Table of Contents

** **

 

** **

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

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**FORM 10-Q**

** **

**x****     ****QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For theQuarterly Period Ended March 31, 2010**

 

**OR**

 

**o****        ****TRANSITION REPORT PURSUANTTO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**Commissionfile number 0-19972**

 

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**HFFINANCIAL CORP.**

(Exact name of registrantas specified in its charter)

 

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

 

(**605) 333-7556**

(Registrant’s telephonenumber, including area code)

 

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

 

Indicate by check mark whether the Registrant hassubmitted electronically and posted on its corporate Web site, if any, everyInteractive Data File required to be submitted and posted pursuant to Rule 405of Regulation S-T (Section 232.405 of this chapter) during the preceding12 months (or for such shorter period that the Registrant was required tosubmit and post such files).  Yes  o    No  o

 

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

 

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

 

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

 

As of May 7, 2010, there were 6,938,538 shares of the registrant’scommon stock outstanding.

 

 

 

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Table ofContents

 

**Quarterly Report on Form 10-Q**

**Table of Contents**

 
| ** **                                    | ** **                                                                                          | **Page Number** |
|-----------------------------------------------|-----------------------------------------------------------------------------------------------------|----------------------|
| **PART I  — FINANCIAL INFORMATION** |                                                                                                |
|                                          |                                                                                                |                 |
| Item 1.                                       | Financial Statements  (Unaudited):                                                                  |                 |
|                                          |                                                                                                |                 |
|                                          | Consolidated Statements of Financial Condition At  March 31, 2010 and June 30, 2009       | 1                    |
|                                          |                                                                                                |                 |
|                                          | Consolidated Statements of Income for the Three and  Nine Months Ended March 31, 2010 and 2009 | 2                    |
|                                          |                                                                                                |                 |
|                                          | Consolidated Statements of Cash Flows for the Nine  Months Ended March 31, 2010 and 2009       | 3                    |
|                                          |                                                                                                |                 |
|                                          | Notes to Consolidated Financial Statements                                                          | 4                    |
|                                          |                                                                                                |                 |
| Item 2.                                       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations         | 19                   |
|                                          |                                                                                                |                 |
| Item 3.                                       | Quantitative  and Qualitative Disclosures about Market Risk                                         | 43                   |
|                                          |                                                                                                |                 |
| Item 4.                                       | Controls and  Procedures                                                                            | 44                   |
|                                          |                                                                                                |                 |
| **PART II  — OTHER INFORMATION**    |                                                                                                |
|                                          |                                                                                                |                 |
| Item 1.                                       | Legal Proceedings                                                                                   | 44                   |
|                                          |                                                                                                |                 |
| Item 1A.                                      | Risk Factors                                                                                        | 44                   |
|                                          |                                                                                                |                 |
| Item 2.                                       | Unregistered  Sales of Equity Securities and Use of Proceeds                                        | 46                   |
|                                          |                                                                                                |                 |
| Item 3.                                       | Defaults upon  Senior Securities                                                                    | 46                   |
|                                          |                                                                                                |                 |
| Item 4.                                       | [Removed and Reserved]                                                                              | 46                   |
|                                          |                                                                                                |                 |
| Item 5.                                       | Other Information                                                                                   | 46                   |
|                                          |                                                                                                |                 |
| Item 6.                                       | Exhibits                                                                                            | 46                   |
|                                          |                                                                                                |                 |
| Form 10-Q                                | Signature Page                                                                                      | 47                   |

 

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Tableof Contents

 

**PART I - FINANCIAL INFORMATION**

 

**Item 1.  *Financial Statements***

 

**HFFINANCIAL CORP.**

**CONSOLIDATED STATEMENTS OF FINANCIALCONDITION**

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

 
| ** **                                                                                                                                                      | ** ** | **March 31, 2010** | ** ** | **June 30, 2009** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                                                                                                                                                      | ** ** | **(Unaudited)**         | ** ** | **(Audited)**          | ** ** |
| **ASSETS**                                                                                                                                                      | ** ** | ** **              | ** ** | ** **             | ** ** |
| Cash  and cash equivalents                                                                                                                                      |       | $                       | 20,420     |                   | $          | 18,511 |   |
| Securities  available for sale                                                                                                                                  |       | 265,655                 |       | 222,910                |       |
| Federal  Home Loan Bank stock                                                                                                                                   |       | 12,227                  |       | 12,476                 |       |
| Loans  held for sale                                                                                                                                            |       | 24,866                  |       | 14,881                 |       |
|                                                                                                                                                            |       |                    |       |                   |       |
| Loans  and leases receivable                                                                                                                                    |       | 850,179                 |       | 851,282                |       |
| Allowance  for loan and lease losses                                                                                                                            |       | (8,935                  | )          | (8,470                 | )          |
| Net  loans and leases receivable                                                                                                                                |       | 841,244                 |       | 842,812                |       |
|                                                                                                                                                            |       |                    |       |                   |       |
| Accrued  interest receivable                                                                                                                                    |       | 8,984                   |       | 7,598                  |       |
| Office  properties and equipment, net of accumulated depreciation                                                                                               |       | 15,319                  |       | 16,917                 |       |
| Foreclosed  real estate and other properties                                                                                                                    |       | 1,294                   |       | 1,085                  |       |
| Cash  value of life insurance                                                                                                                                   |       | 15,007                  |       | 14,594                 |       |
| Servicing  rights                                                                                                                                               |       | 12,526                  |       | 11,768                 |       |
| Goodwill,  net                                                                                                                                                  |       | 4,951                   |       | 4,951                  |       |
| Other  assets                                                                                                                                                   |       | 11,987                  |       | 8,293                  |       |
| Total  assets                                                                                                                                                   |       | $                       | 1,234,480  |                   | $          | 1,176,796 |   |
|                                                                                                                                                            |       |                    |       |                   |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                   |       |                    |       |                   |       |
| ** **                                                                                                                                                      |       |                    |       |                   |       |
| LIABILITIES                                                                                                                                                     |       |                    |       |                   |       |
| Deposits                                                                                                                                                        |       | $                       | 839,560    |                   | $          | 837,868 |   |
| Advances  from Federal Home Loan Bank and other borrowings                                                                                                      |       | 243,387                 |       | 212,869                |       |
| Subordinated  debentures payable to trusts                                                                                                                      |       | 27,837                  |       | 27,837                 |       |
| Advances  by borrowers for taxes and insurance                                                                                                                  |       | 16,517                  |       | 11,899                 |       |
| Accrued  expenses and other liabilities                                                                                                                         |       | 13,467                  |       | 17,648                 |       |
| Total  liabilities                                                                                                                                              |       | 1,140,768               |       | 1,108,121              |       |
|                                                                                                                                                            |       |                    |       |                   |       |
| STOCKHOLDERS’  EQUITY                                                                                                                                      |       |                    |       |                   |       |
| Preferred  stock, $.01 par value, 500,000 shares authorized, none outstanding                                                                                   |       | —                  |       | —                 |       |
| Common  stock, $.01 par value, 10,000,000 shares authorized, 9,021,993 and 6,109,437  shares issued at March 31, 2010 and June 30, 2009, respectively |       | 90                      |       | 61                     |       |
| Common  stock subscribed for but not issued                                                                                                                     |       | —                  |       | 224                    |       |
| Additional  paid-in capital                                                                                                                                     |       | 44,291                  |       | 22,911                 |       |
| Retained  earnings, substantially restricted                                                                                                                    |       | 83,653                  |       | 80,735                 |       |
| Accumulated  other comprehensive (loss), net of related deferred tax effect                                                                                     |       | (3,425                  | )          | (4,359                 | )          |
| Less  cost of treasury stock, 2,083,455 and 2,083,455 shares at March 31, 2010  and June 30, 2009, respectively                                       |       | (30,897                 | )          | (30,897                | )          |
| Total  stockholders’ equity                                                                                                                                |       | 93,712                  |       | 68,675                 |       |
| Total  liabilities and stockholders’ equity                                                                                                                |       | $                       | 1,234,480  |                   | $          | 1,176,796 |   |

 

*Seeaccompanying notes to unaudited consolidated financial statements.*

 

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**HFFINANCIAL CORP.**

**CONSOLIDATED STATEMENTS OF INCOME**

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

**(Unaudited)**

 
| ** **                                                               | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                               | ** ** | **March 31,**     | ** ** | **March 31,**    | ** ** |
| ** **                                                               | ** ** | **2010**               | ** ** | **2009**              | ** ** | **2010** | ** ** | **2009** | ** ** |
| Interest,  dividend and loan fee income:                                 |       |                   |       |                  |       |   |   |   |   |
| Loans  and leases receivable                                             |       | $                      | 12,192     |                  | $          | 12,045 |   | $ | 36,887 |   | $ | 37,709 |   |
| Investment  securities and interest-earning deposits                     |       | 1,928                  |       | 2,963                 |       | 6,213 |   | 8,696 |   |
|                                                                     |       | 14,120                 |       | 15,008                |       | 43,100 |   | 46,405 |   |
| Interest  expense:                                                       |       |                   |       |                  |       |   |   |   |   |
| Deposits                                                                 |       | 2,826                  |       | 3,515                 |       | 9,682 |   | 12,224 |   |
| Advances  from Federal Home Loan Bank and other borrowings               |       | 1,941                  |       | 2,343                 |       | 6,456 |   | 7,335 |   |
|                                                                     |       | 4,767                  |       | 5,858                 |       | 16,138 |   | 19,559 |   |
| Net  interest income                                                     |       | 9,353                  |       | 9,150                 |       | 26,962 |   | 26,846 |   |
| Provision  for losses on loans and leases                                |       | 981                    |       | 414                   |       | 1,748 |   | 801 |   |
|                                                                     |       |                   |       |                  |       |   |   |   |   |
| Net  interest income after provision for losses on loans and leases      |       | 8,372                  |       | 8,736                 |       | 25,214 |   | 26,045 |   |
|                                                                     |       |                   |       |                  |       |   |   |   |   |
| Noninterest  income:                                                     |       |                   |       |                  |       |   |   |   |   |
| Fees  on deposits                                                        |       | 1,293                  |       | 1,304                 |       | 4,142 |   | 4,373 |   |
| Loan  servicing income                                                   |       | 527                    |       | 617                   |       | 1,506 |   | 1,708 |   |
| Gain  on sale of loans, net                                              |       | 369                    |       | 543                   |       | 1,402 |   | 1,079 |   |
| Trust  income                                                            |       | 173                    |       | 158                   |       | 637 |   | 533 |   |
| Gain  on sale of securities, net                                         |       | 229                    |       | 387                   |       | 1,365 |   | 512 |   |
|                                                                     |       |                   |       |                  |       |   |   |   |   |
| Total  other-than-temporary impairment losses                            |       | 59                     |       | (3,158                | )          | (2,022 | ) | (3,158 | ) |
| Portion  of loss recognized in other comprehensive income (before taxes) |       | (263                   | )          | 2,797                 |       | (380 | ) | 2,797 |   |
| Net  impairment losses recognized in earnings                            |       | (204                   | )          | (361                  | )          | (2,402 | ) | (361 | ) |
|                                                                     |       |                   |       |                  |       |   |   |   |   |
| Other                                                                    |       | 423                    |       | 356                   |       | 1,111 |   | 1,138 |   |
|                                                                     |       | 2,810                  |       | 3,004                 |       | 7,761 |   | 8,982 |   |
| Noninterest  expense:                                                    |       |                   |       |                  |       |   |   |   |   |
| Compensation  and employee benefits                                      |       | 5,078                  |       | 5,232                 |       | 15,380 |   | 16,181 |   |
| Occupancy  and equipment                                                 |       | 1,161                  |       | 1,034                 |       | 3,345 |   | 3,023 |   |
| FDIC  insurance                                                          |       | 325                    |       | 272                   |       | 985 |   | 535 |   |
| Check  and data processing expense                                       |       | 659                    |       | 671                   |       | 2,034 |   | 1,945 |   |
| Professional  fees                                                       |       | 338                    |       | 397                   |       | 1,275 |   | 1,352 |   |
| Marketing  and community development                                     |       | 319                    |       | 222                   |       | 1,284 |   | 1,108 |   |
| Foreclosed  real estate and other properties, net                        |       | 34                     |       | 6                     |       | 101 |   | 219 |   |
| Other                                                                    |       | 609                    |       | 574                   |       | 1,847 |   | 1,624 |   |
|                                                                     |       | 8,523                  |       | 8,408                 |       | 26,251 |   | 25,987 |   |
|                                                                     |       |                   |       |                  |       |   |   |   |   |
| Income  before income taxes                                              |       | 2,659                  |       | 3,332                 |       | 6,724 |   | 9,040 |   |
|                                                                     |       |                   |       |                  |       |   |   |   |   |
| Income  tax expense                                                      |       | 868                    |       | 1,161                 |       | 2,117 |   | 3,048 |   |
| Net  income                                                              |       | 1,791                  |       | 2,171                 |       | 4,607 |   | 5,992 |   |
|                                                                     |       |                   |       |                  |       |   |   |   |   |
| Preferred  stock dividends and accretion                                 |       | —                 |       | 340                   |       | — |   | 340 |   |
|                                                                     |       |                   |       |                  |       |   |   |   |   |
| Net  income available to common shareholders                             |       | $                      | 1,791      |                  | $          | 1,831 |   | $ | 4,607 |   | $ | 5,652 |   |
|                                                                     |       |                   |       |                  |       |   |   |   |   |
| Comprehensive  income                                                    |       | $                      | 2,042      |                  | $          | 2,980 |   | $ | 5,541 |   | $ | 5,554 |   |
|                                                                     |       |                   |       |                  |       |   |   |   |   |
| Basic  earnings per common share:                                        |       | $                      | 0.26       |                  | $          | 0.45 |   | $ | 0.86 |   | $ | 1.41 |   |
| Diluted  earnings per common share:                                      |       | 0.26                   |       | 0.45                  |       | 0.86 |   | 1.40 |   |
| Dividends  declared per common share                                     |       | 0.11                   |       | 0.11                  |       | 0.34 |   | 0.34 |   |

 

*See accompanying notes to unaudited consolidatedfinancial statements.*

 

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**HFFINANCIAL CORP.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

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

**(Unaudited)**

 
| ** **                                                                                             | ** ** | **Nine Months Ended March 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                             | ** ** | **2010**                             | ** ** | **2009** | ** ** |
| Cash  flows from operating activities                                                                  |       |                                 |       |   |   |
| Net  income                                                                                            |       | $                                    | 4,607      |   | $ | 5,992 |   |
| Adjustments  to reconcile net income to net cash (used in) operating activities                        |       |                                 |       |   |   |
| Provision  for losses on loans and leases                                                              |       | 1,748                                |       | 801 |   |
| Depreciation                                                                                           |       | 1,499                                |       | 1,292 |   |
| Amortization  of discounts and premiums on securities and other                                        |       | 2,418                                |       | 1,255 |   |
| Stock  based compensation                                                                              |       | 525                                  |       | 303 |   |
| Net  change in loans held for resale                                                                   |       | (8,583                               | )          | (11,318 | ) |
| (Gain)  on sale of loans, net                                                                          |       | (1,402                               | )          | (1,079 | ) |
| Realized  (gain) on sale of securities, net                                                            |       | (1,365                               | )          | (512 | ) |
| Other-than-temporary  impairments recognized in noninterest income                                     |       | 2,402                                |       | 361 |   |
| (Gains)  losses and provision-for-losses on sales of foreclosed real estate and other  properties, net |       | (5                                   | )          | 19 |   |
| (Gain)  loss on disposal of office properties and equipment, net                                       |       | 4                                    |       | — |   |
| Change  in other assets and liabilities                                                                |       | (10,839                              | )          | (4,562 | ) |
| Net  cash (used in) operating activities                                                               |       | (8,991                               | )          | (7,448 | ) |
| Cash  flows from investing activities                                                                  |       |                                 |       |   |   |
| Loan  participations purchased                                                                         |       | (2,250                               | )          | (969 | ) |
| Net  change in loans outstanding                                                                       |       | 1,330                                |       | (34,385 | ) |
| Securities  available for sale                                                                         |       |                                 |       |   |   |
| Sales,  maturities, repayments and adjustments                                                         |       | 78,618                               |       | 74,921 |   |
| Purchases                                                                                              |       | (122,163                             | )          | (99,288 | ) |
| Purchase  of Federal Home Loan Bank stock                                                              |       | (4,104                               | )          | (5,565 | ) |
| Redemption  of Federal Home Loan Bank stock                                                            |       | 4,353                                |       | 4,334 |   |
| Proceeds  from sale of office properties and equipment                                                 |       | 2,048                                |       | — |   |
| Purchase  of office properties and equipment                                                           |       | (1,953                               | )          | (1,965 | ) |
| Purchase  of servicing rights                                                                          |       | (1,108                               | )          | (857 | ) |
| Proceeds  from sale of foreclosed real estate and other properties                                     |       | 330                                  |       | 451 |   |
| Net  cash (used in) investing activities                                                               |       | (44,899                              | )          | (63,323 | ) |
| Cash  flows from financing activities                                                                  |       |                                 |       |   |   |
| Net  increase in deposit accounts                                                                      |       | 1,692                                |       | 19,971 |   |
| Proceeds  of advances from Federal Home Loan Bank and other borrowings                                 |       | 1,357,120                            |       | 4,054,528 |   |
| Payments  on advances from Federal Home Loan Bank and other borrowings                                 |       | (1,326,602                           | )          | (4,042,647 | ) |
| Increase  in advances by borrowers                                                                     |       | 4,618                                |       | 7,352 |   |
| Proceeds  from issuance of preferred stock                                                             |       | —                               |       | 25,000 |   |
| Proceeds  from issuance of common stock                                                                |       | 20,660                               |       | 821 |   |
| Cash  dividends paid                                                                                   |       | (1,689                               | )          | (1,692 | ) |
| Net  cash provided by financing activities                                                             |       | 55,799                               |       | 63,333 |   |
| Increase  (decrease) in cash and cash equivalents                                                      |       | 1,909                                |       | (7,438 | ) |
| Cash  and cash equivalents                                                                             |       |                                 |       |   |   |
| Beginning                                                                                              |       | 18,511                               |       | 21,170 |   |
| Ending                                                                                                 |       | $                                    | 20,420     |   | $ | 13,732 |   |
| Supplemental  disclosures of cash flows information                                                    |       |                                 |       |   |   |
| Cash  payments for interest                                                                            |       | $                                    | 18,146     |   | $ | 21,054 |   |
| Cash  payments for income and franchise taxes, net                                                     |       | 1,957                                |       | 2,795 |   |

 

*See accompanying notes to unaudited consolidatedfinancial statements.*

 

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**HFFINANCIAL CORP.**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

**FORTHE NINE MONTHS ENDED MARCH 31, 2010 AND 2009**

**(Unaudited)**

 

**NOTE1—SELECTED ACCOUNTING POLICIES**

 

*Basis of Financial StatementPresentation*

 

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

 

The interimconsolidated financial statements include the accounts of the Company, itswholly-owned subsidiaries, Home Federal Bank (the “Bank”), HF Financial Group, Inc.(“HF Group”) and HomeFirst Mortgage Corp. (the “Mortgage Corp.”), and the Bank’swholly-owned subsidiaries, Mid America Capital Services, Inc. (“MidAmerica Capital”), Hometown Investment Services, Inc. (“Hometown”), HomeFederal Securitization Corp. (“HFSC”), Mid-America Service Corporation and PMD, Inc.  The interim consolidated financial statementsreflect the deconsolidation of the wholly-owned subsidiary trusts of theCompany: HF Financial Capital Trust III (“Trust III”), HF Financial CapitalTrust IV (“Trust IV”), HF Financial Capital Trust V (“Trust V”) and HFFinancial Capital Trust VI (“Trust VI”). See Note 10 of “Notes to ConsolidatedFinancial Statements.”  All intercompanybalances and transactions have been eliminated in consolidation.

 

Management hasevaluated subsequent events for potential disclosure or recognition through May 14,2010, the date of the filing of the consolidated financial statements with theSecurities and Exchange Commission.

 

**NOTE 2—REGULATORY CAPITAL**

 

The followingtable sets forth the Bank’s compliance with its minimum capital requirementsfor a well-capitalized institution at March 31, 2010:

 
| ** **                                           | ** ** | **Amount**                 | ** ** | **Percent** | ** ** |
|------------------------------------------------------|------------|----------------------------|------------|-------------|------------|
| ** **                                           | ** ** | **(Dollars in Thousands)** | ** ** |
| Tier  I (core) capital (to adjusted total assets):   |       |                       |       |        |       |
| Required                                             |       | $                          | 61,428     |        | 5.00       | % |
| Actual                                               |       | 106,028                    |       | 8.63        |       |
| Excess  over required                                |       | 44,600                     |       | 3.63        |       |
|                                                 |       |                       |       |        |       |
| Total  Risk-based capital (to risk-weighted assets): |       |                       |       |        |       |
| Required                                             |       | $                          | 97,757     |        | 10.00      | % |
| Actual                                               |       | 114,597                    |       | 11.72       |       |
| Excess  over required                                |       | 16,840                     |       | 1.72        |       |

 

**NOTE3—EARNINGS PER COMMON SHARE**

 

Basic earnings percommon share is computed by dividing income available to common stockholders(the numerator) by the weighted-average number of common shares outstanding(the denominator) during the period. Shares issued during the period and shares reacquired during the periodare weighted for the portion of the period they were outstanding. The weightedaverage number of basic common shares outstanding for the three months ended March 31,2010 and 2009 was 6,938,538 and 4,024,335, respectively.  The weighted average number of basic commonshares outstanding for the nine months ended March 31, 2010 and 2009 was5,378,964 and 4,000,456, respectively.

 

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Dilutive earningsper common share is similar to the computation of basic earnings per commonshare except the denominator is increased to include the number of additionalcommon shares that would have been outstanding if the dilutive optionsoutstanding had been exercised. The weighted average number of common anddilutive potential common shares outstanding for the three months ended March 31,2010 and 2009 was 6,940,628 and 4,034,659, respectively.  The weighted average number of common anddilutive potential common shares outstanding for the nine months ended March 31,2010 and 2009 was 5,384,144 and 4,025,426, respectively.

 

**NOTE 4—INVESTMENTS IN SECURITIES**

 

The amortized cost and fair values of investments in securities, all ofwhich are classified as available for sale according to management’s intent,are as follows:

 
| ** **                              | ** ** | **March 31, 2010**    | ** ** | **March 31, 2009** | ** ** |
|-----------------------------------------|------------|----------------------------|------------|-------------------------|------------|
| ** **                              | ** ** | ** **                 | ** ** | **Gross**               | ** ** | ** ** | ** ** | ** ** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                              | ** ** | **Amortized**              | ** ** | **Unrealized**          | ** ** | **Fair** | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **                              | ** ** | **Cost**                   | ** ** | **Gains**               | ** ** | **(Losses)** | ** ** | **Value** | ** ** | **Cost** | ** ** | **Gains** | ** ** | **(Losses)** | ** ** | **Value** | ** ** |
| ** **                              | ** ** | **(Dollars in Thousands)** | ** ** |
|                                    |       |                       |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Debt  securities:                       |       |                       |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| U.S.  government agencies               |       | $                          | 5,183      |                    | $          | 16 |   | $ | (3 | ) | $ | 5,196 |   | $ | 2,617 |   | $ | 54 |   | $ | — |   | $ | 2,671 |   |
| Municipal  bonds                        |       | 13,435                     |       | 429                     |       | (56 | ) | 13,808 |   | 14,419 |   | 389 |   | (136 | ) | 14,672 |   |
| Trust  preferred securities             |       | 9,510                      |       | —                  |       | (5,108 | ) | 4,402 |   | 11,934 |   | — |   | (5,647 | ) | 6,287 |   |
|                                    |       | 28,128                     |       | 445                     |       | (5,167 | ) | 23,406 |   | 28,970 |   | 443 |   | (5,783 | ) | 23,630 |   |
|                                    |       |                       |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Equity  securities:                     |       |                       |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| FNMA                                    |       | —                     |       | —                  |       | — |   | — |   | 8 |   | — |   | (8 | ) | — |   |
| Federal  Ag Mortgage                    |       | 7                          |       | —                  |       | (2 | ) | 5 |   | 7 |   | — |   | (7 | ) | — |   |
| Other  investments                      |       | 253                        |       | —                  |       | — |   | 253 |   | 253 |   | — |   | — |   | 253 |   |
|                                    |       | 260                        |       | —                  |       | (2 | ) | 258 |   | 268 |   | — |   | (15 | ) | 253 |   |
|                                    |       |                       |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Residential  mortgage-backed securities |       | 238,741                    |       | 3,929                   |       | (679 | ) | 241,991 |   | 223,771 |   | 3,625 |   | (1,234 | ) | 226,162 |   |
|                                    |       | $                          | 267,129    |                    | $          | 4,374 |   | $ | (5,848 | ) | $ | 265,655 |   | $ | 253,009 |   | $ | 4,068 |   | $ | (7,032 | ) | $ | 250,045 |   |

 

Management has implemented a process to identify securities that couldpotentially have a credit impairment that is other-than-temporary.  This process involves evaluation of thelength of time and extent to which the fair value has been less than theamortized cost basis, review of available information regarding the financialposition of the issuer, monitoring the rating of the security, cash flow projections,and the Company’s intent to sell a security or whether it is more likely thannot we will be required to sell the security before the recovery of itsamortized cost which, in some cases, may extend to maturity.  To the extent we determine that a security isdeemed to be other-than-temporarily impaired, an impairment loss is recognized.

 

For all securities that are considered temporarily impaired, the Companydoes not intend to sell these securities (has not made a decision to sell) andit is not more likely than not that the Company will be required to sell thesecurity before recovery of its amortized cost, which may occur atmaturity.  The Company believes that itwill collect all principal and interest due on all investments that haveamortized cost in excess of fair value that are considered only temporarilyimpaired.

 

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The following table presents the fair value and age of gross unrealizedlosses by investment category at March 31, 2010*:*

 
| ** **                              | ** ** | **Less than 12 Months**    | ** ** | **12 Months or More** | ** ** | **Total**  | ** ** |
|-----------------------------------------|------------|----------------------------|------------|-----------------------|------------|------------|------------|
| ** **                              | ** ** | ** **                 | ** ** | **Gross**             | ** ** | ** ** | ** ** | **Gross** | ** ** | ** ** | ** ** | **Gross** | ** ** |
| ** **                              | ** ** | **Fair**                   | ** ** | **Unrealized**        | ** ** | **Fair**   | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| ** **                              | ** ** | **Value**                  | ** ** | **(Losses)**          | ** ** | **Value**  | ** ** | **(Losses)** | ** ** | **Value** | ** ** | **(Losses)** | ** ** |
| ** **                              | ** ** | **(Dollars in Thousands)** | ** ** |
| Debt  securities:                       |       |                       |       |                  |       |       |       |   |   |   |   |   |   |
| U.S.  government agencies               |       | $                          | 2,547      |                  | $          | (3         | )          | $ | — |   | $ | — |   | $ | 2,547 |   | $ | (3 | ) |
| Municipal  bonds                        |       | 779                        |       | (8                    | )          | 1,881      |       | (48 | ) | 2,660 |   | (56 | ) |
| Trust  preferred securities             |       | —                     |       | —                |       | 4,402      |       | (5,108 | ) | 4,402 |   | (5,108 | ) |
|                                    |       | 3,326                      |       | (11                   | )          | 6,283      |       | (5,156 | ) | 9,609 |   | (5,167 | ) |
| Equity  securities:                     |       |                       |       |                  |       |       |       |   |   |   |   |   |   |
| Federal  Ag Mortgage                    |       | 5                          |       | (2                    | )          | —     |       | — |   | 5 |   | (2 | ) |
|                                    |       | 5                          |       | (2                    | )          | —     |       | — |   | 5 |   | (2 | ) |
| Residential  mortgage-backed securities |       | 73,336                     |       | (543                  | )          | 11,107     |       | (136 | ) | 84,443 |   | (679 | ) |
|                                    |       | $                          | 76,667     |                  | $          | (556       | )          | $ | 17,390 |   | $ | (5,292 | ) | $ | 94,057 |   | $ | (5,848 | ) |

 

For the three months ended March 31, 2010, gross proceeds from the securities sold at again were $12.1 million, resulting in a gain on sale of securities of$230,000.  This compares to gross proceedsof $15.7 million, resulting in a gain on sale of securities of $387,000 for thethree months ended March 31, 2009.  For the three months ended March 31,2010, gross proceeds from thesecurities sold at a loss were $1.2 million, resulting in a loss on sale ofsecurities of $1,000 compared to the three month period ended March 31,2009, which had no securities sold at a loss.

 

For the ninemonths ended March 31, 2010, gross proceeds from the securities sold at again were $36.4 million, resulting in a gain on sale of securities of $1.4million.  This compares to gross proceedsof $28.6 million, resulting in a gain on sale of securities of $559,000 for thenine months ended March 31, 2009. For the nine months ended March 31, 2010, gross proceeds from thesecurities sold at a loss were $1.2 million, resulting in a loss on sale ofsecurities of $1,000 compared to $8.3 million received in gross proceeds forthe nine months ended March 31, 2009, which resulted in a net loss of$47,000.

 

The unrealizedlosses reported for municipal bonds relate to 17 municipal general obligationor revenue bonds.  The unrealized lossesare primarily attributed to changes in credit spreads or market interest rateincreases since the securities were originally acquired, rather than due tocredit or other causes.  Management does not believe any individualunrealized losses as of March 31, 2010, represent an other-than-temporaryimpairment for these investments.  TheCompany does not have the intent to sell these securities (has not made adecision to sell) and has assessed that it is not more likely than not that theCompany will be required to sell these securities before anticipated recoveryof fair value.

 

The unrealized losses reported for residential mortgage-backed securitiesrelate to 41 securities issued by the Federal National Mortgage Association (“FNMA”),the Government National Mortgage Association (“GNMA”), or the Federal Home LoanMortgage Corporation (“FHLMC”).  Theseunrealized losses are primarily attributable to changes in interest rates andthe contractual cash flows of those investments which are guaranteed by anagency of the U.S. government. Management does not believe any of these unrealized losses as of March 31,2010, represent an other-than-temporary impairment for those investments.  The Company does not have the intent to sellthese securities (has not made a decision to sell) and has assessed that it isnot more likely than not that the Company will be required to sell thesesecurities before anticipated recovery of fair value.

 

The unrealized losses reported for trust preferred securities areattributable to six rated pooled securities. Rating downgrades regarding theseinvestments have occurred placing each in a below investment grade rating. Thesecurities have an amortized cost of $1.9 million rated Caa3, $2.3 millionrated Caa1, and $5.3 million rated Ca. The market for these securities is currently inactive. The CUSIPs of thetrust preferred securities are 74042TAE1 rated Caa3, 740417AB6 and 74042CAE8rated Caa1, and 74041EAC9, 74041RAB2, and 55312HAE9 rated Ca. The Companyperformed assessments of available information for each security during thethird quarter ended March 31, 2010, and also considered factors such as overalldeal structure and its position within the structure, quality of underlyingissuers within each pool, defaults and recoveries, loss severities andprepayments. Based upon scenarios developed in regard to this information,management compared the present value of best estimates of cash flows expectedto be collected from each security at the security’s effective interest rate tothe amortized cost basis of each security. Management determined that threetrust preferred securities exhibited an other-than-temporary impairment. The differencebetween the present value of cash flows and the amortized cost basis for eachof the three securities was recorded as credit loss impairment and recognizedin earnings in the amount of $204,000. The amount of unrealized loss recognized in other comprehensive income,net of applicable taxes, was reduced by $263,000.  The unrealized losses on these trustpreferred securities can primarily be attributed to changes in credit spreadssince the securities were acquired. See Note 13 “Financial Instruments” foradditional information related to the determination of fair value. The Companydoes not have the intent to sell these six securities (has not made a decisionto sell) and has assessed that it is not more likely than not that the Companywill be required to sell these securities before anticipated recovery of fairvalue. Within this segment, five securities with amortized cost of $7.7 millionare quarterly variable-rate securities tied to 3-month LIBOR.

 

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The following table presents the amounts recognized in the ConsolidatedStatements of Income for other-than-temporary impairments related to creditlosses charged to earnings:

 
| ** **                                                                                                                                                                           | ** ** | **Nine Months Ended**      | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                                                                                                                                           | ** ** | **March 31, 2010**    | ** ** |
| ** **                                                                                                                                                                           | ** ** | **(Dollars in Thousands)** | ** ** |
| Beginning balance of  credit losses on securities held as of July 1, 2009 for which a portion  of other-than-temporary impairment was recognized in other comprehensive  income |       | $                          | 405        |   |
|                                                                                                                                                                                 |       |                       |       |
| Credit losses for which  an other-than-temporary impairment was not previously recognized                                                                                            |       | 71                         |       |
|                                                                                                                                                                                 |       |                       |       |
| Increases to the amount  related to the credit losses for which other-than-temporary was previously  recognized                                                                      |       | 2,331                      |       |
|                                                                                                                                                                                 |       |                       |       |
| Ending balance of credit  losses on securities held as of March 31, 2010 for which a portion of  other-than-temporary impairment was recognized in other comprehensive income   |       | $                          | 2,807      |   |

 

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

 
| ** **                              | ** ** | **At March 31, 2010** | ** ** |
|-----------------------------------------|------------|----------------------------|------------|
| ** **                              | ** ** | ** **                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **TOTAL** | ** ** |
| ** **                              | ** ** | **Less than**              | ** ** | **1 to 5** | ** ** | **5 to 10** | ** ** | **Over 10** | ** ** | **Amortized** | ** ** | **Fair** | ** ** |
| ** **                              | ** ** | **1 Year**                 | ** ** | **Years** | ** ** | **Years** | ** ** | **Years** | ** ** | **Cost** | ** ** | **Values** | ** ** |
| ** **                              | ** ** | **(Dollars in Thousands)** | ** ** |
|                                    |       |                       |       |   |   |   |   |   |   |   |   |   |   |
| U.S. government agencies                |       | $                          | 1,132      |   | $ | 4,051 |   | $ | — |   | $ | — |   | $ | 5,183 |   | $ | 5,196 |   |
| Municipal bonds                         |       | 650                        |       | 4,036 |   | 6,173 |   | 2,576 |   | 13,435 |   | 13,808 |   |
| Trust preferred  securities             |       | —                     |       | — |   | — |   | 9,510 |   | 9,510 |   | 4,402 |   |
| Residential mortgage-backed  securities |       | —                     |       | 3,397 |   | 17,512 |   | 217,832 |   | 238,741 |   | 241,991 |   |
| Total investment  securities            |       | $                          | 1,782      |   | $ | 11,484 |   | $ | 23,685 |   | $ | 229,918 |   | $ | 266,869 |   | $ | 265,397 |   |

 

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**NOTE5—LOAN SERVICING**

 

Mortgageloans serviced for others (primarily the South Dakota Housing DevelopmentAuthority) are not included in the accompanying consolidated statements offinancial condition.

 

Thefollowing tables summarize the activity in, and the main assumptions used toestimate the amortization of servicing rights:

 
| ** **                     | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                     | ** ** | **March 31,**         | ** ** | **March 31,**    | ** ** |
| ** **                     | ** ** | **2010**                   | ** ** | **2009**              | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                     | ** ** | **(Dollars in Thousands)** | ** ** |
|                           |       |                       |       |                  |       |   |   |   |   |
| Balance, beginning             |       | $                          | 12,351     |                  | $          | 11,412 |   | $ | 11,768 |   | $ | 11,189 |   |
| Additions                      |       | 528                        |       | 265                   |       | 1,957 |   | 1,223 |   |
| Amortization                   |       | (353                       | )          | (303                  | )          | (1,199 | ) | (1,038 | ) |
| Balance, ending                |       | $                          | 12,526     |                  | $          | 11,374 |   | $ | 12,526 |   | $ | 11,374 |   |
|                           |       |                       |       |                  |       |   |   |   |   |
| Servicing fees received        |       | $                          | 880        |                  | $          | 920 |   | $ | 2,705 |   | $ | 2,745 |   |
| Balance of loans  serviced at: |       |                       |       |                  |       |   |   |   |   |
| Beginning of period            |       | 1,111,380                  |       | 1,033,884             |       | 1,046,600 |   | 994,065 |   |
| End of period                  |       | 1,131,979                  |       | 1,026,498             |       | 1,131,979 |   | 1,026,498 |   |

 

Amortizationof servicing rights is adjusted each quarter as the result of the evaluation ofhistorical prepayment activity.  For thethird quarter ended March 31, 2010 and 2009, the constant prepayment rates(CPR) used to calculate the amortization was 7.29% and 6.39%,respectively.  Management utilized adiscount rate of 10.00% for valuation purposes for both periods.

 

**NOTE6—SEGMENT REPORTING**

 

Operating segmentsare defined as components of an enterprise for which discrete financialinformation is available that is evaluated regularly by the chief operatingdecision makers in deciding how to allocate resources and in assessingperformance.  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 smallernon-reportable segments, the Company and intersegment eliminations.

 

The managementapproach is used as the conceptual basis for identifying reportable segmentsand is based on the way that management organizes the segments within theenterprise for making operating decisions, allocating resources and monitoringperformance, which is primarily based on products.

 
| ** **                                | ** ** | **Three Months Ended March 31,** | ** ** |
|-------------------------------------------|------------|---------------------------------------|------------|
| ** **                                | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| ** **                                | ** ** | **Banking**                           | ** ** | **Other** | ** ** | **Total** | ** ** | **Banking** | ** ** | **Other** | ** ** | **Total** | ** ** |
| ** **                                | ** ** | **(Dollars in Thousands)**            | ** ** |
|                                      |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Net interest income                       |       | $                                     | 9,796      |   | $ | (443 | ) | $ | 9,353 |   | $ | 9,574 |   | $ | (424 | ) | $ | 9,150 |   |
| Provision for losses on  loans and leases |       | (981                                  | )          | — |   | (981 | ) | (414 | ) | — |   | (414 | ) |
| Non-interest income                       |       | 2,624                                 |       | 186 |   | 2,810 |   | 2,968 |   | 36 |   | 3,004 |   |
| Intersegment  non-interest income         |       | (60                                   | )          | (3 | ) | (63 | ) | (21 | ) | (40 | ) | (61 | ) |
| Non-interest expense                      |       | (8,208                                | )          | (315 | ) | (8,523 | ) | (8,105 | ) | (303 | ) | (8,408 | ) |
| Intersegment  non-interest expense        |       | —                                |       | 63 |   | 63 |   | — |   | 61 |   | 61 |   |
| Income (loss) before  income taxes        |       | $                                     | 3,171      |   | $ | (512 | ) | $ | 2,659 |   | $ | 4,002 |   | $ | (670 | ) | $ | 3,332 |   |
|                                      |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Total assets at  March 31            |       | $                                     | 1,218,814  |   | $ | 15,666 |   | $ | 1,234,480 |   | $ | 1,146,675 |   | $ | 25,316 |   | $ | 1,171,991 |   |

 

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| ** **                                | ** ** | **Nine Months Ended March 31,** | ** ** |
|-------------------------------------------|------------|--------------------------------------|------------|
| ** **                                | ** ** | **2010**                             | ** ** | **2009** | ** ** |
| ** **                                | ** ** | **Banking**                          | ** ** | **Other** | ** ** | **Total** | ** ** | **Banking** | ** ** | **Other** | ** ** | **Total** | ** ** |
| ** **                                | ** ** | **(Dollars in Thousands)**           | ** ** |
|                                      |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Net interest income                       |       | $                                    | 28,386     |   | $ | (1,424 | ) | $ | 26,962 |   | $ | 28,152 |   | $ | (1,306 | ) | $ | 26,846 |   |
| Provision for losses on  loans and leases |       | (1,748                               | )          | — |   | (1,748 | ) | (801 | ) | — |   | (801 | ) |
| Non-interest income                       |       | 7,389                                |       | 372 |   | 7,761 |   | 8,746 |   | 236 |   | 8,982 |   |
| Intersegment  non-interest income         |       | (108                                 | )          | (79 | ) | (187 | ) | (85 | ) | (97 | ) | (182 | ) |
| Non-interest expense                      |       | (25,103                              | )          | (1,148 | ) | (26,251 | ) | (24,878 | ) | (1,109 | ) | (25,987 | ) |
| Intersegment  non-interest expense        |       | —                               |       | 187 |   | 187 |   | — |   | 182 |   | 182 |   |
| Income (loss) before  income taxes        |       | $                                    | 8,816      |   | $ | (2,092 | ) | $ | 6,724 |   | $ | 11,134 |   | $ | (2,094 | ) | $ | 9,040 |   |
|                                      |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Total assets at  March 31            |       | $                                    | 1,218,814  |   | $ | 15,666 |   | $ | 1,234,480 |   | $ | 1,146,675 |   | $ | 25,316 |   | $ | 1,171,991 |   |

 

**NOTE7—DEFINED BENEFIT PLAN**

 

The Company has anoncontributory (cash balance) defined benefit pension plan covering allemployees of the Company and its wholly-owned subsidiaries who have attainedthe age of 21 and have completed 1,000 hours of service in a plan year.  The benefits are based on 6% of each eligibleparticipant’s annual compensation, plus income earned in the accounts at a ratedetermined annually based on 30-year treasury note rates.  The Company’s funding policy is to make theminimum annual required contribution plus such amounts as the Company maydetermine to be appropriate from time to time. One hundred percent vesting occurs after three years with a retirementage of the later of age 65 or three years of participation.  The Company has adopted all plan provisionsrequired by the Pension Protection Act of 2006. Information relative to the components of net periodic benefit cost forthe Company’s defined benefit plan is presented below:

 
| ** **                         | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                         | ** ** | **March 31,**         | ** ** | **March 31,**    | ** ** |
| ** **                         | ** ** | **2010**                   | ** ** | **2009**              | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                         | ** ** | **(Dollars in Thousands)** | ** ** |
|                               | ** ** | ** **                 | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Service  cost                      |       | $                          | 142        |                  | $          | 119 |   | $ | 426 |   | $ | 356 |   |
| Interest  cost                     |       | 143                        |       | 120                   |       | 430 |   | 360 |   |
| Amortization  of prior losses      |       | 45                         |       | 16                    |       | 136 |   | 46 |   |
| Expected  return on plan assets    |       | (138                       | )          | (115                  | )          | (416 | ) | (368 | ) |
| Total  costs recognized in expense |       | $                          | 192        |                  | $          | 140 |   | $ | 576 |   | $ | 394 |   |
|                                    |            |                            |            |                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The Companypreviously disclosed in its consolidated financial statements for fiscal 2009,which are included in Part II, Item 8 “Financial Statements andSupplementary Data” of the Company’s Annual Report on Form 10-K for fiscal2009, that it contributed $2.35 million to fund its qualified pensionplan.  During the third quarter of thefiscal 2010, the Company made contributions of $425,000 to fund its qualifiedpension plan.  The Company anticipates noadditional contributions will be made in fiscal 2010.

 

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

 

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

 

The Companyassumes the responsibility for funding the plan benefits out of general assets;however, employees cover some of the costs of covered benefits throughcontributions, deductibles, co-pays and participation amounts.  An employee is eligible for coverage uponcompletion of 30 calendar days of regular employment.  The plan, which is on a calendar year basis,is intended to comply with, and be governed by, the Employee Retirement IncomeSecurity Act of 1974, as amended.

 

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

 
| ** **                       | ** ** | **Fiscal Years Ended June 30,** | ** ** |
|----------------------------------|------------|--------------------------------------|------------|
| ** **                       | ** ** | **2010**                             | ** ** | **2009** | ** ** |
| ** **                       | ** ** | **(Dollars in Thousands)**           | ** ** |
|                             |       |                                 |       |   |   |
| Quarter ended  September 30 |       | $                                    | 748        |   | $ | 358 |   |
| Quarter ended  December 31  |       | 311                                  |       | 945 |   |
| Quarter ended  March 31     |       | 486                                  |       | 704 |   |
| Quarter ended  June 30      |       | —                               |       | 555 |   |
| Net healthcare costs             |       | $                                    | 1,545      |   | $ | 2,562 |   |

 

**NOTE9—STOCK-BASED COMPENSATION PLANS**

 

The fair value ofeach incentive stock option and each stock appreciation right grant isestimated at the grant date using the Black-Scholes option-pricing model.  The following assumptions were used forgrants in the nine months ended March 31:

 
| ** **                | ** ** | **2010** | ** ** | **2009**   | ** ** |
|---------------------------|------------|----------|------------|------------|------------|
|                      |       |     | ** ** | ** ** | ** ** |
| Expected volatility       |       | 22.00    | %          | 19.00      | %          |
| Expected dividend yield   |       | 3.61     | %          | 3.06       | %          |
| Risk-free interest rate   |       | 2.35     | %          | 2.87       | %          |
| Expected term (in  years) |       | 5        |       | 5          |       |

 

Stock optionactivity for the nine months ended March 31, 2010 was as follows:

 
| ** **             | ** ** | ** ** | ** ** | ** **   | ** ** | **Weighted**    | ** ** | ** **    | ** ** |
|------------------------|------------|------------|------------|--------------|------------|-----------------|------------|---------------|------------|
| ** **             | ** ** | ** ** | ** ** | **Weighted** | ** ** | **Average**     | ** ** | ** **    | ** ** |
| ** **             | ** ** | ** ** | ** ** | **Average**  | ** ** | **Remaining**   | ** ** | **Aggregate** | ** ** |
| ** **             | ** ** | ** ** | ** ** | **Exercise** | ** ** | **Contractual** | ** ** | **Intrinsic** | ** ** |
| ** **             | ** ** | **Shares** | ** ** | **Price**    | ** ** | **Term**        | ** ** | **Value**     | ** ** |
|                   |       |       |       |         |       |            |       |          |       |
| Beginning balance      |       | 139,919    |       | $            | 12.89      |            |       |          |       |   |
| Granted                |       | —     |       | —       |       |            |       |          |       |
| Forfeited              |       | —     |       | —       |       |            |       |          |       |
| Exercised              |       | —     |       | —       |       |            |       |          |       |
|                   |       |       |       |         |       |            |       |          |       |
| Ending balance         |       | 139,919    |       | $            | 12.89      |            | 3.27       |          | $          | 24,912 |   |
|                   |       |       |       |         |       |            |       |          |       |
| Vested and exercisable |       | 139,919    |       | $            | 12.89      |            | 3.27       |          | $          | 24,912 |   |

 

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Stock appreciationrights activity for the nine months ended March 31, 2010 was as follows:

 
| ** **             | ** ** | ** ** | ** ** | ** **   | ** ** | **Weighted**    | ** ** | ** **    | ** ** |
|------------------------|------------|------------|------------|--------------|------------|-----------------|------------|---------------|------------|
| ** **             | ** ** | ** ** | ** ** | **Weighted** | ** ** | **Average**     | ** ** | ** **    | ** ** |
| ** **             | ** ** | ** ** | ** ** | **Average**  | ** ** | **Remaining**   | ** ** | **Aggregate** | ** ** |
| ** **             | ** ** | ** ** | ** ** | **Exercise** | ** ** | **Contractual** | ** ** | **Intrinsic** | ** ** |
| ** **             | ** ** | **SARs**   | ** ** | **Price**    | ** ** | **Term**        | ** ** | **Value**     | ** ** |
|                   |       |       |       |         |       |            |       |          |       |
| Beginning balance      |       | 87,650     |       | $            | 15.35      |            |       |          |       |   |
| Granted                |       | 115,747    |       | 12.48        |       |            |       |          |       |
| Forfeited              |       | (2,084     | )          | 15.38        |       |            |       |          |       |
| Exercised              |       | —     |       | —       |       |            |       |          |       |
|                   |       |       |       |         |       |            |       |          |       |
| Ending balance         |       | 201,313    |       | $            | 13.70      |            | 8.75       |          | $          | — |   |
|                   |       |       |       |         |       |            |       |          |       |
| Vested and exercisable |       | 35,463     |       | $            | 15.62      |            | 7.44       |          | $          | — |   |

 

The totalintrinsic value of options exercised during the nine months ended March 31,2010 and 2009 was $0 and $188,000, respectively.  Cash received from the exercise of theseoptions was $0 and $546,000, respectively, and the related tax benefit realizedfor the tax deductions from cashless option exercises totaled $0 and $700,respectively.  The weighted-average grantdate fair value of stock appreciation rights (SARs) granted during the ninemonths ended March 31, 2010 and 2009 was $1.75 and $2.06,respectively.  The total unrecognizedcompensation cost related to nonvested SARs awards at March 31, 2010 was$281,000.  The unrecognized cost at March 31,2010 is expected to be recognized over a weighted average period of 29 months.

 

Nonvested shareactivity for the nine months ended March 31 follows:

 
| ** **                    | ** ** | **2010**   | ** ** | **2009**       | ** ** |
|-------------------------------|------------|------------|------------|----------------|------------|
| ** **                    | ** ** | ** ** | ** ** | **Weighted**   | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                    | ** ** | ** ** | ** ** | **Average**    | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                    | ** ** | ** ** | ** ** | **Grant Date** | ** ** | ** ** | ** ** | **Grant Date** | ** ** |
| ** **                    | ** ** | **Shares** | ** ** | **Fair Value** | ** ** | **Shares** | ** ** | **Fair Value** | ** ** |
|                          |       |       |       |           |       |   |   |   |   |
| Nonvested balance,  beginning |       | 90,708     |       | $              | 15.81      |   | 121,746 |   | $ | 16.57 |   |
| Granted                       |       | 38,062     |       | 10.80          |       | 23,602 |   | 13.33 |   |
| Vested                        |       | (55,716    | )          | 15.31          |       | (49,295 | ) | 16.43 |   |
| Forfeited                     |       | (506       | )          | 16.53          |       | (1,551 | ) | 16.70 |   |
| ** **                    | ** ** | ** ** | ** ** | ** **     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Nonvested balance,  ending    |       | 72,548     |       | $              | 13.56      |   | 94,502 |   | $ | 15.83 |   |

 

Pretax compensationexpense recognized for nonvested shares for the nine months ended March 31,2010, and 2009 was $366,000 and $276,000, respectively.  The tax benefit for the nine months ended March 31,2010, and 2009 was $124,000 and $94,000, respectively.  Annually, the expected forfeiture rate isconsidered and a cumulative amortization adjustment is recorded to compensationexpense if necessary.  During the secondquarter of fiscal 2010, the expected forfeiture rate was changed to 14%, downfrom 22% from the evaluation in the second quarter of fiscal 2009, based uponhistorical employee turnover and expectations about the future.  This resulted in a pretax cumulativeadjustment to increase compensation expense totaling $103,000.  This compares to a pretax adjustment todecrease compensation expense totaling $34,000 recognized in the second quarterof fiscal 2009, when the forfeiture rate increased from 19% to 22%.  As of March 31, 2010, there was $477,000of total unrecognized compensation cost related to nonvested shares grantedunder the Company’s 2002 Stock Option and Incentive Plan, as amended (“the Plan”).  The cost is expected to be recognized over aweighted-average period of 22 months. The total fair value of shares vested during the nine months ended March 31,2010 and 2009 was $673,000 and $618,000, respectively.

 

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In associationwith the 2002 Option Plan, awards of nonvested shares of the Company’s commonstock are made to outside directors of the Company.  Each outside director is entitled to allvoting, dividend and distribution rights during the vesting period.  During the second quarter of fiscal 2010,19,626 shares of nonvested stock were awarded. Nonvested shares vest on the first anniversary of the date ofgrant.  As of March 31, 2010, therewas $136,000 of total unrecognized compensation cost related to nonvestedshares, which are expected to be recognized over the remaining period of 9months.  For the nine months ended March 31,2010, amortization expense was recorded in the amount of $105,000.  The total fair value of shares vested duringthe nine months ended March 31, 2010 and 2009 was $181,000 and $109,000,respectively.

 

These stock optionand incentive plans are described more fully in Part II, Item 8 “FinancialStatements and Supplementary Data” of the Company’s Annual Report on Form 10-Kfor fiscal 2009, under Note 16 of “Notes to Consolidated Financial Statements.”

 

**NOTE10—SUBORDINATED DEBENTURES PAYABLE TO TRUSTS**

 

On December 19,2002, the Company issued 5,000 shares totaling $5.0 million of CompanyObligated Mandatorily Redeemable Preferred Securities of Trust III. Trust IIIwas established and exists for the sole purpose of issuing trust preferredsecurities and investing the proceeds in subordinated debentures of theCompany. These subordinated debentures constitute the sole asset of Trust III.The securities provide for cumulative cash distributions calculated at a ratebased on three-month LIBOR plus 3.35% adjusted quarterly. The Company may, atone or more times, defer interest payments on the capital securities for up to20 consecutive quarterly periods, but not beyond January 7, 2033. At theend of the deferral period, all accumulated and unpaid distributions must bepaid. The capital securities must be redeemed on January 7, 2033; however,the Company has the option to shorten the maturity date as the call option datehas passed. Holders of the capital securities have no voting rights, areunsecured, and rank junior in priority of the payment to all of the Company’sindebtedness and senior to the Company’s capital stock.

 

On September 25,2003, the Company issued 7,000 shares totaling $7.0 million of CompanyObligated Mandatorily Redeemable Preferred Securities of Trust IV. Trust IV wasestablished and exists for the sole purpose of issuing trust preferredsecurities and investing the proceeds in subordinated debentures of theCompany. These subordinated debentures constitute the sole asset of Trust IV.The securities provide for cumulative cash distributions calculated at a ratebased on three-month LIBOR plus 3.10% adjusted quarterly. The Company may, atone or more times, defer interest payments on the capital securities for up to20 consecutive quarterly periods, but not beyond October 8, 2033. At theend of the deferral period, all accumulated and unpaid distributions must bepaid. The capital securities must be redeemed on October 8, 2033; however,the Company has the option to shorten the maturity date as the call option datehas passed. Holders of the capital securities have no voting rights, areunsecured, and rank junior in priority of the payment to all of the Company’sindebtedness and senior to the Company’s capital stock.

 

On December 7,2006, the Company issued 10,000 shares totaling $10.0 million of CompanyObligated Mandatorily Redeemable Preferred Securities of Trust V. Trust V wasestablished and exists for the sole purpose of issuing trust preferredsecurities and investing the proceeds in subordinated debentures of theCompany. These subordinated debentures constitute the sole asset of Trust V.The securities provide for cumulative cash distributions calculated at a ratebased on three-month LIBOR plus 1.83%, fixed for five years at 6.61%;thereafter, adjusted quarterly. The Company may, at one or more times, deferinterest payments on the capital securities for up to 20 consecutive quarterlyperiods, but not beyond March 1, 2037. At the end of the deferral period,all accumulated and unpaid distributions must be paid. The capital securitiesmust be redeemed on March 1, 2037; however, the Company has the option toshorten the maturity date to a date not earlier than March 1, 2012. Holdersof the capital securities have no voting rights, are unsecured, and rank juniorin priority of the payment to all of the Company’s indebtedness and senior tothe Company’s capital stock.

 

On July 5,2007, the Company issued 5,000 shares totaling $5.0 million of CompanyObligated Mandatorily Redeemable Preferred Securities of Trust VI. Trust VI wasestablished and exists for the sole purpose of issuing trust preferredsecurities and investing the proceeds in subordinated debentures of theCompany. These subordinated debentures constitute the sole asset of Trust VI.The securities provide for cumulative cash distributions calculated at a ratebased on three- month LIBOR plus 1.65% adjusted quarterly. The Company may, atone or more times, defer interest payments on the capital securities for up to20 consecutive quarterly periods, but not beyond October 1, 2037. At theend of the deferral period, all accumulated and unpaid distributions must bepaid. The capital securities must be redeemed on October 1, 2037; however,the Company has the option to shorten the maturity date to a date not earlierthan October 1, 2012. Holders of the capital securities have no votingrights, are unsecured, and rank junior in priority of the payment to all of theCompany’s indebtedness and senior to the Company’s capital stock.

 

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**NOTE 11—INTEREST RATE CONTRACTS**

 

Interest rate swapcontracts are entered into primarily as an asset/liability management strategyof the Company to modify interest rate risk. The primary risk associated with all swaps is the exposure to movementsin interest rates and the ability of the counterparties to meet the terms ofthe contract.  The Company is exposed tolosses if the counterparty fails to make its payments under a contract in whichthe Company is in a receiving status. The Company minimizes its risk bymonitoring the credit standing of the counterparty.  The Company anticipates the counterparty willbe able to fully satisfy its obligations under the remaining agreements.  These contracts are designated as cash flowhedges.

 

During the firstquarter of fiscal 2008, the Company entered into an interest rate swapagreement with a $5.0 million notional amount to convert the variable-rateTrust Preferred VI security into a fixed-rate instrument for a term of fiveyears at a fixed rate of 6.69%.  The fairvalue of the derivative was a $505,000 unrealized loss at March 31, 2010.

 

During the fourthquarter of fiscal 2008, the Company entered into an interest rate swapagreement with a $7.0 million notional amount to convert the variable-rateTrust Preferred IV security into a fixed-rate instrument for a term of threeyears at a fixed rate of 6.19%.  The fairvalue of the derivative was a $192,000 unrealized loss at March 31, 2010.

 

During the firstquarter of fiscal 2009, the Company entered into an interest rate swapagreement with a $3.0 million notional amount to convert a portion of thevariable-rate Trust Preferred III security into a fixed-rate instrument for aterm of three years at a fixed rate of 6.70%. The Company also entered into an interest rate swap agreement with a$2.0 million notional amount to convert the remaining portion of variable rateTrust Preferred III security into a fixed rate instrument for a term of fouryears at a fixed rate of 6.91%.  The fairvalue of the $3.0 million notional amount derivative was a $137,000 unrealizedloss, while the fair value of the $2.0 million notional amount derivative was a$120,000 unrealized loss at March 31, 2010.

 

During the secondquarter of fiscal 2010, the Company entered into three interest rate swapagreements with notional amounts totaling $22.0 million to convert thevariable-rate attributes of trust preferred debt into fixed-rate instrumentsthrough forward-starting swaps.  The$10.0 million notional amount fixed-rate instrument has a term of five years ata fixed rate of 5.68%, effective December 1, 2011 for Trust PreferredV.  The $7.0 million notional amountfixed-rate instrument has a term of three years at a fixed rate of 5.93%,effective January 8, 2011 for Trust Preferred IV. The $5.0 millionnotional amount fixed-rate instrument has a term of five years at a fixed rateof 5.95%, effective October 1, 2012 for Trust Preferred VI.  The fair value of the $10.0 million and $5.0million notional amount derivatives were unrealized gains of $67,000 and$30,000, respectively, at March 31, 2010. The fair value of the $7.0million notional amount derivative was an unrealized loss of $39,000 at March 31,2010.

 

No gain or losswas recognized in earnings for the nine months ended March 31, 2010, and2009 related to interest rate swaps.  Nodeferred net losses on interest rate swaps in other comprehensive loss as of March 31,2010, are expected to be reclassified into earnings during the current fiscalyear.  See Note 12 “Accumulated OtherComprehensive Loss” for amounts reported as other comprehensive loss.

 

The Company posted$1.8 million in cash under collateral arrangements as of March 31, 2010,to satisfy collateral requirements associated with our interest rate swapcontracts.

 

The followingtable summarizes the derivative financial instruments utilized as of March 31,2010:

 
| ** **                    | ** ** | **Balance**                           | ** ** | **Notional**               | ** ** | **Estimated Fair Value** | ** ** |
|-------------------------------|------------|---------------------------------------|------------|----------------------------|------------|--------------------------|------------|
| **Cash flow  hedge**          | ** ** | **Sheet Location**                    | ** ** | **Amount**                 | ** ** | **Gain**                 | ** ** | **Loss** | ** ** |
| ** **                    | ** ** | ** **                            | ** ** | **(Dollars in Thousands)** | ** ** |
|                          |       |                                  |       |                       |       |                     |       |   |   |
| Interest rate swap  contracts |       | Accumulated other  comprehensive loss |       | $                          | 39,000     |                     | $          | 97 |   | $ | (993 | ) |
|                               |            |                                       |            |                            |            |                          |            |  |  |  |  |  |

 

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The followingtable details the derivative financial instruments, the average remainingmaturities and the weighted-average interest rates being paid and received asof March 31, 2010:

 
| ** **                                            | ** ** | **Notional**               | ** ** | **Average  Maturity** | ** ** | **Fair**   | ** ** | **Weighted Average Rate** | ** ** |
|-------------------------------------------------------|------------|----------------------------|------------|-----------------------|------------|------------|------------|---------------------------|------------|
| **Liability  conversion swaps**                       | ** ** | **Amount**                 | ** ** | **(years)**           | ** ** | **Value**  | ** ** | **Receive**               | ** ** | **Pay** | ** ** |
| ** **                                            | ** ** | **(Dollars in Thousands)** | ** ** |
| ** **                                            | ** ** | ** **                 | ** ** | ** **            | ** ** | ** ** | ** ** | ** **                | ** ** |   | ** ** |
| Interest rate swap  contracts                         |       | $                          | 17,000     |                  | 1.7        |       | $          | (954                      | )          | 3.0 | % | 6.5 | % |
| Interest rate swap  contracts purchased-not effective |       | 22,000                     |       | 4.4                   |       | 58         |       | na                        |       | na |   |
|                                                  |       |                       |       |                  |       |       |       |                      |       |   |   |
| Totals                                                |       | $                          | 39,000     |                  |       |       | $          | (896                      | )          |   |   |   |   |

 

**NOTE 12—ACCUMULATED OTHER COMPREHENSIVE LOSS**

 

The components ofaccumulated other comprehensive loss are as follows:

 
| ** **                                                                                                                                               | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                               | ** ** | **March 31,**         | ** ** | **March 31,**    | ** ** |
| ** **                                                                                                                                               | ** ** | **2010**                   | ** ** | **2009**              | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                                                                                                                                               | ** ** | **(Dollars in Thousands)** | ** ** |
| Net income                                                                                                                                               |       | $                          | 1,791      |                  | $          | 2,171 |   | $ | 4,607 |   | $ | 5,992 |   |
| Other comprehensive  income (loss), net of tax:                                                                                                          |       |                       |       |                  |       |   |   |   |   |
| Securities available  for sale:                                                                                                                          |       |                       |       |                  |       |   |   |   |   |
| Change in unrealized  losses on available-for-sale securities for which a portion of an  other-than-temporary impairment has been recognized in earnings |       | 59                         |       | (3,158                | )          | (2,022 | ) | (3,158 | ) |
| Change in unrealized  gain (losses) on other securities available for sale                                                                               |       | 748                        |       | 4,589                 |       | 2,432 |   | 3,683 |   |
| Reclassification  adjustment:                                                                                                                            |       |                       |       |                  |       |   |   |   |   |
| Net impairment credit  loss recognized in earnings                                                                                                       |       | 204                        |       | 361                   |       | 2,402 |   | 361 |   |
| Security (gains)  recognized in earnings                                                                                                                 |       | (229                       | )          | (387                  | )          | (1,365 | ) | (512 | ) |
| Net unrealized gains  (losses)                                                                                                                           |       | 782                        |       | 1,405                 |       | 1,447 |   | 374 |   |
| Income tax benefit  (expense)                                                                                                                            |       | (298                       | )          | (534                  | )          | (550 | ) | (143 | ) |
| Other comprehensive  income (loss) on securities available for sale                                                                                      |       | 484                        |       | 871                   |       | 897 |   | 231 |   |
|                                                                                                                                                     |       |                       |       |                  |       |   |   |   |   |
| Defined benefit plan:                                                                                                                                    |       |                       |       |                  |       |   |   |   |   |
| Other comprehensive  (loss) on defined benefit plan                                                                                                      |       | —                     |       | —                |       | — |   | — |   |
|                                                                                                                                                     |       |                       |       |                  |       |   |   |   |   |
| Cash flow hedging  activities-interest rate swap contracts:                                                                                              |       |                       |       |                  |       |   |   |   |   |
| Net unrealized gains  (losses)                                                                                                                           |       | (353                       | )          | (94                   | )          | 56 |   | (1,014 | ) |
| Income tax benefit  (expense)                                                                                                                            |       | 120                        |       | 32                    |       | (19 | ) | 345 |   |
| Other comprehensive  income (loss) on cash flow hedging activities-interest rate swap contracts                                                          |       | (233                       | )          | (62                   | )          | 37 |   | (669 | ) |
|                                                                                                                                                     |       |                       |       |                  |       |   |   |   |   |
| Total other  comprehensive income (loss)                                                                                                                 |       | 251                        |       | 809                   |       | 934 |   | (438 | ) |
|                                                                                                                                                     |       |                       |       |                  |       |   |   |   |   |
| Comprehensive income                                                                                                                                     |       | $                          | 2,042      |                  | $          | 2,980 |   | $ | 5,541 |   | $ | 5,554 |   |
|                                                                                                                                                     |       |                       |       |                  |       |   |   |   |   |
| Cumulative other  comprehensive (loss) balances were:                                                                                                    | ** ** | ** **                 | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                                                                               | ** ** | ** **                 | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Unrealized loss on  securities available for sale, net of related tax effect of $560 and $1,127                                                          |       |                       |       |                  |       | $ | (914 | ) | $ | (1,837 | ) |
| Unrealized loss on  defined benefit plan, net of related tax effect of $1,177 and $523                                                                   |       |                       |       |                  |       | (1,920 | ) | (853 | ) |
| Unrealized loss on cash  flow hedging activities, net of related tax effect of $305 and $385                                                             |       |                       |       |                  |       | (591 | ) | (749 | ) |
|                                                                                                                                                     |       |                       |       |                  |       | $ | (3,425 | ) | $ | (3,439 | ) |

 

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**NOTE 13—FINANCIAL INSTRUMENTS AND FAIR VALUEMEASUREMENT**

 

The Bank is aparty to financial instruments with off-balance sheet risk in the normal courseof business to meet the financing needs of its customers. These financialinstruments include commitments to extend credit, standby letters of credit andfinancial guarantees. Those instruments involve, to varying degrees, elementsof credit and interest-rate risk in excess of amounts recognized in theconsolidated statements of financial condition. The contract or notionalamounts of those instruments reflect the extent of the Bank’s involvement inparticular classes of financial instruments.

 

The Bank’sexposure to credit loss in the event of nonperformance by the other party tothe financial instrument for commitments to extend credit, standby letters ofcredit, and financial guarantees written is represented by the contractualnotional amount of those instruments. The Bank uses the same credit policies inmaking commitments and conditional obligations as it does for on-balance sheetinstruments.

 

Unless notedotherwise, the Bank does not require collateral or other security to supportfinancial instruments with credit risk.

 

The followingmethods and assumptions were used by the Company in estimating the fair valueof its financial instruments:

 

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

 

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

 

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

 

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

 

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

 

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

 

Off-balance sheetinstruments - Loan commitments are negotiated at current market rates and arerelatively short-term in nature. Therefore, the estimated value of loan commitments approximates the faceamount.   Rates for these commitments areset at time of loan closing, such that no adjustment is necessary to reflectthese commitments at market value.

 

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

 

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

 

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

 

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

 

Estimated fairvalues of the Company’s financial instruments are as follows:

 
| ** **                                                                  | ** ** | **March 31, 2010**    | ** ** | **June 30, 2009** | ** ** |
|-----------------------------------------------------------------------------|------------|----------------------------|------------|------------------------|------------|
| ** **                                                                  | ** ** | **Carrying**               | ** ** | **Fair**               | ** ** | **Carrying** | ** ** | **Fair** | ** ** |
| ** **                                                                  | ** ** | **Amount**                 | ** ** | **Value**              | ** ** | **Amount** | ** ** | **Value** | ** ** |
| ** **                                                                  | ** ** | **(Dollars in Thousands)** | ** ** |
| Financial Assets                                                            |       |                       |       |                   |       |   |   |   |   |
| Cash and cash  equivalents                                                  |       | $                          | 20,420     |                   | $          | 20,420 |   | $ | 18,511 |   | $ | 18,511 |   |
| Securities                                                                  |       | 265,655                    |       | 265,655                |       | 222,910 |   | 222,910 |   |
| Federal Home Loan Bank  Stock                                               |       | 12,227                     |       | 12,227                 |       | 12,476 |   | 12,476 |   |
| Loans and leases                                                            |       | 866,110                    |       | 868,783                |       | 857,693 |   | 863,453 |   |
| Accrued interest  receivable                                                |       | 8,984                      |       | 8,984                  |       | 7,598 |   | 7,598 |   |
| Servicing rights                                                            |       | 12,526                     |       | 17,338                 |       | 11,768 |   | 15,055 |   |
| Interest rate swap  contracts                                               |       | (896                       | )          | (896                   | )          | (952 | ) | (952 | ) |
|                                                                        |       |                       |       |                   |       |   |   |   |   |
| Financial liabilities                                                       |       |                       |       |                   |       |   |   |   |   |
| Deposits                                                                    |       | 839,560                    |       | 846,078                |       | 837,868 |   | 844,243 |   |
| Borrowed funds                                                              |       | 243,387                    |       | 249,974                |       | 212,869 |   | 219,249 |   |
| Subordinated debentures  payable to trusts                                  |       | 27,837                     |       | 13,763                 |       | 27,837 |   | 9,990 |   |
| Accrued interest  payable and advances by borrowers for taxes and insurance |       | 20,031                     |       | 20,031                 |       | 17,421 |   | 17,421 |   |
|                                                                             |            |                            |            |                        |            |  |  |  |  |  |  |  |  |

 

*FairValue Measurement*

 

Effective July 1,2009, FASB Staff Position 157-2, *EffectiveDate of SFAS No. 157 (ASC Topic 820)*, the Company applied theprovisions of this statement to non-financial assets and liabilities.  The Company early adopted FASB Staff Position157-4, in April 2009, *Determining FairValue When the Volume and Level of Activity for the Asset or Liability HaveSignificantly Decreased and Identifying Transactions That Are Not Orderly (ASC820-10-65)*.  ASC 820-10-65defines fair value and establishes a consistent framework for measuring fairvalue under GAAP and expands disclosure requirements for fair valuemeasurements. Fair values represent the estimated price that would be receivedfrom selling an asset or paid to transfer a liability in an orderly transactionbetween market participants at the measurement date under current marketconditions. The standard describes three levels of inputs that may be used tomeasure fair value:

 

Level 1:  Quoted prices (unadjusted) for identical assetsor liabilities in active markets that the entity has the ability to access asof the measurement date.

 

Level 2:  Significant other observable inputs otherthan Level 1 prices such as quoted prices for similar assets orliabilities; quoted prices in markets that are not active; or other inputs thatare observable or can be corroborated by observable market data.

 

Level 3:  Significant unobservable inputs that reflecta company’s own assumptions about the assumptions that market participantswould use in pricing an asset or liability. Level 3 assets and liabilitiesinclude financial instruments whose value is determined using pricing models,discounted cash flow methodologies, or similar techniques, as well asinstruments for which the determination of fair value requires significantmanagement judgment or estimation.

 

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The table belowpresents the Company’s assets and liabilities measured at fair value on arecurring basis by level within the hierarchy at March 31, 2010:

 
| ** **                     | ** ** | **Quoted Prices**                    | ** ** | **Significant Other** | ** ** | **Significant**  | ** ** | ** **     | ** ** |
|--------------------------------|------------|--------------------------------------|------------|-----------------------|------------|------------------|------------|----------------|------------|
| ** **                     | ** ** | **In Active**                        | ** ** | **Observable**        | ** ** | **Unobservable** | ** ** | ** **     | ** ** |
| ** **                     | ** ** | **Markets**                          | ** ** | **Inputs**            | ** ** | **Inputs**       | ** ** | **Total at**   | ** ** |
| ** **                     | ** ** | **(Level 1)**                        | ** ** | **(Level 2)**         | ** ** | **(Level 3)**    | ** ** | **Fair Value** | ** ** |
| ** **                     | ** ** | **(Dollars in Thousands)** | ** ** |
|                           |       |                                 |       |                  |       |             |       |           |       |
| Securities available  for sale |       | $                                    | 5          |                  | $          | 261,248          |       | $              | 4,402      |   | $ | 265,655 |   |
| Interest rate swap  contracts  |       | —                               |       | (896                  | )          | —           |       | (896           | )          |
| Total assets                   |       | $                                    | 5          |                  | $          | 260,352          |       | $              | 4,402      |   | $ | 264,759 |   |

 

The Company usedthe following methods and significant assumptions to estimate the fair value ofitems:

 

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

 

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

 

The results ofthird party valuation and valuation derived by management cash flow scenarioswere weighted each at 50% and used to measure fair value for each security. Theapproaches to determining fair value for the trust preferred securitiesincluded the following factors:

 

1.               The credit quality of the collateral is estimatedusing average probability of default values for each industry within the thirdpart valuation.

 

2.               The loss given default was assumed to be 100% (i.e. norecovery) for third party valuations. Management utilized a range of loss given default based upon a review ofthe financial condition of underlying issuers in each pool, under multiplescenarios for each security.

 

3.               The cash flows were forecasted for the underlyingcollateral and applied to each tranche to determine the resulting distributionamong the securities.

 

4.               For third party valuation, the expected cash flows foreach scenario are discounted at 3-month Libor plus 300 basis points.  Management scenarios of the best estimates ofexpected cash flows were discounted to calculate the present value of thesecurity.  Management considered a rangeof discount rates based upon three factors: (1) 3-Month Libor or a risk-free rate based on the rate of returnon government debt securities, (2) the credit spread for BBB BankCorporate Debt Indices, and (3) a liquidity or “risk premium” of 200 basispoints.

 

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

 

Interest rateswaps:  The fair values of interest rateswaps relate to cash flow hedges of trust preferred debt securities issued bythe Company.  The fair value is estimatedby a third party using inputs that are observable or that can be corroboratedby observable market data and, therefore, are classified within Level 2 of thevaluation hierarchy. These fair value estimations include primarily marketobservable inputs, such as yield curves, and include the value associated withcounterparty credit risk.

 

The followingtable reconciles the beginning and ending balances of securities available forsale that are measured at fair value on a recurring basis using significantunobservable inputs:

 
| ** **                                    | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                                    | ** ** | **March 31, 2010**    | ** ** |
| ** **                                    | ** ** | **(Dollars in Thousands)** | ** ** |
|                                          |       |                       |       |                  |       |
| Beginning balance                             |       | $                          | 4,213      |                  | $          | 6,051 |   |
| Total  realized/unrealized gains (losses)     |       |                       |       |                  |       |
| Included in earnings                          |       | (204                       | )          | (2,402                | )          |
| Included in other  comprehensive loss         |       | 380                        |       | 716                   |       |
| Purchases, issuances,  (paydowns) and (sales) |       | 13                         |       | 37                    |       |
| Transfers into or (out)  of Level 3           |       | —                     |       | —                |       |
| Ending balance                                |       | $                          | 4,402      |                  | $          | 4,402 |   |

 

The table belowpresents the Company’s assets subject to the nonrecurring fair valuemeasurements by level within the hierarchy at March 31, 2010:

 
| ** **                 | ** ** | **Quoted Prices**          | ** ** | **Significant Other** | ** ** | **Significant**  | ** ** | ** **      | ** ** |
|----------------------------|------------|----------------------------|------------|-----------------------|------------|------------------|------------|-----------------|------------|
| ** **                 | ** ** | **In Active**              | ** ** | **Observable**        | ** ** | **Unobservable** | ** ** | **Fiscal 2010** | ** ** |
| ** **                 | ** ** | **Markets**                | ** ** | **Inputs**            | ** ** | **Inputs**       | ** ** | **Incurred**    | ** ** |
| ** **                 | ** ** | **(Level 1)**              | ** ** | **(Level 2)**         | ** ** | **(Level 3)**    | ** ** | **Losses**      | ** ** |
| ** **                 | ** ** | **(Dollars in Thousands)** | ** ** |
|                       |       |                       |       |                  |       |             |       |            |       |
| Loans held for sale        |       | $                          | —     |                  | $          | 24,866           |       | $               | —     |   | $ | — |   |
| Impaired loans             |       | —                     |       | 6,476                 |       | 1,072            |       | —          |       |
| Mortgage servicing  rights |       | —                     |       | —                |       | 12,526           |       | —          |       |
| Foreclosed assets          |       | —                     |       | —                |       | —           |       | 7               |       |
|                            |            |                            |            |                       |            |                  |            |                 |            |  |  |  |  |

 

Loans held forsale, which consist generally of current production of certain fixed-rate,first-lien residential mortgage loans and student loans, are carried at thelower of cost or estimated fair value. The estimated fair value is based onwhat secondary markets are currently offering for portfolios with similarcharacteristics, which the Company classifies as a Level 2 nonrecurringfair value measurement.

 

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

 

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Foreclosed assets’values are originally derived from the estimated value of the collateral basedasset upon repossession by the Bank. During the period the foreclosed asset remains in the possession of theBank, the asset is evaluated periodically for any valuation adjustments. Thoseforeclosed assets, for which a reduction in asset value is needed, are adjustedand determined to be an impaired asset of the Company.  These assets will remain an impaired assetuntil ultimately sold or disposed.

 

Mortgage servicingrights do not trade in an active, open market with readily observable prices.While sales of mortgage servicing rights do occur, the precise terms andconditions typically are not readily available to allow for a “quoted price forsimilar assets” comparison. Accordingly, the Company relies on an internaldiscounted cash flow model to estimate the fair value of its mortgage servicingrights. The Company uses a valuation model to project mortgage servicing rightscash flows based on the current interest rate scenario, which is thendiscounted to estimate an expected fair value of the mortgage servicing rights.The valuation model considers portfolio characteristics of the underlyingmortgages, contractually specified servicing fees, prepayment assumptions,discount rate assumptions, other ancillary revenue, costs to service, and othereconomic factors. The Company reassesses and periodically adjusts theunderlying inputs and assumptions used in the model to reflect marketconditions and assumptions that a market participant would consider in valuingthe mortgage servicing rights asset. In addition, the Company compares its fairvalue estimates and assumptions to observable market data for mortgageservicing rights, where available, and to recent market activity and actualportfolio experience. Due to the nature of the valuation inputs, mortgageservicing rights are classified within Level 3 of the fair valuehierarchy. The Company uses the amortization method (i.e., lower ofamortized cost or estimated fair value measured on a nonrecurring basis), notfair value measurement accounting, for its mortgage servicing rights assets.

 

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

 

**Forward-Looking Statements**

 

This QuarterlyReport on Form 10-Q (“Form 10-Q”), as well as other reports issued bythe Company include “forward-looking statements” within the meaning of Section 27Aof the Securities Act of 1933, as amended, and Section 21E of theSecurities Exchange Act of 1934, as amended. In addition, the Company’smanagement may make forward-looking statements orally to the media, securitiesanalyst, investors and others from time to time. Forward-looking statements canbe identified by the fact that they do not relate strictly to historical orcurrent facts. Words such as “optimism,” “look-forward,” “bright,” “believe,” “expect,”“anticipate,” “intend,” “hope,” “plan,” “estimate” or words of similar meaning,or future or conditional verbs such as “will,” “would,” “should,” “could” or “may,”are intended to identify these forward-looking statements.

 

Theseforward-looking statements might include one or more of the following:

 

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

 

·                  descriptions of plans or objectivesof management 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.

 

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Forward-lookingstatements are subject to certain risks and uncertainties that could causeactual results to differ materially from our historical experience and ourpresent expectations or projections. Factors that could cause actual results todiffer from those discussed in the forward-looking statements include, but arenot limited to:

 

·                  adverse economic and marketconditions of the financial services industry in general, including, withoutlimitation, the credit markets;

 

·                  the effect of recent legislation tohelp stabilize the financial markets or the effect of the phase-out of existingrecovery programs;

 

·      future losses on our holdings of trustpreferred securities;

 

·      increase of non-performing loans andadditional provisions for loan losses;

 

·      the failure of assumptions underlying theestablishment of reserves for loan losses and other estimates;

 

·      the failure to maintain our reputation inour market area;

 

·      prevailing economic, political andbusiness conditions in South Dakota;

 

·                  the effects of competition from awide variety of local, regional, national and other providers of financialservices;

 

·                  compliance with existing and futurebanking laws and regulations, including, without limitation, regulatory capitalrequirements and FDIC insurance coverages and costs;

 

·      changes in the availability and cost ofcredit and capital in the financial markets;

 

·      the effects of FDIC deposit insurancepremiums and assessments;

 

·                  the risks of changes in marketinterest rates on the composition and costs of deposits, loan demand, netinterest income, and the values and liquidity of loan collateral, and ourability or inability to manage interest rate and other risks;

 

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

 

·                  an extended period of low commodityprices, significantly reduced yields on crops, reduced levels of governmentalassistance to the agricultural industry, and reduced farmland values;

 

·      soundness of other financial institutions;

 

·                  the risks of future acquisitions andother expansion opportunities, including, without limitation, the related timeand costs of implementing such transactions, integrating operations as part ofthese transactions and possible failures to achieve expected gains, revenuegrowth and expense savings from such transactions;

 

·      security and operations risks associatedwith the use of technology;

 

·                  the loss of one or more of our keypersonnel, or the failure to attract, assimilate and retain other highlyqualified personnel in the future;

 

·      changes in or interpretations ofaccounting standards, rules or principles; and

 

·                  other factors and risks describedunder Part I, Item 2—“Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” and Item 3—“Quantitative andQualitative Disclosures About Market Risk” in this Form 10-Q.

 

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Forward-lookingstatements speak only as of the date they are made. Forward-looking statementsare based upon management’s then-current beliefs and assumptions, butmanagement does not give any assurance that such beliefs and assumptions willprove to be correct. We undertake no obligation to publicly update or reviseany forward-looking statements included or incorporated by reference in this Form 10-Qor to update the reasons why actual results could differ from those containedin such statements, whether as a result of new information, future events orotherwise, except to the extent required by federal securities laws. Based uponchanging conditions, should any one or more of the above risks or uncertaintiesmaterialize, or should any of our underlying beliefs or assumptions proveincorrect, actual results may vary materially from those described in anyforward-looking statement.

 

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

 

**ExecutiveSummary**

 

The Company’s netincome available to common shareholders for the third quarter of fiscal 2010was $1.8 million, or $0.26 in diluted earnings per common share, compared to$1.8 million, or $0.45 in diluted earnings per common share, for the thirdquarter of fiscal 2009.  The Company’snet income available to common shareholders for the nine months ended March 31,2010 was $4.6 million, or $0.86 in diluted earnings per common share, comparedto $5.7 million, or $1.40 in diluted earnings per common share, for the ninemonths ended March 31, 2009.

 

Net interest income forthe first nine months of fiscal 2010 was $27.0 million, an increase of$116,000, or 0.4%, compared to the same period a year ago.  For the nine months ended March 31,2010, average interest-earning assets and average interest-bearing liabilitiesincreased 2.4% and 2.0%, respectively, compared to the same period a yearago.  Yields on earning assets decreasedto 5.22% in the first nine months of fiscal 2010, compared to 5.76% a year ago,a decrease of 54 basis points.  For thesame period, interest-bearing cost of funds decreased to 2.22%, compared to2.75%, a decrease of 53 basis points.

 

The net interest marginon a fully taxable equivalent basis (“Net Interest Margin, TE”) for the ninemonths ended March 31, 2010 was 3.32%, compared to 3.39% for the sameperiod a year ago, a decrease of 7 basis points. A sustained overall decline inthe interest rate yield curve affected the yield for the interest-earningassets and the interest-bearing liabilities, while the average balances forthese categories increased over the comparable period of the prior year.  Net Interest Margin, TE is a non-GAAPfinancial measure.  See “Analysis of NetInterest Income” for a calculation of this non-GAAP financial measure and forfurther discussion as to the reasons we believe this non-GAAP financial measureis useful.

 

The allowance for loanand lease losses increased $465,000 to $8.9 million at March 31, 2010,compared to June 30, 2009.  Theratio of allowance for loan and lease losses to total loans and leases was1.02% as of March 31, 2010 compared to 0.98% at June 30, 2009.  Total nonperforming assets at March 31,2010 were $11.1 million as compared to $12.6 million at June 30, 2009, adecrease of $1.4 million.  The ratio ofnonperforming assets to total assets decreased to 0.90% at March 31, 2010,compared to 1.07% at June 30, 2009. The allowance for loan and lease losses is calculated based on loan andlease levels, loan and lease loss history over 12, 36, and 60 month timeperiods, credit quality of the loan and lease portfolio, and environmentalfactors such as economic health of the region and management experience.  This risk rating analysis is designed to givethe Company a consistent and systematic methodology to determine proper levelsfor the allowance at a given time. Management intends to continue its disciplined credit administration andloan underwriting processes and to remain focused on the creditworthiness ofnew loan originations.  Managementbelieves that it has identified the most significant nonperforming assets inits loan portfolio and is working to resolve the credit issues related to theseassets to obtain the most favorable outcome for the Company.

 

The Company held$9.5 million in trust preferred securities at March 31, 2010 that arecurrently impaired under applicable accounting rules.  These are comprised of pooled securitiesissued primarily by banks throughout the United States, and were downgradedwhich place each in a below investment grade rating.  The Company performed analysis to determineif any of the securities had a credit loss by estimating if any of the cashflows are not expected to be received as contracted.  Based upon the analysis, the Companyrecognized total other-than-temporary impairment of $2.0 million for four trustpreferred securities for the nine months ended March 31, 2010.  Thedifference between the present value of cash flows and the amortized cost basisfor each of the four securities was recorded as credit loss impairment andrecognized in earnings for a total of $2.4 million. The amortized cost basis ofthe four securities was reduced by the amount of credit loss. The remainingamount of change in the fair value related to other factors was an increase of$380,000 and is recognized in other comprehensive income, net of applicabletaxes.

 

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Total deposits at March 31,2010, were $839.6 million, an increase of $1.7 million, or 0.2%, from June 30,2009.  During the nine month period,money market account balances increased $30.1 million, or 20.7%, whilein-market certificates of deposits decreased $24.3 million, or 6.1% due in partto the transfer of maturing certificates to money market accounts based uponcustomer preference.  Public fund accountbalances decreased $37.1 million which are categorized in multiple categoriesof deposits.  The decrease in publicfunds was offset by the overall increase in the non-public funds included intotal deposits.  The primary factoraffecting interest expense was the decrease in the average rates paid on totaldeposits for the nine month period ended March 31, 2010, of 1.76% comparedto 2.38% for the nine month period ended March 31, 2009.

 

On April 26,2010, the Company announced it will pay a quarterly cash dividend of 11.25cents per common share for the third quarter of fiscal 2010.  The dividend will be paid on May 14,2010, to stockholders of record on May 7, 2010.

 

The total risk-basedcapital ratio of 11.72% at March 31, 2010, increased by 67 basis pointsfrom 11.05% at June 30, 2009.  Thiscontinues to place the Bank in the “well-capitalized” category within OTSregulation at March 31, 2010 and is consistent with the “well-capitalized”OTS category in which the Company plans to operate.  The Company historically has been able tomanage the size of its assets through secondary market loan sales ofsingle-family mortgages and student loans.

 

Noninterestincome was $7.8 million for the nine months ended March 31, 2010 comparedto $9.0 million for the same period in the prior fiscal year, a decrease of$1.2 million or 13.6%.  This decrease isdue primarily to net impairment credit losses recognized in earnings of $2.4million for the nine months ended March 31, 2010, compared to $361,000 forthe nine months ended March 31, 2009.  Net gain on sale of loans and net gain on sale of securities increased$323,000 and $853,000, respectively, which partially offset the decrease forthe comparable period.

 

Noninterestexpense was $26.3 million for the nine months ended March 31, 2010, ascompared to $26.0 million for the nine months ended March 31, 2009, anincrease of $264,000, or 1.0%.  Theincrease was attributed to an increase in FDIC insurance premiums and occupancyand equipment of $450,000 and $322,000, respectively.  The increase in noninterest expense wasneutralized by a decrease in compensation and employee benefits of $801,000,which was attributed primarily to performance-based incentive pay andhealthcare cost decreases.

 

The Bank is a member ofthe Deposit Insurance Fund (the “DIF”), which is administered by the FederalDeposit Insurance Corporation (“FDIC”). Deposits are insured up to the applicable limits by the FDIC and suchinsurance is backed by the full faith and credit of the United StatesGovernment.  As insurer, the FDIC imposesdeposit insurance premiums and is authorized to conduct examinations of and torequire reporting by FDIC-insured institutions. Recent bank failures have decreased the DIF to levels below its requiredreserve ratio.  In order to replenish theDIF, the FDIC has increased deposit insurance premiums to a level designed torestore the DIF to required levels within seven years, and the Company paid aone-time special assessment of $535,000 on September 30, 2009, based upondeposits at June 30, 2009.  Thisassessment was accrued in the fourth quarter of fiscal 2009.  In addition, on November 12, 2009, the FDIC Board approved a rule requiringprepayment of the quarterly assessments for the fourth quarter of calendar2009, and the entire calendar years of 2010, 2011, and 2012.  On December 30, 2009, the Company paid$4.9 million which was recorded as a prepaid asset and will be proportionallyexpensed over future periods. At March 31, 2010, the remaining balancerecorded as a prepaid asset was $4.0 million. The FDIC may impose additional special assessments which would berecorded as they are incurred.  The FDICalso instituted the Transaction Account Guarantee Program (“TAGP”).  The TAGP extended the FDIC’s insurance tofull coverage of non-interest bearing transaction accounts for participatinginstitutions through June 30, 2010 at an annualized rate of 10 basispoints on deposit balances in excess of the $250,000 insurance limit currentlyin place.  The Bank is a participant inthe TAGP, but does not expect this program to have a material impact on theFDIC assessment.  The Bank had previouslypaid assessments under the Savings Association Insurance Fund (“SAIF”) and waseligible for certain credit against deposit insurance assessments when SAIF wasmerged into the DIF in 2005.  This credithad offset the majority of the Bank’s FDIC premium expense in past fiscalyears, but was fully utilized during the second quarter of fiscal 2009.

 

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**General**

 

The Company is afinancial services provider and, as such, has inherent risks that must bemanaged in order to achieve net income. Primary risks that affect net income include credit risk, liquidityrisk, operational risk, regulatory compliance risk and reputation risk.  The Company’s net income is derived bymanaging net interest margin, the ability to collect fees from servicesprovided, by controlling the costs of delivering services and the management ofloan and lease losses.  The 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 interestmargin is affected by regulatory, economic and competitive factors thatinfluence interest rates, loan demand and deposit flows.  Fees earned include charges for depositservices, trust services and loan services. Personnel costs are the primary expenses required to deliver theservices to customers.  Other costsinclude occupancy and equipment and general and administrative expenses.

 

**Financial Condition Data**

 

At March 31,2010, the Company had total assets of $1.2 billion, and exhibited an increaseof $57.7 million from the level at June 30, 2009.  The increase in assets in the nine months offiscal 2010 was due primarily to an increases in securities available for saleand loans held for sale of $42.7 million and $10.0 million, respectively.  Total liabilities increased $32.6 million at March 31,2010, as compared to June 30, 2009. This increase was primarily due to an increases in advances from theFHLB and other borrowings of $30.5 million. Stockholders’ equity increased $25.0 million to $93.7 million at March 31,2010, from $68.7 million at June 30, 2009, due primarily to the equity offeringin November 2009 and current earnings.

 

The increase insecurities available for sale of $42.7 million indicated above, was primarilythe result of net increases of agency residential mortgage-backed securities of$41.5 million during the third quarter of fiscal 2010.  Loans held for sale increased $10.0 millionat March 31, 2010, as compared to June 30, 2009, due primarily toseasonal fluctuation of student loan activity and increased single family loanproduction activity.

 

Cash and cashequivalents increased $1.9 million at March 31, 2010 as compared to June 30,2009.  See the Consolidated Statement ofCash Flows for an in-depth analysis in the change in cash and cash equivalentsfor the nine months ended March 31, 2010.

 

Deposits increased $1.7 million at March 31, 2010as compared to June 30, 2009.  Moneymarket accounts increased $30.1 million during the nine month period ended March 31,2010, while in-market certificates of deposits decreased $24.3 million tooffset this increase.  Public fund accountbalances, which are included in money markets, savings and certificates ofdeposits, decreased $37.1 million to $145.4 million at March 31, 2010 inpart as a result of seasonal fluctuations typical with these types of municipaldeposits.

 

Advances from theFHLB and other borrowings increased $30.5 million at March 31, 2010 ascompared to June 30, 2009. This increase was primarily the result of a netincrease in securities available for sale and loans held for sale of $42.7million and $10.0 million, respectively, and partially offset by the cashraised in the equity offering of $20.7 million.

 

Stockholders’equity increased $25.0 million at March 31, 2010 when compared to June 30,2009.  This increase was due primarily tothe underwritten public offering in November 2009, whereby the Companyissued 2.875 million shares of its common stock at a public offering of $8.00per share, for gross proceeds of $23.0 million. The net proceeds of theoffering after deducting underwriting discounts and commissions and estimatedoffering expenses totaled approximately $20.7 million.  The increase in stockholders’ equity was alsoattributed to the net income available to common shareholders for the ninemonths ended March 31, 2010 of $4.6 million.

 

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

 

**Loan andLease Portfolio Composition**

 
| ** **                               | ** ** | **March 31, 2010**    | ** ** | **June 30, 2009** | ** ** |
|------------------------------------------|------------|----------------------------|------------|------------------------|------------|
| ** **                               | ** ** | **Amount**                 | ** ** | **Percent**            | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| ** **                               | ** ** | **(Dollars in Thousands)** | ** ** |
|                                     |       |                       |       |                   |       |   |   |   |   |
| One-to four-family (1)                   |       | $                          | 74,029     |                   | 8.71       | % | $ | 84,849 |   | 9.97 | % |
| Commercial business and  real estate (2) |       | 307,137                    |       | 36.13                  |       | 322,416 |   | 37.87 |   |
| Multi-family real  estate                |       | 50,460                     |       | 5.94                   |       | 48,342 |   | 5.68 |   |
| Equipment finance  leases                |       | 11,828                     |       | 1.39                   |       | 16,010 |   | 1.88 |   |
| Consumer direct (3)                      |       | 120,475                    |       | 14.17                  |       | 116,777 |   | 13.72 |   |
| Consumer indirect (4)                    |       | 10,808                     |       | 1.27                   |       | 21,394 |   | 2.51 |   |
| Agricultural                             |       | 252,276                    |       | 29.67                  |       | 231,315 |   | 27.17 |   |
| Construction                             |       | 23,166                     |       | 2.72                   |       | 10,179 |   | 1.20 |   |
| Total loans and leases  receivable (5)   |       | $                          | 850,179    |                   | 100.00     | % | $ | 851,282 |   | 100.00 | % |

 

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(1) Excludes $15,562 and $8,888 loans held forsale at March 31, 2010 and June 30, 2009, respectively.

(2) Includes $2,706and $2,810 tax exempt leases at March 31, 2010 and June 30, 2009,respectively.

(3) Excludes $9,304 and $5,993 student loans heldfor sale at March 31, 2010 and June 30, 2009, respectively.

(4) The Company announced consumer indirectoriginations ceased during the first quarter of Fiscal 2008.

(5) Includesdeferred loan fees and discounts.

 

**DepositComposition**

 
| ** **                             | ** ** | **March 31, 2010**    | ** ** | **June 30, 2009** | ** ** |
|----------------------------------------|------------|----------------------------|------------|------------------------|------------|
| ** **                             | ** ** | **Amount**                 | ** ** | **Percent**            | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| ** **                             | ** ** | **(Dollars in Thousands)** | ** ** |
|                                   |       |                       |       |                   |       |   |   |   |   |
| Noninterest bearing  checking accounts |       | $                          | 96,774     |                   | 11.53      | % | $ | 94,067 |   | 11.23 | % |
| Interest bearing  checking accounts    |       | 94,773                     |       | 11.29                  |       | 94,846 |   | 11.32 |   |
| Money market accounts                  |       | 175,295                    |       | 20.88                  |       | 145,214 |   | 17.33 |   |
| Savings accounts                       |       | 77,337                     |       | 9.21                   |       | 81,417 |   | 9.72 |   |
| In-market certificates  of deposit     |       | 376,999                    |       | 44.90                  |       | 401,291 |   | 47.89 |   |
| Out-of-market  certificates of deposit |       | 18,382                     |       | 2.19                   |       | 21,033 |   | 2.51 |   |
| Total deposits                         |       | $                          | 839,560    |                   | 100.00     | % | $ | 837,868 |   | 100.00 | % |

 

**Analysis of Net Interest Income**

 

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

 

*AverageBalances, Interest Rates and Yields.*  The following table presents for the periodsindicated, 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.  Thetable does not reflect any effect of income 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 balancesinclude nonaccruing loans and leases. The yields on loans and leases include origination fees, net of costs,which are considered adjustments to yield.

 

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| ** **                                     | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                     | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| ** **                                     | ** ** | **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)      |       | $                                     | 856,414    |   | $ | 12,192 |   | 5.77 | % | $ | 837,501 |   | $ | 12,045 |   | 5.83 | % |
| Investment securities  (2) (3)            |       | 259,318                               |       | 1,872 |   | 2.93 | % | 252,812 |   | 2,937 |   | 4.71 | % |
| FHLB stock                                     |       | 11,207                                |       | 56 |   | 2.03 | % | 12,476 |   | 26 |   | 0.85 | % |
|                                           |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Total interest-earning  assets                 |       | 1,126,939                             |       | $ | 14,120 |   | 5.08 | % | 1,102,789 |   | $ | 15,008 |   | 5.52 | % |
| Noninterest-earning  assets                    |       | 79,250                                |       |   |   |   |   | 66,679 |   |   |   |   |   |
| Total assets                                   |       | $                                     | 1,206,189  |   |   |   |   |   | $ | 1,169,468 |   |   |   |   |   |
|                                           |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:                 |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Deposits:                                      |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Checking and money  market                     |       | $                                     | 244,753    |   | $ | 353 |   | 0.58 | % | $ | 214,277 |   | $ | 310 |   | 0.59 | % |
| Savings                                        |       | 81,077                                |       | 72 |   | 0.36 | % | 70,165 |   | 74 |   | 0.43 | % |
| Certificates of deposit                        |       | 416,991                               |       | 2,401 |   | 2.34 | % | 397,126 |   | 3,131 |   | 3.20 | % |
| Total interest-bearing  deposits               |       | 742,821                               |       | 2,826 |   | 1.54 | % | 681,568 |   | 3,515 |   | 2.09 | % |
| FHLB advances and other  borrowings            |       | 215,165                               |       | 1,488 |   | 2.80 | % | 241,338 |   | 1,896 |   | 3.19 | % |
| Subordinated debentures  payable to trusts     |       | 27,837                                |       | 453 |   | 6.60 | % | 27,837 |   | 447 |   | 6.51 | % |
|                                           |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Total interest-bearing  liabilities            |       | 985,823                               |       | 4,767 |   | 1.96 | % | 950,743 |   | 5,858 |   | 2.50 | % |
| Noninterest-bearing  deposits                  |       | 90,084                                |       |   |   |   |   | 79,969 |   |   |   |   |   |
| Other liabilities                              |       | 37,618                                |       |   |   |   |   | 45,995 |   |   |   |   |   |
| Total liabilities                              |       | 1,113,525                             |       |   |   |   |   | 1,076,707 |   |   |   |   |   |
| Equity                                         |       | 92,664                                |       |   |   |   |   | 92,761 |   |   |   |   |   |
| Total liabilities and  equity                  |       | $                                     | 1,206,189  |   |   |   |   |   | $ | 1,169,468 |   |   |   |   |   |
|                                           |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Net interest income;  interest rate spread (4) |       |                                  |       | $ | 9,353 |   | 3.12 | % |   |   | $ | 9,150 |   | 3.02 | % |
|                                           |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Net interest margin  (4) (5)              |       |                                  |       |   |   | 3.37 | % |   |   |   |   | 3.36 | % |
|                                           |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Net interest margin, TE  (6)                   |       |                                  |       |   |   | 3.42 | % |   |   |   |   | 3.43 | % |

 

----

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

(2)  Includes federal funds sold.

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

(4)  Percentages for the three months ended March 31,2010 and March 31, 2009 have been annualized.

(5)  Net interest income divided by averageinterest-earning assets.

(6)  Net interestmargin expressed on a fully taxable equivalent basis (“Net Interest Margin,TE”) is a non-GAAP financial measure. The tax-equivalent adjustment to net interest income recognizes theincome tax savings when comparing taxable and tax-exempt assets and adjustingfor federal and state exemption of interest income and certain other permanentincome tax differences.  We believe thatit is a standard practice in the banking industry to present net interestmargin expressed on a fully taxable equivalent basis, and accordingly believethe presentation of this non-GAAP financial measure may be useful for peercomparison purposes.  As a non-GAAPfinancial measure, Net Interest Margin, TE should be considered supplemental toand not a substitute for or superior to, financial measures calculated inaccordance with GAAP.  As other companiesmay use different calculations for Net Interest Margin, TE, this presentationmay not be comparable to similarly titled measures reported by other companies.

 

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| ** **                                     | ** ** | **Nine Months Ended March 31,** | ** ** |
|------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                     | ** ** | **2010**                             | ** ** | **2009** | ** ** |
| ** **                                     | ** ** | **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)      |       | $                                    | 852,249    |   | $ | 36,887 |   | 5.77 | % | $ | 820,766 |   | $ | 37,709 |   | 6.12 | % |
| Investment securities  (2) (3)            |       | 235,183                              |       | 5,991 |   | 3.39 | % | 240,551 |   | 8,512 |   | 4.71 | % |
| FHLB stock                                     |       | 11,873                               |       | 222 |   | 2.49 | % | 12,207 |   | 184 |   | 2.01 | % |
|                                           |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Total interest-earning  assets                 |       | 1,099,305                            |       | $ | 43,100 |   | 5.22 | % | 1,073,524 |   | $ | 46,405 |   | 5.76 | % |
| Noninterest-earning  assets                    |       | 77,148                               |       |   |   |   |   | 66,772 |   |   |   |   |   |
| Total assets                                   |       | $                                    | 1,176,453  |   |   |   |   |   | $ | 1,140,296 |   |   |   |   |   |
|                                           |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:                 |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Deposits:                                      |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Checking and money  market                     |       | $                                    | 230,015    |   | $ | 968 |   | 0.56 | % | $ | 233,156 |   | $ | 1,727 |   | 0.99 | % |
| Savings                                        |       | 72,158                               |       | 197 |   | 0.36 | % | 68,298 |   | 462 |   | 0.90 | % |
| Certificates of deposit                        |       | 432,630                              |       | 8,517 |   | 2.62 | % | 383,205 |   | 10,035 |   | 3.49 | % |
| Total interest-bearing  deposits               |       | 734,803                              |       | 9,682 |   | 1.76 | % | 684,659 |   | 12,224 |   | 2.38 | % |
| FHLB advances and other  borrowings            |       | 205,067                              |       | 5,084 |   | 3.30 | % | 235,778 |   | 5,952 |   | 3.36 | % |
| Subordinated debentures  payable to trusts     |       | 27,837                               |       | 1,372 |   | 6.57 | % | 27,837 |   | 1,383 |   | 6.62 | % |
|                                           |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Total interest-bearing  liabilities            |       | 967,707                              |       | 16,138 |   | 2.22 | % | 948,274 |   | 19,559 |   | 2.75 | % |
| Noninterest-bearing  deposits                  |       | 93,956                               |       |   |   |   |   | 76,360 |   |   |   |   |   |
| Other liabilities                              |       | 33,526                               |       |   |   |   |   | 37,091 |   |   |   |   |   |
| Total liabilities                              |       | 1,095,189                            |       |   |   |   |   | 1,061,725 |   |   |   |   |   |
| Equity                                         |       | 81,264                               |       |   |   |   |   | 78,571 |   |   |   |   |   |
| Total liabilities and  equity                  |       | $                                    | 1,176,453  |   |   |   |   |   | $ | 1,140,296 |   |   |   |   |   |
|                                           |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Net interest income;  interest rate spread (4) |       |                                 |       | $ | 26,962 |   | 3.00 | % |   |   | $ | 26,846 |   | 3.01 | % |
|                                           |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Net interest margin  (4) (5)              |       |                                 |       |   |   | 3.27 | % |   |   |   |   | 3.33 | % |
|                                           |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Net interest margin, TE  (6)                   |       |                                 |       |   |   | 3.32 | % |   |   |   |   | 3.39 | % |

 

----

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

(2)  Includesfederal funds sold.

(3)  Yields do notreflect the tax-exempt nature of loans, equipment leases and municipalsecurities.

(4)  Percentages for the nine months ended March 31,2010 and March 31, 2009 have been annualized.

(5)  Net interestincome divided by average interest-earning assets.

(6)  Net interestmargin expressed on a fully taxable equivalent basis (“Net Interest Margin,TE”) is a non-GAAP financial measure. The tax-equivalent adjustment to net interest income recognizes theincome tax savings when comparing taxable and tax-exempt assets and adjustingfor federal and state exemption of interest income and certain other permanentincome tax differences.  We believe thatit is a standard practice in the banking industry to present net interestmargin expressed on a fully taxable equivalent basis, and accordingly believethe presentation of this non-GAAP financial measure may be useful for peercomparison purposes.  As a non-GAAPfinancial mea- sure, Net Interest Margin, TE should be considered supplementalto and not a substitute for or superior to, financial measures calculated inaccordance with GAAP.  As other companiesmay use different calculations for Net Interest Margin, TE, this presentationmay not be comparable to similarly titled measures reported by other companies.

 

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

 
| ** **                       | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                       | ** ** | **March 31,**         | ** ** | **March 31,**    | ** ** | **March 31,** | ** ** | **March 31,** | ** ** |
| ** **                       | ** ** | **2010**                   | ** ** | **2009**              | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                       | ** ** | **(Dollars in Thousands)** | ** ** |
| Net interest income              |       | $                          | 9,353      |                  | $          | 9,150 |   | $ | 26,962 |   | $ | 26,846 |   |
| Taxable equivalent  adjustment   |       | 140                        |       | 181                   |       | 428 |   | 502 |   |
| Adjusted net interest  income    |       | 9,493                      |       | 9,331                 |       | 27,390 |   | 27,348 |   |
| Average  interest-earning assets |       | 1,126,939                  |       | 1,102,789             |       | 1,099,305 |   | 1,073,524 |   |
| Net interest margin, TE          |       | 3.42                       | %          | 3.43                  | %          | 3.32 | % | 3.39 | % |
|                                  |            |                            |            |                       |            |  |  |  |  |  |  |  |  |

 

**Rate/VolumeAnalysis of Net Interest Income**

 

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

 

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

 
| ** **                                 | ** ** | **Three Months Ended March 31,** | ** ** | **Nine Months Ended March 31,** | ** ** |
|--------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                 | ** ** | **2010 vs 2009**                      | ** ** | **2010 vs 2009**                     | ** ** |
| ** **                                 | ** ** | **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)           |       | $                                     | 273        |                                 | $          | (126 | ) | $ | 147 |   | $ | 1,435 |   | $ | (2,257 | ) | $ | (822 | ) |
| Investment securities  (2)                 |       | 76                                    |       | (1,141                               | )          | (1,065 | ) | (190 | ) | (2,331 | ) | (2,521 | ) |
| FHLB stock                                 |       | (3                                    | )          | 33                                   |       | 30 |   | (5 | ) | 43 |   | 38 |   |
|                                       |       |                                  |       |                                 |       |   |   |   |   |   |   |   |   |
| Total interest-earning  assets             |       | $                                     | 346        |                                 | $          | (1,234 | ) | $ | (888 | ) | $ | 1,240 |   | $ | (4,545 | ) | $ | (3,305 | ) |
|                                       |       |                                  |       |                                 |       |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:             |       |                                  |       |                                 |       |   |   |   |   |   |   |   |   |
| Deposits:                                  |       |                                  |       |                                 |       |   |   |   |   |   |   |   |   |
| Checking and money  market                 |       | $                                     | 48         |                                 | $          | (5 | ) | $ | 43 |   | $ | (23 | ) | $ | (736 | ) | $ | (759 | ) |
| Savings                                    |       | 12                                    |       | (14                                  | )          | (2 | ) | 26 |   | (291 | ) | (265 | ) |
| Certificates of deposit                    |       | 157                                   |       | (887                                 | )          | (730 | ) | 1,299 |   | (2,817 | ) | (1,518 | ) |
| Total interest-bearing  deposits           |       | 217                                   |       | (906                                 | )          | (689 | ) | 1,302 |   | (3,844 | ) | (2,542 | ) |
| FHLB advances and other  borrowings        |       | (204                                  | )          | (204                                 | )          | (408 | ) | (776 | ) | (92 | ) | (868 | ) |
| Subordinated debentures  payable to trusts |       | —                                |       | 6                                    |       | 6 |   | — |   | (11 | ) | (11 | ) |
|                                       |       |                                  |       |                                 |       |   |   |   |   |   |   |   |   |
| Total interest-bearing  liabilities        |       | $                                     | 13         |                                 | $          | (1,104 | ) | $ | (1,091 | ) | $ | 526 |   | $ | (3,947 | ) | $ | (3,421 | ) |
|                                       |       |                                  |       |                                 |       |   |   |   |   |   |   |   |   |
| Net interest income  increase              |       | $                                     | 333        |                                 | $          | (130 | ) | $ | 203 |   | $ | 714 |   | $ | (598 | ) | $ | 116 |   |

 

----

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

(2)  Includes federal funds sold.

 

**Applicationof Critical Accounting Policies**

 

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

 

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

 

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

 

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

 

The Company has includedMSRs as a critical accounting policy because the use of estimates fordetermining fair value using present value concepts may produce results whichmay significantly differ from other fair value analysis perhaps even to thepoint of recording impairment.  The riskto earnings is when the underlying mortgages pay off significantly faster thanthe assumptions used in the previously recorded amortization.  Estimating future cash flows on theunderlying mortgages is a difficult analysis and requires judgment based on thebest information available.  The Companylooks at alternative assumptions and projections when preparing a reasonableand supportable analysis.  Based on theCompany’s quarterly analysis of MSRs, there was no impairment to the MSRs at March 31,2010.

 

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

 

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

 

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

 

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

 

**AssetQuality and Potential Problem Loans and Leases**

 

Nonperforming assets(nonaccrual loans and leases, accruing loans and leases delinquent more than 90days and foreclosed assets) decreased to $11.1 million at March 31, 2010from $12.6 million at June 30, 2009, a decrease of $1.4 million, or11.3%.  Nonaccruing loans and leasesdecreased $4.5 million from June 30, 2009 to March 31, 2010, to atotal of $4.8 million.  Accruing loansand leases delinquent more than 90 days increased $2.9 million to $5.0 millionat March 31, 2010 from $2.1 million at June 30, 2009.  Foreclosed assets increased $209,000 to $1.3million at March 31, 2010, from $1.1 million at June 30, 2009.  In addition, the ratio of nonperformingassets to total assets, which is one indicator of credit risk exposure, was0.90% at March 31, 2010, which is a decrease from 1.07% as reported at June 30,2009.

 

Nonaccruing loans andleases decreased $4.5 million to $4.8 million at March 31, 2010 comparedto $9.4 million at June 30, 2009. In the third fiscal quarter of 2010, a troubled debt restructuring of$6.5 million of loans for one agricultural relationship returned $4.0 millionto performing status at March 31, 2010. The reported amount in nonaccrual status from this relationship consistsof one loan totaling $2.5 million secured by agricultural business assets.  The remaining loans and leases included innonaccruing loans and leases at March 31, 2010 were six loans totaling$92,000 secured by one- to four-family real estate, eight loans totaling$732,000 secured by commercial real estate, 10 loans totaling $619,000 securedby commercial business assets, 23 leases totaling $350,000 secured byequipment, and 22 loans totaling $464,000 secured by consumer assets.

 

Accruing loans and leasesdelinquent more than 90 days increased $2.9 million, to $5.0 million at March 31,2010 compared to $2.1 million at June 30, 2009.  Included in accruing loans and leasesdelinquent more than 90 days at March 31, 2010 were four loans totaling$351,000 secured by commercial real estate, nine loans totaling $1.4 millionsecured by agricultural real estate, five loans totaling $1.5 million securedby commercial business assets, 19 loans totaling $1.1 million secured byagricultural business assets, six leases totaling $666,000 secured by equipmentand three loans totaling $11,000 of unsecured overdraft and reserve accounts.

 

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

 

As of March 31,2010, foreclosed assets increased by $209,000, or 19.3%, to $1.3 million ascompared to $1.1 million at June 30, 2009. The balance at March 31, 2010 consisted of $401,000 of one- tofour-family collateral owned, $346,000 of leased equipment owned, $482,000 ofagricultural collateral owned, and $65,000 of consumer collateral owned.

 

At March 31, 2010,the Company had designated $32.3 million of its assets as special mention and$24.7 million of its assets as classified that management has determined needto be closely monitored because of possible credit problems of the borrowers orthe cash flows of the secured properties. The Company also classified $9.5 million of trust preferred securitiesin accordance with OTS debt security classification guidelines.  At March 31, 2010, the Company had $12.7million in multi-family, commercial business, commercial real estate andagricultural participation loans purchased, of which $1.4 million wereclassified.  These loans and leases wereconsidered in determining the adequacy of the allowance for loan and leaselosses.  The allowance for loan and leaselosses is established based on management’s evaluation of the risks probable inthe loan and lease portfolio and changes in the nature and volume of loan andlease activity.  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.

 

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Although the Company’s management believes the March 31,2010 recorded allowance for loan and lease losses was adequate to provide forprobable losses on the related loans and leases, there can be no assurance theallowance will be adequate in the future.

 

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

 

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

 
| ** **                                                                      | ** ** | **Nonperforming Assets**   | ** ** |
|---------------------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                                      | ** ** | **March 31, 2010**    | ** ** | **June 30, 2009** | ** ** |
| ** **                                                                      | ** ** | **(Dollars in Thousands)** | ** ** |
| Nonaccruing loans and  leases:                                                  |       |                       |       |   |   |
| One- to four-family                                                             |       | $                          | 92         |   | $ | 977 |   |
| Commercial real estate                                                          |       | 732                        |       | 177 |   |
| Commercial business                                                             |       | 620                        |       | 405 |   |
| Equipment finance  leases                                                       |       | 350                        |       | 272 |   |
| Consumer                                                                        |       | 464                        |       | 355 |   |
| Agricultural                                                                    |       | 2,591                      |       | 7,195 |   |
| Total                                                                           |       | 4,849                      |       | 9,381 |   |
|                                                                            |       |                       |       |   |   |
| Accruing loans and  leases delinquent more than 90 days:                        |       |                       |       |   |   |
| Commercial real estate                                                          |       | 351                        |       | 277 |   |
| Commercial business                                                             |       | 1,511                      |       | 349 |   |
| Equipment finance  leases                                                       |       | 666                        |       | 264 |   |
| Consumer                                                                        |       | 10                         |       | 8 |   |
| Agricultural                                                                    |       | 2,456                      |       | 1,194 |   |
| Total                                                                           |       | 4,994                      |       | 2,092 |   |
|                                                                            |       |                       |       |   |   |
| Foreclosed assets:                                                              |       |                       |       |   |   |
| One- to four-family                                                             |       | 401                        |       | 406 |   |
| Equipment finance  leases                                                       |       | 346                        |       | 105 |   |
| Consumer                                                                        |       | 65                         |       | 92 |   |
| Agricultural                                                                    |       | 482                        |       | 482 |   |
| Total (1)                                                                       |       | 1,294                      |       | 1,085 |   |
|                                                                            |       |                       |       |   |   |
| Total nonperforming  assets (2)                                                 |       | $                          | 11,137     |   | $ | 12,558 |   |
|                                                                            |       |                       |       |   |   |
| Ratio of nonperforming  assets to total assets (3)                              |       | 0.90                       | %          | 1.07 | % |
|                                                                            |       |                       |       |   |   |
| Ratio of nonperforming  loans and leases to total loans and leases (4) (5) |       | 1.12                       | %          | 1.32 | % |

 

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(1) Total foreclosed assets do not include land or other real estate owned held forsale.

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

(3)  Percentageis calculated based upon total assets of the Company and its direct andindirect subsidiaries on a consolidated basis.

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

(5)  Total loans and leases include loans heldfor sale.

 

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

 
| ** **                                                                                           | ** ** | **Nine Months Ended March 31,** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                           | ** ** | **2010**                             | ** ** | **2009** | ** ** |
| ** **                                                                                           | ** ** | **(Dollars in Thousands)**           | ** ** |
|                                                                                                 |       |                                 |       |   |   |
| Balance at beginning of  period                                                                      |       | $                                    | 8,470      |   | $ | 5,933 |   |
| Charge-offs:                                                                                         |       |                                 |       |   |   |
| One-to four-family                                                                                   |       | (108                                 | )          | (97 | ) |
| Commercial real estate                                                                               |       | (11                                  | )          | (108 | ) |
| Commercial business                                                                                  |       | (319                                 | )          | (36 | ) |
| Equipment finance leases                                                                             |       | (263                                 | )          | (45 | ) |
| Consumer                                                                                             |       | (704                                 | )          | (661 | ) |
| Construction                                                                                         |       | (11                                  | )          | (35 | ) |
| Total charge-offs                                                                                    |       | (1,416                               | )          | (982 | ) |
|                                                                                                 |       |                                 |       |   |   |
| Recoveries:                                                                                          |       |                                 |       |   |   |
| One-to four-family                                                                                   |       | 4                                    |       | 4 |   |
| Commercial business                                                                                  |       | —                               |       | 2,217 |   |
| Equipment finance  leases                                                                            |       | 5                                    |       | — |   |
| Consumer                                                                                             |       | 124                                  |       | 162 |   |
| Agricultural                                                                                         |       | —                               |       | 5 |   |
| Total recoveries                                                                                     |       | 133                                  |       | 2,388 |   |
|                                                                                                 |       |                                 |       |   |   |
| Net recoveries(charge-offs)                                                                          |       | (1,283                               | )          | 1,406 |   |
|                                                                                                 |       |                                 |       |   |   |
| Additions charged to  operations                                                                     |       | 1,748                                |       | 801 |   |
|                                                                                                 |       |                                 |       |   |   |
| Balance at end of  period                                                                            |       | $                                    | 8,935      |   | $ | 8,140 |   |
|                                                                                                 |       |                                 |       |   |   |
| Ratio of allowance for  loan and lease losses to total loans and leases at end of period (1)         |       | 1.02                                 | %          | 0.97 | % |
|                                                                                                 |       |                                 |       |   |   |
| Ratio of allowance for  loan and lease losses to nonperforming loans and leases at end of period (2) |       | 90.78                                | %          | 180.09 | % |
|                                                                                                 |       |                                 |       |   |   |
| Ratio of net charge  offs to average loans and leases for the year-to-date period (3)                |       | 0.20                                 | %          | (0.23 | )% |

 

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(1)  Total loans andleases include loans held for sale.

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

(3)  Percentages forthe nine months ended March 31, 2010 and March 31, 2009 have beenannualized.

 

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

 
| ** **                | ** ** | **FAS 5**                  | ** ** | **FAS 114**            | ** ** | **FAS 5**        | ** ** | **FAS 114**       | ** ** |
|---------------------------|------------|----------------------------|------------|------------------------|------------|------------------|------------|-------------------|------------|
| ** **                | ** ** | **Allowance**              | ** ** | **Impaired Loan**      | ** ** | **Allowance**    | ** ** | **Impaired Loan** | ** ** |
| ** **                | ** ** | **for Loan and**           | ** ** | **Valuation**          | ** ** | **for Loan and** | ** ** | **Valuation**     | ** ** |
| ** **                | ** ** | **Lease Losses**           | ** ** | **Allowance**          | ** ** | **Lease Losses** | ** ** | **Allowance**     | ** ** |
| **Loan Type**             | ** ** | **March 31, 2010**    | ** ** | **June 30, 2009** | ** ** |
| ** **                | ** ** | **(Dollars in Thousands)** | ** ** |
|                      |       |                       |       |                   |       |             |       |              |       |
| One- to four-family       |       | $                          | 321        |                   | $          | —           |       | $                 | 416        |   | $ | — |   |
| Commercial real estate    |       | 1,450                      |       | 165                    |       | 1,110            |       | —            |       |
| Multi-family real  estate |       | 190                        |       | —                 |       | 192              |       | —            |       |
| Commercial business       |       | 1,741                      |       | 67                     |       | 2,136            |       | 153               |       |
| Equipment finance  leases |       | 347                        |       | —                 |       | 409              |       | —            |       |
| Consumer                  |       | 1,378                      |       | —                 |       | 1,280            |       | —            |       |
| Agricultural              |       | 3,226                      |       | 50                     |       | 2,724            |       | 50                |       |
| Total                     |       | $                          | 8,653      |                   | $          | 282              |       | $                 | 8,267      |   | $ | 203 |   |

 

**FAS 114 Impaired Loan Summary**

 
| ** **             | ** ** | ** **                 | ** ** | ** **             | ** ** | **Impaired**  | ** ** | ** **    | ** ** | ** **  | ** ** | **Impaired**  | ** ** |
|------------------------|------------|----------------------------|------------|------------------------|------------|---------------|------------|---------------|------------|-------------|------------|---------------|------------|
| ** **             | ** ** | **Number**                 | ** ** | ** **             | ** ** | **Loan**      | ** ** | **Number**    | ** ** | ** **  | ** ** | **Loan**      | ** ** |
| ** **             | ** ** | **of Loan**                | ** ** | **Loan**               | ** ** | **Valuation** | ** ** | **of Loan**   | ** ** | **Loan**    | ** ** | **Valuation** | ** ** |
| ** **             | ** ** | **Customers**              | ** ** | **Balance**            | ** ** | **Allowance** | ** ** | **Customers** | ** ** | **Balance** | ** ** | **Allowance** | ** ** |
| **Loan Type**          | ** ** | **March 31, 2010**    | ** ** | **June 30, 2009** | ** ** |
| ** **             | ** ** | **(Dollars in Thousands)** | ** ** |
|                   |       |                       |       |                   |       |          |       |          |       |        |       |          |       |
| Commercial real estate |       | 4                          |       | $                      | 896        |          | 165        |          | 3          |        | 177        |          | $          | — |   |
| Commercial business    |       | 6                          |       | 591                    |       | 67            |       | 4             |       | 453         |       | 153           |       |
| Agricultural           |       | 3                          |       | 6,343                  |       | 50            |       | 2             |       | 7,997       |       | 50            |       |
| Total                  |       | 13                         |       | $                      | 7,830      |          | $          | 282           |       | 9           |       | $             | 8,627      |   | $ | 203 |   |
|                        |            |                            |            |                        |            |               |            |               |            |             |            |               |            |  |  |  |  |

 

The allowance for loanand lease losses was $8.9 million at March 31, 2010, as compared to $8.1million at March 31, 2009.  Theratio of the allowance for loan and lease losses to total loans and leases was1.02% at March 31, 2010, compared to 0.97% at March 31, 2009.  The Company’s management has considerednonperforming loans and leases and potential problem loans and leases inestablishing the allowance for loan and lease losses.  The Company continues to monitor itsallowance for probable loan and lease losses and make future additions orreductions in light of the level of loans and leases in its portfolio and aseconomic conditions dictate.  Thecurrent level of the allowance for loan and lease losses is a result ofmanagement’s assessment of the risks within the portfolio based on theinformation revealed in credit reporting processes. The Company utilizes arisk-rating system on all commercial business, agricultural, construction andmulti-family and commercial real estate loans, including purchased loans andleases.  A periodic credit review isperformed on all types of loans and leases to establish the necessary reservebased on the estimated risk within the portfolio. This assessment of risk takesinto account the composition of the loan and lease portfolio, historical lossexperience for each loan and lease category, previous loan and leaseexperience, concentrations of credit, current economic conditions and otherfactors that in management’s judgment deserve recognition.

 

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

 

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

 

**Comparisonof the Three Months Ended March 31, 2010, and March 31, 2009**

 

*General*.  The Company’snet income available to common shareholders was $1.8 million, or $0.26 in basicand $0.26 in diluted earnings per common share for the three months ended March 31,2010, a $40,000 decrease in earnings available to common shareholders comparedto $1.8 million, or $0.45 in basic and $0.45 in diluted earnings per commonshare for the same period in the prior fiscal year.  For the three months ended March 31,2010, the return on average equity and the return on average assets was 7.84%and 0.60%, respectively, compared to 9.49% and 0.75%, respectively, for thesame period in the prior fiscal year.

 

*Interest, Dividend and Loan Fee Income.* Interest, dividend and loan fee income was $14.1 million for the threemonths ended March 31, 2010, as compared to $15.0 million for the sameperiod in the prior fiscal year, a decrease of $888,000 or 5.9%.  This decrease was primarily the result ofdeclining average yields on the interest-earning assets.  Loans and leases receivable had an averageyield of 5.77% for the three months ended March 31, 2010, which is 6 basispoints less than the average yield of 5.83% for the three months ended March 31,2009.  Investment securities had adecline in average yield of 178 basis points when comparing the third quarterof fiscal 2010 against the same period of the prior year.  The average interest-earning assets for loansand leases receivables increased $18.9 million, or 2.3% to $856.4 million forthe three months ended March 31, 2010, when compared to the three monthsended March 31, 2009.  Investmentsecurities increased in average balance $6.5 million, or 2.6% to $259.3 millionfor the third quarter of fiscal 2010, when compared to the average balance ofthe same quarter of the prior fiscal year. The revenue decrease attributable to the overall declining yield forinterest-earning assets was $1.2 million, which was partially offset by therevenue increase due to an increase in average interest-earning assets balancesof $346,000.

 

*InterestExpense.*  Interest expense was $4.8 million for the threemonths ended March 31, 2010, as compared to $5.9 million for the sameperiod in the prior fiscal year, a decrease of $1.1 million or 18.6%.  A $906,000 decrease in interest expense wasthe result of a decrease in the average rate paid of 1.54% on interest-bearingdeposits for the three months ended March 31, 2010, compared to an averagerate paid of 2.09% for the three months ended March 31, 2009.  The average balance of interest-bearingdeposits increased by $61.3 million, or 9.0%, which increased interest expenseby $217,000 for the three months ended March 31, 2010, as compared to thesame period of fiscal 2009.  The neteffect of interest-bearing deposits on interest expense due to rate and volumewas a decrease of $689,000 for the third quarter of fiscal 2010 as compared tothe third quarter of 2009.  FHLB advancesand other borrowings decreased by $26.2 million, or 10.8% for the three monthperiod ended March 31, 2010, as compared to the three month period ended March 31,2009, while the rate decreased to 2.80% from 3.19% for the periods.  The resulting reduction in volume and ratedecreased interest expense by $408,000 due to these liabilities.  The average rate paid on totalinterest-bearing liabilities, which include interest-bearing deposits and liabilities,was 1.96% for the three months ended March 31, 2010 as compared to 2.50%for the same period in fiscal 2009.

 

*Net Interest Income.* The Company’s net interestincome for the three months ended March 31, 2010, increased $203,000 or2.2%, to $9.4 million compared to $9.2 million for the same period in the priorfiscal year.  The net increase in volumesof interest-earning assets in excess of increased volumes of interest-bearingliabilities resulted in a net increase in net interest income of $333,000.  This was partially offset by the net effectof the reduction of rates earned for interest-earning assets in excess of thereduction of rates paid for interest-bearing liabilities and resulted in a netdecrease in net interest income of $130,000. The Company’s Net Interest Margin, TE was 3.42% for the three monthsended March 31, 2010, as compared to 3.43% for the three months ended March 31,2009.  Net Interest Margin, TE is anon-GAAP financial measure.  See “Analysisof Net Interest Income” for a calculation of this non-GAAP financial measureand for further discussion as to the reasons we believe this non-GAAP financialmeasure is useful.

 

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

 

Duringthe three months ended March 31, 2010, the Company recorded a provisionfor losses on loans and leases of $981,000 compared to $414,000 for the threemonths ended March 31, 2009.  See “AssetQuality and Potentially Problem Loans and Leases” for further discussion.

 

*Noninterest Income.*  Noninterest income was $2.8 million for thequarter ended March 31, 2010, compared to $3.0 million for the quarterended March 31, 2009, a decrease of $194,000 or 6.5%.  This decrease is due primarily to decreasesin net gain on sale of loans and net gain on sale of securities of $174,000 and$158,000, respectively.  Net impairmentcredit losses on trust preferred securities recognized in earnings of $204,000for the quarter ended March 31, 2010 was $157,000 less than the impairmentcredit losses recognized for the quarter ended March 31, 2009, whichpartially offset the decrease in noninterest income when comparing the twoperiods.

 

Loanservicing income decreased by $90,000 to $527,000 for the third quarter fiscal2010 due primarily to increased servicing rights amortization expense recordedduring the period based upon the Company’s quarterly analysis of portfolioprepayment experience.  Net gain on saleof loans decreased $174,000 to $369,000 for the three months ended March 31,2010 from $543,000 for the three months ended March 31, 2009, primarilydue to a decrease in mortgage loan activity and the related loan sales whencomparing the quarter-over-quarter activity. Net gain on the sale of securities totaled $229,000, a decrease of$158,000 for the three months ended March 31, 2010, as compared to thesame period in fiscal 2009.  In the thirdquarter of fiscal 2009, rates initially decreased enabling the Company to takeadvantage of elevated fixed-rate mortgage-backed securities prices whilerestructuring the portfolio for a higher rate environment.  Net impairment credit losses on trustpreferred securities recognized in earnings were $204,000 for the quarter endedMarch 31, 2010, compared to a net credit loss of $361,000 recognized inearnings for the third quarter of fiscal 2009.

 

*Noninterest Expense.*  Noninterest expense was $8.5 million for thethree months ended March 31, 2010 as compared to $8.4 million for thethree months ended March 31, 2009, an increase of $115,000, or 1.4%.  Occupancy and equipment, marketing andcommunity development, and FDIC insurance increased $127,000, $97,000 and$53,000, respectively, for the third quarter of fiscal 2010 compared to thesame period of fiscal 2009.  Compensationand employee benefits decreased $154,000, or 2.9%, for the quarter ended March 31,2010 compared to March 31, 2009. Net healthcare costs, also a component of compensation and employeebenefits, decreased $218,000, to $486,000, the result of a reduction inspecific high dollar claims from the prior year.

 

Compensation and employee benefits were $5.1million for the three months ended March 31, 2010, a decrease of $154,000or 2.9% when compared to the three months ended March 31, 2009.  Performance-based incentives decreased$403,000, or 62.4%, due to a reduction in performance outcomes through thethird quarter of fiscal 2010 as compared to the prior year’s outcomes.  This decrease was partially offset by anincrease in salaries and wages of $198,000, or 5.8% to $3.6 million for thesame comparable period.  The salary andwage expense increase was due to year-over-year salary increases and personneladditions.  Net healthcare costs, which are included inthe total for compensation and employee benefits, decreased $218,000, or 31.0%to $486,000 due to a reduction in specific high dollar claims and generaloverall utilization.  Managementcurrently believes the self-insured structure is a reasonable alternative totraditional healthcare plans over the long term.  The level of healthcare costs which theCompany incurs may vary from year to year. Retirement costs and other compensation costs increased $92,000 and$197,000, respectively, which partially offset the decreases from thecompensation and healthcare costs.  Retirement costs increased primarily due to higher pension costs asdetermined by an actuarial valuation in the first quarter of fiscal 2010, whileother compensation costs increased primarily from payroll taxes, recruitingexpenses and other related costs.

 

Occupancyand equipment increased $127,000, or 12.3% to $1.2 million for the three monthsended March 31, 2010 as compared to the same period ended March 31,2009.  A new facility in Watertown, SouthDakota was placed in service in July 2009, and subsequently sold as aleased back facility to an unrelated group in the third quarter of fiscal2010.  The depreciation of equipment,rental expense, and other operating expenses related to this new facilityaccounted for the majority of increased costs. Other equipment purchased since the third quarter of fiscal 2009 alsocontributed to the increase in depreciation expense since the prior fiscalyear.

 

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Marketingand community development increased $97,000, or 43.7% to $319,000 for the thirdquarter of fiscal 2010, compared to the third quarter of fiscal 2009.  Community development increases for thequarter as compared to the prior year’s period and an ancillary rewards programimplemented during the current fiscal year were the main factors in theincrease when compared to the third quarter of fiscal 2009.

 

FDIC insurance premiums increased $53,000, or 19.5%,to $325,000 for the third quarter of fiscal 2010, compared to the same periodof fiscal 2009.  FDIC rate increasestotaling 8 basis points were added during the last twelve months, whichincreased the total expense for the current quarter versus the comparablequarter of the prior fiscal year.

 

*Incometax expense.*  The Company’s income tax expensefor the three months ended March 31, 2010 decreased to $868,000 comparedto $1.2 million for the same period in the prior fiscal year.  The effective tax rate was 32.6% and 34.8%for the three months ended March 31, 2010 and 2009, respectively.  The amount of permanent tax difference as anet deduction was a higher percentage to income before income taxes in thethird quarter of fiscal 2010 than the same period of fiscal 2009.  Permanent tax differences as a net deductionincreased by $90,000 for the three months ended March 31, 2010 as comparedto the same period of the prior year, while income before income tax decreased$673,000 in comparing the current quarter to the prior year’s quarter.

 

**Comparisonof the Nine Months Ended March 31, 2010, and March 31, 2009**

 

*General*.  The Company’snet income available to common shareholders was $4.6 million, or $0.86 in basicand $0.86 in diluted earnings per common share for the nine months ended March 31,2010, a $1.0 million decrease in earnings available to common shareholderscompared to $5.7 million, or $1.41 in basic and $1.40 in diluted earnings percommon share for the same period in the prior fiscal year.  For the nine months ended March 31,2010, the return on average equity and the return on average assets was 7.55%and 0.52%, respectively, compared to 10.16% and 0.70%, respectively, for thesame period in the prior fiscal year.  Asdiscussed in more detail below, the decrease to earnings was due primarily tothe recording of net impairment credit losses of $2.4 million for the firstnine months of fiscal 2010 compared to net impairment credit losses of $361,000for the comparable period of fiscal 2009.

 

*Interest, Dividend and Loan Fee Income.* Interest, dividend and loan fee income was $43.1 million for the ninemonths ended March 31, 2010 as compared to $46.4 million for the sameperiod in the prior fiscal year, a decrease of $3.3 million or 7.1%.  This decrease was primarily the result ofdeclining average yields on the interest-earning assets.  Loans and leases receivable had an averageyield of 5.77% for the nine months ended March 31, 2010, which is 35 basispoints less than the average yield of 6.12% for the nine months ended March 31,2009.  Investment securities had adecline in average yield of 132 basis points when comparing the nine months offiscal 2010 against the same period of the prior year.  The average interest-earning assets for loansand leases receivables increased $31.5 million, or 3.8% to $852.2 million forthe nine months ended March 31, 2010, when compared to the nine monthsended March 31, 2009.  Investmentsecurities decreased in average balance $5.4 million, or 2.2% to $235.2 millionfor the first nine months of fiscal 2010, when compared to the average balanceof the comparable period of fiscal 2009. The net revenue decrease from loans and leases receivable attributableto the overall declining yield and partially offset by the increasing averagevolume was $2.3 million and $1.4 million, respectively, which netted to adecrease of $822,000.  The net revenuedecrease from investment securities attributable to the overall declining yieldand declining average volume was $2.3 million and $190,000, respectively.

 

*InterestExpense.*  Interest expense was $16.1 million for thenine months ended March 31, 2010 as compared to $19.6 million for the sameperiod in the prior fiscal year, a decrease of $3.4 million or 17.5%.  A $3.8 million decrease in interest expensewas the result of a decrease in the average rate paid of 1.76% oninterest-bearing deposits for the nine months ended March 31, 2010compared to an average rate paid of 2.38% for the nine months ended March 31,2009.  The average balance ofinterest-bearing deposits increased by $50.1 million, or 7.3%, resulting in anincrease of $1.3 million in interest expense. The average balance of FHLB advances and other borrowings decreased by$30.7 million, or 13.0% for the nine month period ended March 31, 2010, ascompared to the nine month period ended March 31, 2009.  This net decrease in volume of FHLB advancesand other borrowings accounted for a reduction in interest expense of$776,000.  The average rate paid on totalinterest-bearing liabilities was 2.22% for the nine months ended March 31,2010 as compared to 2.75% for the same period in fiscal 2009.

 

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*Net Interest Income.* The Company’s net interestincome for the nine months ended March 31, 2010, increased $116,000 or0.4%, to $27.0 million compared to $26.8 million for the same period in theprior fiscal year.  The net effect of thenet increase in volumes of interest-earning assets in excess of the increasedvolumes of interest-bearing liabilities, resulted in a net increase in netinterest income of $714,000.  This wasoffset by the net effect of the reduction of rates earned for interest-earningassets in excess of the reduction of rates paid for interest-bearingliabilities and resulted in a net decrease in net interest income of$598,000.  The Company’s Net InterestMargin, TE was 3.32% for the nine months ended March 31, 2010, as comparedto 3.39% for the nine months ended March 31, 2009.  Net Interest Margin, TE is a non-GAAPfinancial measure.  See “Analysis of NetInterest Income” for a calculation of this non-GAAP financial measure and forfurther discussion as to the reasons we believe this non-GAAP financial measureis useful.

 

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

 

Duringthe nine months ended March 31, 2010, the Company recorded a provision forlosses on loans and leases of $1.7 million compared to $801,000 for the ninemonths ended March 31, 2009.  See “AssetQuality and Potentially Problem Loans and Leases” for further discussion.

 

*Noninterest Income.*  Noninterest income was $7.8 million for thenine months ended March 31, 2010 compared to $9.0 million for the ninemonths ended March 31, 2009, a decrease of $1.2 million or 13.6%.  This decrease is due primarily to the netincrease in net impairment credit losses on trust preferred securitiesrecognized in earnings of $2.0 million for the nine months ended March 31,2010.   Net gain on sale of loans and netgain on sale of securities increased $323,000 and $853,000, respectively, whichpartially offset the decrease caused by the net impairment credit losses.

 

Netimpairment credit losses on trust preferred securities recognized in earningswere $2.4 million for the nine months ended March 31, 2010 compared to$361,000 for the same period of the prior fiscal year.  Fees on deposits decreased $231,000 to $4.1million for the nine months ended March 31, 2010 as compared to the ninemonths ended March 31, 2009, due largely to a decrease in NSF andoverdraft fees of $530,000 and partially offset by an increase in point-of-saleinterchange and ATM fee income of $350,000. Loan servicing income decreased by $202,000 to $1.5 million for the ninemonths of fiscal 2010 due primarily to increased servicing rights amortizationexpense recorded during the period based upon the Company’s quarterly analysisof portfolio prepayment experience.  Netgain on sale of loans increased $323,000 to $1.4 million for the nine monthsended March 31, 2010 as compared to $1.1 million for the nine months endedMarch 31, 2009, primarily due to an increase in mortgage loan activity andthe related loan sales.  Net gain on thesale of securities totaled $1.4 million, an increase of $853,000 for the ninemonths ended March 31, 2010 as compared to the same period in fiscal2009.  The Company took advantage ofelevated fixed-rate mortgage-backed securities prices which were influenced byU.S. government participation in the mortgage-backed securities market, whilealso restructuring the portfolio for a higher rate environment.

 

*Noninterest Expense.*  Noninterest expense was $26.3 million for thenine months ended March 31, 2010 as compared to $26.0 million for the ninemonths ended March 31, 2009, an increase of $264,000, or 1.0%.  The increase was attributed to increases insalaries and wages of $679,000, occupancy and equipment of $322,000, and FDICinsurance premiums of $450,000.  Theincreases in noninterest expense were neutralized primarily by a decrease inperformance-based incentive pay and healthcare costs of $1.3 million and$462,000, respectively.

 

Compensation and employee benefits were$15.4 million for the nine months ended March 31, 2010, a decrease of$801,000 or 5.0% when compared to the nine months ended March 31,2009.  Performance-based incentive paydecreased $1.3 million, or 62.2% due to a reduction in performance outcomesthrough the third quarter of fiscal 2010 as compared to the prior year’soutcomes.  This decrease in compensationwas partially offset by an increase in salaries and wages of $679,000, or 6.5%to $11.2 million for this same comparable period.  The salary and wage expense increase was dueto year-over-year salary increases and personnel additions.  Net healthcare costs, which are included in thetotal for compensation and employee benefits, decreased $462,000, or 23.0% to$1.5 million due to a reduction of specific high dollar claims and generaloverall utilization for the nine month period of fiscal 2010 compared to thesame period of the prior fiscal year. Management currently believes the self-insured structure is a reasonablealternative to traditional healthcare plans over the long term.  The level of healthcare costs which theCompany incurs may vary from year to year. Retirement costs, which are included in the total forcompensation and employee benefits, increased $269,000, or41.3% to $919,000 for the year-to-date amounts in fiscal 2010 compared tofiscal 2009 primarily due to the increased costs determined during theactuarial valuation in the first quarter of fiscal 2010.

 

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Occupancyand equipment increased $322,000, or 10.7% to $3.3 million for the nine monthsended March 31, 2010 as compared to the same period ended March 31,2009.  A new facility in Watertown, SouthDakota was placed in service in July 2009, and subsequently sold as aleased back facility to an unrelated group in the third quarter of fiscal2010.  The depreciation of equipment,rental expense, and other operating expenses related to this new facilityaccounted for the majority of increased costs.  Otherequipment purchased since the third quarter of fiscal 2009 also contributed tothe increase in depreciation expense since the prior fiscal year.

 

FDIC insurance premiums increased $450,000, to$985,000 for the nine months of fiscal 2010, compared to the same period offiscal 2009.  In the first quarter offiscal 2009, the Bank applied previously unused credits in the payment of itsinsurance premiums.  The credits werefully utilized in the second quarter of fiscal 2009.  FDIC rate increases totaling 8 basis pointswere also added during the last twelve months, which increased the totalexpense for the nine months of fiscal 2010 versus fiscal 2009.

 

*Incometax expense.*  The Company’s income tax expensefor the nine months ended March 31, 2010 decreased to $2.1 millioncompared to $3.0 million for the same period in the prior fiscal year.  The effective tax rate was 31.5% and 33.7%for the nine months ended March 31, 2010 and 2009, respectively.  The amount of permanent tax difference as anet deduction was a higher percentage to income before income taxes in thefirst three quarters of fiscal 2010 than the same period of fiscal 2009.  Permanent tax differences as a net deductionincreased by $16,000 for the nine months ended March 31, 2010 as comparedto the same period of the prior year, while income before income tax decreased$2.3million in comparing the current quarter to the prior year’s quarter.

 

**Liquidityand Capital Resources**

 

The Bank’s primarysources of funds are earnings, in-market deposits, FHLB advances and otherborrowings, repayments of loan principal, residential mortgage-backedsecurities and callable agency securities and, to a lesser extent, sales ofmortgage loans, 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.

 

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

 

Although in-marketdeposits is one of the Bank’s primary source of funds, the Bank’s policy hasbeen to utilize borrowings where the funds can be invested in either loans orsecurities at a positive rate of return or to use the funds for short-termliquidity purposes. As of March 31, 2010, the Bank had the followingsources of additional borrowings:

 

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

 

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

 

·                  $6.0 million in an uncommitted, unsecured line of federal fundswith United Bankers’ Bank;

 

·                  $57.4 million of available credit from the Federal Reserve Bank;and

 

·                  $56.9 million of available credit from FHLB of Des Moines (afterdeducting outstanding borrowings with FHLB of Des Moines).

 

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The Bank may alsoseek other sources of contingent liquidity including additional federal fundspurchased lines with correspondent banks and lines of credit with the FederalReserve Bank. There were no funds drawn on the uncommitted, unsecured lines offederal funds with First Tennessee Bank, NA and Zions Bank at March 31,2010. The Bank, as a member of the FHLB of Des Moines, is required to acquireand hold shares of capital stock in the FHLB of Des Moines equal to 0.12% ofthe total assets of the Bank at December 31 annually. The Bank is alsorequired to own activity-based stock, which is based on 4.45% of the Bank’soutstanding advances. These percentages are subject to change at the discretionof the FHLB Board of Directors.

 

On September 30,2009, the Company entered into a Loan Agreement (the “Loan Agreement”) withUnited Bankers’ Bank (the “Lender”) in order to refinance its outstandingborrowings of $5.966 million under its line of credit with First TennesseeBank, NA (the “FTB Line of Credit”) that matured. Under the Loan Agreement, theLender committed to lend to the Company an aggregate principal amount not toexceed $6.0 million. On November 25, 2009, the Company repaid itsoutstanding borrowings of $6.044 million (principal plus accrued interest)under the Loan Agreement.  The loan isevidenced by a promissory note, accrues interest at the United Bankers’ BankRate with a minimum interest rate of 4.75% per annum, and the principal balance(plus any accrued and unpaid interest) is due and payable in full on October 1,2010.

 

In connection withentering into the Loan Agreement, the Company also entered into a CommercialPledge Agreement with the Lender, granting the Lender a first security interestin all of the stock of the Bank.  The LoanAgreement contains customary events of default and affirmative covenants withwhich the Company and Bank were in compliance at March 31, 2010.

 

In addition to theabove sources of additional borrowings, the Bank has implemented arrangementsto acquire out-of-market certificates of deposit as an additional source offunding. As of March 31, 2010, the Bank had $18.4 million inout-of-market certificates of deposit.

 

The Bankanticipates that it will have sufficient funds available to meet current loancommitments. At March 31, 2010, the Bank had outstanding commitments tooriginate and purchase mortgage and commercial loans of $40.9 million andto sell mortgage loans of $31.6 million. Commitments by the Bank tooriginate loans are not necessarily executed by the customer. The Bank monitorsthe ratio of commitments to funding for use in liquidity management. At March 31,2010, the Bank had outstanding commitments to sell and purchase $3.1 millionand $125,000, respectively, of investment securities available for sale.

 

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

 

Savings institutionsinsured by the Federal Deposit Insurance Corporation are required by theFinancial Institutions Reform, Recovery and Enforcement Act of 1989 to meetthree 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 March 31,2010, 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 8.63% at March 31, 2010.  The minimum OTS total risk-based capitalrequirement for well-capitalized institutions is 10.00% of risk-weightedassets.  The Bank had total risk-basedcapital of 11.72% at March 31, 2010.

 

**Impact of Inflation and ChangingPrices**

 

The unauditedconsolidated financial statements and notes thereto presented in this QuarterlyReport on Form 10-Q have been prepared in accordance with GAAP, whichrequire the measurement of financial position and operating results in terms ofhistorical dollars without considering the change in the relative purchasingpower of money over time due to inflation. The impact of inflation is reflected in the increased cost of the Bank’soperations.  Unlike most industrialcompanies, nearly all the assets and liabilities of the Bank are monetary innature.  As a result, interest rates havea greater impact on the Bank’s performance than do the effects of generallevels of inflation.  Interest rates donot necessarily move in the same direction or to the same extent as the pricesof goods and services.

 

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**RecentAccounting Pronouncements**

 

**FASBEstablishes Accounting Standards Codification**

 

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

 

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

 

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

 

**FairValue Accounting**

 

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

 

FSP FAS 107-1 andAPB 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (ASCTopic 320-10-65). This update requires fair value disclosures for financialinstruments that are not currently reflected on the balance sheet at fair valueon a quarterly basis.  The Companyadopted this update effective June 30, 2009 and the adoption did not havea material effect on the Company’s consolidated financial condition or resultsof operations or cash flow.

 

In August 2009,FASB issued ASU No. 2009-05 which amends Fair Value Measurements andDisclosures — Overall (ASC Topic 820-10) to provide guidance on the fair valuemeasurement of liabilities. This update requires clarification forcircumstances in which a quoted price in an active market for the identicalliability is not available, a reporting entity is required to measure fairvalue using one or more of the following techniques: 1) a valuation techniquethat uses either the quoted price of the identical liability when traded as anasset or quoted prices for similar liabilities or similar liabilities whentraded as an asset; or 2) another valuation technique that is consistent withthe principles in ASC Topic 820 such as the income and market approach tovaluation. The amendments in this update also clarify that when estimating thefair value of a liability, a reporting entity is not required to include aseparate input or adjustment to other inputs relating to the existence of arestriction that prevents the transfer of the liability. This update furtherclarifies that if the fair value of a liability is determined by reference to aquoted price in an active market for an identical liability, that price wouldbe considered a Level 1 measurement in the fair value hierarchy. Similarly, ifthe identical liability has a quoted price when traded as an asset in an activemarket, it is also a Level 1 fair value measurement if no adjustments to thequoted price of the asset are required. The Company adopted this updateeffective in the second quarter of fiscal 2010 and the adoption did not have amaterial effect on the Company’s consolidated financial condition or results ofoperations or cash flow.

 

**BusinessCombinations and Noncontrolling Interests**

 

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

 

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

 

**OtherAccounting Changes**

 

On June 12,2009, the FASB issued SFAS No. 166, “Accounting for Transfers of FinancialAssets”, (ASC Topic 860). This updated guidance removed the concept of aqualifying special-purpose entity and removed the exception from applyingconsolidation guidance to these entities. This update also clarified therequirements for isolation and limitations on portions of financial assets thatare eligible for sale accounting. ASC Topic 860 is reportable for interim andannual reports and effective for the Company on reporting periods beginning July 1,2010.  Management is currently evaluatingthe impact of adopting this update on the Company’s consolidated financialcondition, results of operations and cash flow.

 

On June 122009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No. 46(R),Consolidation of Variable Interest Entities” (ASC Topic 810-10). This updatedguidance requires an analysis to determine whether a variable interest givesthe entity a controlling financial interest in a variable interest entity. Italso requires an ongoing reassessment and eliminates the quantitative approachpreviously required for determining whether an entity is the primarybeneficiary.  This updated guidance waseffective January 1, 2010, and the adoption did not have a material effecton the Company’s consolidated financial condition, results of operations orcash flow.

 

In 2008, the FASBissued Staff Position No. FAS 132(R)-1, “Employers’ Disclosures aboutPostretirement Benefit Plan Assets” (ASC Topic 715-20-65). This guidance willexpand disclosure by requiring the following new disclosures: 1) how investmentallocation decisions are made by management; 2) major categories of planassets; and 3) significant concentrations of risk. Additionally, ASC 715-20-65will require an employer to disclose information about the valuation of planassets similar to that required in ASC Topic 820 Fair Value Measurements andDisclosures. ASC 715-20-65 is effective for the Company for annual reportingperiods beginning July 1, 2010 and the Company does not expect theadoption to have a material effect on the Company’s consolidated financialcondition, results of operations or cash flow.

 

In April, 2010,the FASB issued ASU No. 2010-18,”Effect of a Loan Modification When theLoan Is Part of a Pool That Is Accounted for as a Single Asset”.  As a result of this update, modifications ofloans that are accounted for within a pool under Subtopic 310-30 do not resultin the removal of those loans from the pool even if the modification of thoseloans would otherwise be considered a troubled debt restructuring.  An entity will continue to be required toconsider whether the pool of assets in which the loan is included is impairedif expected cash flows for the pool change. ASU No. 2010-18 is effective for the Company in the first interimperiod of Fiscal 2011 (September 30, 2010) and the annual reporting periodbeginning June 30, 2011.  Managementis currently evaluating the impact of adopting this update on the Company’sconsolidated financial condition, results of operations and cash flow.

 

During the thirdquarter of fiscal 2010, the FASB issued several ASUs: ASU No. 2010-08through ASU No. 2010-18.  Except forASU no. 2010-18 mentioned above, the ASUs issued entail technical correctionsor clarifications to existing guidance or affect guidance related tospecialized industries or entities and therefore have minimal, if any, impacton the Company.

 

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

 

**InterestRate Risk Management**

 

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

 

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

 

The Company adjusts itsasset/liability position to mitigate the Company’s interest rate risk.  At times, depending on the level of generalinterest rates, the relationship between long- and short-term interest rates,market conditions and competitive factors, management may increase the Company’sinterest rate risk position in order to increase its net interest margin.  The Company’s results of operations and netportfolio values remain vulnerable to increases in interest rates and tofluctuations in the difference between long- and short-term interest rates.

 

Asset forth below, the volatility of a rate change, the change in asset orliability mix of the Company or other factors may produce a decrease in netinterest margin in an upward moving rate environment even as the net portfoliovalue (“NPV”) estimate indicates an increase in net value.  The inverse situation may also occur.  One approach used by the Company to quantify interest rate risk is an NPVanalysis.  This analysis calculates thedifference between the present value of the liabilities and the present valueof expected cash flows from assets and off-balance sheet contracts.  The following tables set forth, at March 31,2010 and 2009, respectively, an analysis of the Company’s interest rate risk asmeasured by the estimated changes in NPV resulting from instantaneous andsustained parallel shifts in the yield curve. Management does not believe that the Company has experienced anymaterial changes in its market risk position from that disclosed in the Company’sAnnual Report on Form 10-K for fiscal 2009 or that the Company’s primarymarket risk exposures and how those exposures were managed during the ninemonths ended March 31, 2010 changed significantly when compared to June 30,2009.

 

Even if interest rates change in the designatedamounts, there can be no assurance that the Company’s assets and liabilitieswould perform as set forth below.  Inaddition, a change in U.S. Treasury rates in the designated amounts accompaniedby a change in the shape of the Treasury yield curve would cause significantlydifferent changes to the NPV than indicated below.

 
| **March 31, 2010** | ** ** |
|-------------------------|------------|
| ** **              | ** ** | ** ** | ** ** | **Estimated Increase** | ** ** |
| **Change in**           | ** ** | **Estimated** | ** ** | **(Decrease) in NPV** | ** ** |
| **Interest  Rates**     | ** ** | **NPV Amount** | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| **Basis  Points**       |       | **(Dollars  in Thousands)** |   |   |   |
|                    |       |   |   |   |   |   |   |
| +300                    |       | $ | 120,720 |   | $ | 7,216 |   | 6 | % |
| +200                    |       | 120,421 |   | 6,917 |   | 6 |   |
| +100                    |       | 118,279 |   | 4,775 |   | 4 |   |
| —                  |       | 113,504 |   | — |   | — |   |
| -100                    |       | 101,355 |   | (12,149 | ) | (11 | ) |
|                         |            |  |  |  |  |  |  |  |  |

 

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| **March 31, 2009** | ** ** |
|-------------------------|------------|
| ** **              | ** ** | ** ** | ** ** | **Estimated Increase** | ** ** |
| **Change in**           | ** ** | **Estimated** | ** ** | **(Decrease) in NPV** | ** ** |
| **Interest  Rates**     | ** ** | **NPV Amount** | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| **Basis Points**        |       | **(Dollars in Thousands)** |   |   |   |
|                    |       |   |   |   |   |   |   |
| +300                    |       | $ | 113,963 |   | $ | 4,196 |   | 4 | % |
| +200                    |       | 114,842 |   | 5,075 |   | 5 |   |
| +100                    |       | 114,075 |   | 4,308 |   | 4 |   |
| —                  |       | 109,767 |   | — |   | — |   |
| -100                    |       | 100,012 |   | (9,755 | ) | (9 | ) |
|                         |            |  |  |  |  |  |  |  |  |

 

In managing market riskand the asset/liability mix, the Bank has placed an emphasis on developing aportfolio in which, to the extent practicable, assets and liabilities repricewithin similar periods.  The goal of thispolicy is to provide a relatively consistent level of net interest income invarying interest rate cycles and to minimize the potential for significantfluctuations from period to period.

 

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

 

As of March 31,2010, an evaluation was performed by the Company’s management, including theCompany’s Chairman, President and Chief Executive Officer and the Company’sExecutive Vice President, Chief Financial Officer and Treasurer, of theeffectiveness of the design and operation of the Company’s disclosure controlsand procedures (as defined in Rules 13a-15(e) and 15d-15(e) underthe Securities Exchange Act of 1934, as amended) to provide reasonableassurance that information required to be disclosed in the reports the Companyfiles and submits under the Securities Exchange Act of 1934, as amended, isrecorded, processed, summarized and reported within the time periods specifiedin the Securities and Exchange Commission’s rules and forms. Based uponthat evaluation, the Company’s Chairman, President and Chief Executive Officerand the Company’s Executive Vice President, Chief Financial Officer andTreasurer concluded that the Company’s disclosure controls and procedures wereeffective as of March 31, 2010. There were no changes in the Company’s internal control over financialreporting that occurred during the third quarter ended March 31, 2010,that have materially affected, or are reasonably likely to materially affect,the Company’s internal control over financial reporting.

 

**PART II - OTHER INFORMATION**

 

**Item 1.  *Legal Proceedings***

 

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

 

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

 

The discussion of our businessand operations should be read together with the risk factors contained in Part I,Item 1A of our Annual Report on Form 10-K for the fiscal year ended June 30,2009, and our Quarterly Report on Form 10-Q for the fiscal quarters ended September 30,2009 and December 31, 2009, which describe various risks and uncertaintiesto which we are or may become subject. These risks and uncertainties have the potential to affect our business,financial condition, results of operations, cash flows, strategies or prospectsin a material and adverse manner.  Otherthan as set forth below, there have been no material changes to the riskfactors set forth in the above-referenced filing as of March 31, 2010.

 

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

 

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

 

We held six TRUPS pools with an adjusted cost basis of $11.9 millionand a fair value of $6.1 million at June 30, 2009. Rating downgradeson these investments occurred during fiscal year 2009, placing each in a belowinvestment grade rating. Due to an inactive market for these securities,management utilized a “Level 3” fair value input according to Statement ofFinancial Accounting Standard No. 157(ASC Topic 820), utilizing discountedcash flow methodologies to determine fair value and OTTI. During fiscal 2009,we determined that three debt securities exhibited OTTI. The aggregate OTTIlosses recorded for the three securities for the fiscal year 2009 were$3.9 million, of which $3.5 million was recognized on the balancesheet in other comprehensive income, with the balance being $397,000 of creditloss recognized through earnings. The remaining difference between amortizedcost basis and fair value of $2.3 million recognized in othercomprehensive income is primarily attributable to the three TRUPS for whichOTTI was not recognized for the fiscal year 2009.

 

At March 31, 2010, we carried the six TRUPS pools at an adjustedcost basis of $9.5 million and a fair value of $4.4 million. Wedetermined that four debt securities exhibited OTTI of $2.0 million, ofwhich $2.4 million of credit loss was recognized through earnings for thenine months ended March 31, 2010, with the balance of $380,000 of netchange recognized on the balance sheet in other comprehensive income since June 30,2009.

 

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

 

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

 

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

 

On November 12,2009, the FDIC adopted a final rule that requires insured depositoryinstitutions to prepay their quarterly risk-based assessments for the fourthquarter of 2009, and for all of 2010, 2011, and 2012, on December 30,2009, along with each institution’s risk-based deposit insurance assessment forthe third quarter of 2009. For purposes of calculating the prepaid amount, thebase assessment rate in effect at September 30, 2009 would be used for2010. That rate would be increased by an annualized 3 basis points for 2011 and2012 assessments. The prepayment calculation would also assume a 5 percentannual growth rate, increased quarterly, through the end of 2012. Under thefinal rule, an institution will account for the prepayment by recording theentire amount of its prepaid assessment as a prepaid expense (an asset) as of December 30,2009. Subsequently, each institution will record an expense (charge toearnings) for its regular quarterly assessment and an offsetting credit to theprepaid assessment until the asset is exhausted. Once the asset is exhausted,the institution would resume paying and accounting for quarterly depositinsurance assessments as they do currently. Under the final rule, the FDICstated that its requirement for prepaid assessments does not preclude the FDICfrom changing assessment rates or from further revising the risk-basedassessment system during 2009, 2010, 2011, 2012, or thereafter, pursuant tonotice-and-comment rulemaking procedures provided by statute, and therefore,continued actions by the FDIC could significantly increase the Bank’snoninterest expense in fiscal 2010 and for the foreseeable future.  On December 30, 2009, the Company paid$4.9 million for its quarterly risk-based assessments for the fourth quarter of2009 and for all of 2010, 2011, and 2012, of which $4.3 million was recorded asa prepaid asset and will be proportionally expensed over the futureperiods.  At March 31, 2010 $4.0million is recorded as a prepaid asset.

 

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TheBank participates in the FDIC’s Temporary Liquidity Guarantee Program, or TLGP,for noninterest-bearing transaction deposit accounts. Banks that participate inthe TLGP’s noninterest-bearing transaction account guarantee program pay theFDIC an annual assessment of 10 basis points on the amounts in such accountsabove the amounts covered by FDIC deposit insurance. The general terminationdate for the transaction account guarantee portion of the TLGP is December 31,2009. To promote an orderly phase-out of the program, on August 26, 2009,the FDIC adopted a final rule extending the program for six months, throughJune 30, 2010. For institutions that choose to remain in the program, thefee will be raised and adjusted to reflect the institution’s risk profile. TheBank has decided to remain in the program, and therefore will be subject toadditional fees for the extended portion of the program. Continued actions bythe FDIC could significantly increase the Bank’s noninterest expense in fiscal2010 and for the foreseeable future.

 

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

 

None

 

**Item 3.  *Defaults upon Senior Securities***

 

None

 

**Item4.  *[Removed and Reserved]***

 

**Item5.  *Other Information***

 

None

 

**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 |

 

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**SIGNATURES**

 

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

 

 
|   |              |   |   | HF Financial Corp.                                                                                                                 |
|--------|-------------------|--------|--------|------------------------------------------------------------------------------------------------------------------------------------|
|   |              |   |   | (Registrant)                                                                                                                       |
|   |              |   |   |                                                                                                                               |
|   |              |   |   |                                                                                                                               |
| Date:  | May 14, 2010 |   | By:    | /s/  Curtis L. Hage                                                                                                                |
|   |              |   |   | Curtis L. Hage,  Chairman, President and Chief Executive Officer  (Principal Executive Officer)                                    |
|   |              |   |   |                                                                                                                               |
| Date:  | May 14, 2010 |   | By:    | /s/  Darrel L. Posegate                                                                                                            |
|   |              |   |   | Darrel L. Posegate,  Executive Vice President, Chief Financial Officer and Treasurer  (Principal Financial and Accounting Officer) |

 

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**Exhibit Index**

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

 

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