncontrolling Interests in Consolidated Financial Statements — anamendment of ARB No. 51.”  SFAS 160is effective for fiscal years beginning after December 15, 2008.  SFAS 160 improves the relevance,comparability, and transparency of financial information provided to investorsby requiring all entities to report noncontrolling (minority) interest insubsidiaries in the same way — as equity in the consolidated financialstatements.  The Company does notcurrently have any noncontrolling interest in the consolidated financialstatements.

 

**Item3.  Quantitative and QualitativeDisclosures About Market Risk**

 

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.

 

Inan attempt to manage its exposure to change in interest rates, management monitorsthe Company’s interest rate risk.  TheCompany’s Asset/Liability Committee meets periodically to review the Company’sinterest rate risk position and profitability, and to recommend adjustments forconsideration by executive management. Management also reviews the Bank’ssecurities portfolio, formulates investment strategies, and oversees the timingand 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.

 

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 inasset or liability mix of the Company or other factors may produce a decreasein net interest margin in an upward moving rate environment even as the netportfolio value (“NPV”) estimate indicates an increase in net value.  The inverse situation may also occur.  One approach used by the Company to quantifyinterest rate risk is an NPV analysis. This analysis calculates the difference between the present value of theliabilities and the present value of expected cash flows from assets andoff-balance sheet contracts.  Thefollowing tables set forth, at September 30, 2007 (the most recent reportavailable) and December 31, 2006, an analysis of the Company’s interestrate risk as measured by the estimated changes in NPV resulting frominstantaneous and sustained parallel shifts in the yield curve (+300 or —200basis points, measured in 100 basis point increments).  Management does not believe that the Companyhas experienced any material changes in its market risk position from thatdisclosed in the Company’s Annual Report on Form 10-K for Fiscal 2007 orthat the Company’s primary market risk exposures and how those exposures weremanaged during the six months ended December 31, 2007 changedsignificantly when compared to June 30, 2007.

 

Page 35

 

Thedata in the following tables is based on assumptions utilized by the OTS inassessing interest rate risk of thrift institutions and published in “SelectedAsset and Liability Price Tables as of September 30, 2007” and “SelectedAsset and Liability Price Tables as of December 31, 2006.”  Even if interest rates change in thedesignated amounts, there can be no assurance that the Company’s assets andliabilities would perform as set forth below.

 

| **September 30, 2007** |
|----------------------------------|
| ** **                       |   |   |   |   |   |   |   |
| **Change in**               |   | **Estimated  NPV** |   | **Estimated Increase  (Decrease) in NPV** |   |
| **Interest Rates**          |   | **Amount** |   | **Amount** |   | **Percent** |   |
|                             |   |   |   |   |   |   |   |
| **Basis  Points**                |   | **(Dollars  in Thousands)** |   |   |   |
| ** **                       |   |   |   |   |   |   |   |
| +300                             |   | $100,026 |   | $(23,435 | ) | (19 | ) % |
| +200                             |   | 109,065 |   | (14,396 | ) | (12 | ) |
| +100                             |   | 117,085 |   | (6,376 | ) | (5 | ) |
| - - - -                          |   | 123,461 |   | - - - - |   | - - - - |   |
| -100                             |   | 125,554 |   | 2,093 |   | 2 |   |
| -200                             |   | 124,386 |   | 925 |   | 1 |   |

 

| **December  31, 2006**  |
|-------------------------|
| ** **              |   |   |   |   |   |   |   |
| **Change in**      |   | **Estimated  NPV** |   | **Estimated Increase  (Decrease) in NPV** |   |
| **Interest Rates** |   | **Amount** |   | **Amount** |   | **Percent** |   |
|                    |   |   |   |   |   |   |   |
| **Basis  Points**       |   | **(Dollars  in Thousands)** |   |   |   |
| ** **              |   |   |   |   |   |   |   |
| +300                    |   | $98,526 |   | $(24,353 | ) | (20 | ) % |
| +200                    |   | 107,462 |   | (15,416 | ) | (13 | ) |
| +100                    |   | 115,964 |   | (6,914 | ) | (6 | ) |
| - - - -                 |   | 122,878 |   | - - - - |   | - - - - |   |
| -100                    |   | 124,943 |   | 2,065 |   | 2 |   |
| -200                    |   | 123,352 |   | 473 |   | - - - - |   |

 

Page 36

 

In managing market risk and the asset/liabilitymix, 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 a relativelyconsistent level of net interest income in varying interest rate cycles and tominimize the potential for significant fluctuations from period to period.

 

**Item4.  Controls and Procedures**

 

The Company’s management hasevaluated, under the supervision and with the participation of the Company’sChairman, President and Chief Executive Officer and the Company’s ExecutiveVice President, Chief Financial Officer and Treasurer, the effectiveness of thedesign and operation of the Company’s disclosure controls and procedures, asdefined in Rule 13a-15(e), and have concluded that, as of the end of theperiod covered by this Quarterly Report, the Company’s disclosure controls andprocedures are effective for gathering, analyzing and disclosing informationthe Company is required to disclose in its periodic reports filed under theExchange Act.  There were no significantchanges in the Company’s internal control over financial reporting during theperiod covered by the Quarterly Report that materially affected, or arereasonably likely to materially affect, the Company’s internal control overfinancial reporting.

 

**PART II  — OTHER INFORMATION**

 

**Item 1.             LegalProceedings**

 

On June 26,2006, the Company filed a $3.8 million lawsuit against MetaBank and two individuals, J. Tyler Haahr and DanielA. Nelson, for their role in aparticipation loan, alleging fraud, breach of fiduciary duty, conspiracyand negligent misrepresentation.  These damages were the result of afailure by the lead bank to make disclosures regarding an investigation of thecommercial customer by the Iowa Attorney General at the time the Bank agreed toan extension of loan participation agreements. Legal proceedings are currently pending in the Second Judicial CircuitCourt, Minnehaha County, South Dakota.

 

Inaddition, the Company, the Bankand each of their subsidiaries are, from time to time, involved as plaintiff ordefendant in various legal actions arising in the normal course of theirbusinesses.  While the ultimate outcomeof any such proceedings cannot be predicted with certainty, it is generally theopinion of management, after consultation with counsel representing the Bankand the Company in any such proceedings, the resolution of any such proceedingsshould not have a material effect on the Company’s consolidated financialposition or results of operations.  TheCompany, the Bank and each of their subsidiaries are not aware of any legalactions or other proceedings contemplated by governmental authorities outsideof the normal course of business.

 

**Item 1A.          RiskFactors**

 

There have been no material changes from the risk factors disclosed in Part 1,Item 1A “Risk Factors” in the Company’s Annual Report on Form 10-K forFiscal 2007.

 

Page 37

** **

**Item 2.             UnregisteredSales of Equity Securities and Use of Proceeds**

 

The following table sets forth the purchases by the Company of itscommon stock during the quarterly period ended December 31, 2007.

 
| **Period**            | ** ** | **Total  Number  of Shares  Purchased** | ** ** | **Average  Price Paid  per Share** | ** ** | **Total Number  of Shares Purchased   as Part of Publicly  Announced Programs** | ** ** | **Maximum Number  of Shares that May Yet  Be Purchased Under  the Current Program** | ** ** |
|-----------------------|------------|-----------------------------------------|------------|----------------------------------------------|------------|---------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|
| October 1 - 31, 2007  |       | - - - -                            |       | $0.00                                   |       | - - - -                                                                    |       | 329,141                                                                                                                     |       |
| November 1 - 30, 2007 |       | 6,000                              |       | $15.76                                  |       | 6,000                                                                      |       | 323,141                                                                                                                     |       |
| December 1 - 31, 2007 |       | - - - -                            |       | $0.00                                   |       | - - - -                                                                    |       | 323,141                                                                                                                     |       |
| 2nd Quarter Total     |       | 6,000                              |       | $0.00                                   |       | 6,000                                                                      |       |                                                                                                                             |       |

 

The Company currently has in effect a stock buyback program, which waspublicly announced on April 30, 2007 and pursuant to which up to 10% ofthe common stock of the Company that was outstanding on May 1, 2007, whichequals 399,141 shares, may be acquired through April 30, 2008.  As of December 31, 2007, 76,000 sharesof common stock have been purchased pursuant to this program.

 

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

 

At the Company’s Annual Meeting ofStockholders held on November 14, 2007 (the “Annual Meeting”), thestockholders elected the two individuals nominated to serve as Class IIdirectors until 2010 or until their respective successors are elected andqualified, as set forth in Proposal 1 in the Company’s Proxy Statement relatingto the Annual Meeting.  The twoindividuals elected, and the number of votes cast for, or withheld, withrespect to each of them, is as follows:

 
| Charles T. Day   |   | For:   2,974,559 |   | Vote Withheld:    425,327 |
|------------------|--------|----------------------------|--------|------------------------------------------|
| Robert L. Hanson |   | For:   2,847,388 |   | Vote Withheld:    552,498 |

 

The following directors continue to serve on the Board of Directorsfollowing the Annual Meeting:  Curtis L.Hage, Curtis J. Bernard, Christine E. Hamilton, Wm. G. Pederson and Thomas L.Van Wyhe.

 

Page 38

 

**Item 6.             Exhibits**

 
| **Regulation  S-K Exhibit Number** | ** ** | **Document**                                                                                                                                      |
|-----------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------|
| 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 |

 

Page 39

 

**HF FINANCIAL CORP.**

 

**FORM 10-Q**

**SIGNATURES**

 

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

 
|   |                   HF  Financial Corp. |
|--------|---------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                            |
|   | (Registrant)                                                                                                                    |

 
| Date:  | February 14, 2008 |   |   | By:                                            |    /s/ Curtis L. Hage           |   |
|--------|------------------------|--------|--------|------------------------------------------------|-------------------------------------------|--------|
|   |                   |   |   | Curtis L. Hage,  Chairman, President           |
|   |                   |   |   | And Chief Executive  Officer                   |
|   |                   |   |   | (Principal Executive  Officer)                 |
|   |                   |   |   |                                           |
| Date:  | February 14, 2008 |   |   | By:                                            |     /s/ Darrel L. Posegate |   |
|   |                   |   |   | Darrel L. Posegate,  Executive Vice President, |
|   |                   |   |   | Chief Financial Officer  and Treasurer         |
|   |                   |   |   | (Principal Financial  and Accounting Officer)  |
|        |                        |        |        |                                                |                                           |        |  |

 

Page 40

 

**Index to Exhibits**

 

** **
| **Exhibit Number** |
|-------------------------|
|                    |   |   |
| 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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