**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

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**FORM10-Q**

 

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

 

**For the Quarterly Period ended March 31, 2006**

 

**Commission File Number: 0-19972**

 

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**HF FINANCIAL CORP.**

(Exact name of registrant as specified in itscharter.)

 

| **Delaware**                                                      | ** ** | **46-0418532**                           |
|-------------------------------------------------------------------|------------|------------------------------------------|
| (State or other jurisdiction  of   incorporation or organization) |       | (I.R.S. Employer  Identification Number) |

 

| **225 South Main Avenue,**               | ** ** | ** ** |
|------------------------------------------|------------|------------|
| **Sioux Falls, SD**                      | ** ** | **57104**  |
| (Address of principal  executive office) |       | (ZIP Code) |

 

**(605) 333-7556**

(Registrant’s telephone number, includingarea code)

 

Indicate bycheck mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes    ý  No  o

 

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

 

| LARGE ACCELERATED FILER o |   | ACCELERATED FILER o |   | NON-ACCELERATED FILER ý |
|--------------------------------|--------|--------------------------|--------|-----------------------------------|

 

Indicate bycheck mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act.) Yes    o  No  ý

 

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date.

 

Asof May 11, 2006 there were 3,944,829 issued and outstanding shares of theRegistrant’s Common Stock, with $.01 par value per share.

 

 

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**HF FINANCIAL CORP.**

 

**Form 10-Q**

 

**Table of Contents**

 
| **PART I –  FINANCIAL INFORMATION** |
|------------------------------------------|
|                                     |   |
| Item 1.                                  |   | Financial Statements (Unaudited): |   |
|                                     |   |   |   |
|                                     |   | Consolidated  Statements of Financial Condition As of March 31, 2006 and June 30, 2005 |   |
|                                     |   |   |   |
|                                     |   | Consolidated Statements of Income for the  Three Months and Nine Months Ended March 31, 2006 and 2005 |   |
|                                     |   |   |   |
|                                     |   | Consolidated  Statements of Cash Flows for the Nine Months Ended March 31, 2006 and 2005 |   |
|                                     |   |   |   |
|                                     |   | Notes to Consolidated Financial Statements |   |
|                                     |   |   |   |
| Item  2.                                 |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |   |
|                                     |   |   |   |
| Item 3.                                  |   | Quantitative  and Qualitative Disclosures about Market Risk |   |
|                                     |   |   |   |
| Item 4.                                  |   | Controls and  Procedures |   |
|                                     |   |   |   |
| **PART II – OTHER INFORMATION**     |
|                                     |   |   |   |
| Item 1.                                  |   | Legal Proceedings |   |
|                                     |   |   |   |
| Item 2.                                  |   | Unregistered  Sales of Equity Securities and Use of Proceeds |   |
|                                     |   |   |   |
| Item 6.                                  |   | Exhibits |   |
|                                     |   |   |   |
| Form 10-Q                                |   | Signature  Page |   |

 

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**PART I – FINANCIAL INFORMATION**

 

**Item 1.    FinancialStatements**

 

**HF FINANCIAL CORP. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION**

**(Dollars in Thousands)**

 
| ** **                                                                                                                                            | ** ** | **March 31, 2006** | ** ** | **June 30, 2005** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                            | ** ** | **(Unaudited)**              | ** ** | **(Audited)**               | ** ** |
| **ASSETS**                                                                                                                                            |       |                         |       |                        |       |
| Cash and cash equivalents                                                                                                                             |       | $                            | 17,426     |                        | $          | 18,248 |   |
| Securities available for sale                                                                                                                         |       | 143,226                      |       | 142,429                     |       |
| Federal Home Loan Bank stock                                                                                                                          |       | 6,489                        |       | 7,699                       |       |
| Loans held for sale                                                                                                                                   |       | 9,243                        |       | 10,238                      |       |
| Loans and leases receivable                                                                                                                           |       | 698,838                      |       | 675,657                     |       |
| Allowance for loan and lease losses                                                                                                                   |       | (5,369                       | )          | (5,076                      | )          |
| Net loans and leases receivable                                                                                                                       |       | 693,469                      |       | 670,581                     |       |
| Accrued interest receivable                                                                                                                           |       | 6,288                        |       | 5,087                       |       |
| Office properties and equipment, net of accumulated  depreciation                                                                                     |       | 13,947                       |       | 12,978                      |       |
| Foreclosed real estate and other properties                                                                                                           |       | 1,336                        |       | 1,387                       |       |
| Cash value of life insurance                                                                                                                          |       | 12,891                       |       | 12,530                      |       |
| Servicing rights                                                                                                                                      |       | 5,612                        |       | 5,211                       |       |
| Goodwill, net                                                                                                                                         |       | 4,951                        |       | 4,951                       |       |
| Other assets                                                                                                                                          |       | 6,371                        |       | 6,535                       |       |
| Total assets                                                                                                                                          |       | $                            | 921,249    |                        | $          | 897,874 |   |
|                                                                                                                                                  |       |                         |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                         |       |                         |       |                        |       |
| **LIABILITIES**                                                                                                                                       |       |                         |       |                        |       |
| Deposits                                                                                                                                              |       | $                            | 705,265    |                        | $          | 681,216 |   |
| Advances from Federal Home Loan Bank and  other borrowings                                                                                            |       | 114,515                      |       | 119,664                     |       |
| Subordinated debentures payable to trusts                                                                                                             |       | 27,837                       |       | 27,837                      |       |
| Advances by borrowers for taxes and  insurance                                                                                                        |       | 9,486                        |       | 6,446                       |       |
| Accrued expenses and other liabilities                                                                                                                |       | 8,456                        |       | 9,076                       |       |
| Total liabilities                                                                                                                                     |       | 865,559                      |       | 844,239                     |       |
|                                                                                                                                                  |       |                         |       |                        |       |
| **STOCKHOLDERS’ EQUITY**                                                                                                                         |       |                         |       |                        |       |
| Preferred stock, $.01 par value, 500,000  shares authorized, none outstanding                                                                         |       | —                       |       | —                      |       |
| Series A Junior Participating Preferred  Stock, $1.00 stated value, 50,000 shares authorized, none outstanding                                        |       | —                       |       | —                      |       |
| Common stock, $.01 par value, 10,000,000  shares authorized, 5,918,191 and 5,462,066 shares issued at March 31, 2006  and June 30, 2005, respectively |       | 59                           |       | 55                          |       |
| Common stock subscribed for but not issued,  73,308 shares at June 30, 2005                                                                           |       | —                       |       | 1,266                       |       |
| Additional paid-in capital                                                                                                                            |       | 19,181                       |       | 19,190                      |       |
| Retained earnings, substantially restricted                                                                                                           |       | 67,650                       |       | 65,267                      |       |
| Deferred compensation                                                                                                                                 |       | —                       |       | (2,140                      | )          |
| Accumulated other comprehensive income  (loss), net of related deferred tax effect                                                                    |       | (2,033                       | )          | (836                        | )          |
| Less cost of treasury stock, 1,977,836 and  1,977,836 shares at March 31, 2006 and June 30, 2005, respectively                                        |       | (29,167                      | )          | (29,167                     | )          |
| Total stockholders’ equity                                                                                                                       |       | 55,690                       |       | 53,635                      |       |
| Total liabilities and stockholders’ equity                                                                                                       |       | $                            | 921,249    |                        | $          | 897,874 |   |

 

*See accompanying notes to unaudited consolidatedfinancial statements.*

 

1

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**HF FINANCIAL CORP. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF INCOME**

**(Dollars in Thousands, Except PerShare Data)**

**(Unaudited)**

 
| ** **                                                              | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                              | ** ** | **March 31,**               | ** ** | **March 31,**              | ** ** |
| ** **                                                              | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                                    |       |                             |       |                            |       |   |   |   |   |
| Interest, dividend and loan fee income:                                 |       |                             |       |                            |       |   |   |   |   |
| Loans and leases receivable                                             |       | $                                | 11,829     |                            | $          | 9,882 |   | $ | 34,543 |   | $ | 29,820 |   |
| Investment securities and interest-earning  deposits                    |       | 1,637                            |       | 1,108                           |       | 4,538 |   | 3,109 |   |
|                                                                    |       | 13,466                           |       | 10,990                          |       | 39,081 |   | 32,929 |   |
| Interest expense:                                                       |       |                             |       |                            |       |   |   |   |   |
| Deposits                                                                |       | 5,239                            |       | 3,259                           |       | 14,328 |   | 8,971 |   |
| Advances from Federal Home Loan Bank and other  borrowings              |       | 1,845                            |       | 1,449                           |       | 5,643 |   | 4,332 |   |
|                                                                    |       | 7,084                            |       | 4,708                           |       | 19,971 |   | 13,303 |   |
| **Net interest income**                                                 |       | 6,382                            |       | 6,282                           |       | 19,110 |   | 19,626 |   |
| Provision for losses on loans and leases                                |       | 418                              |       | 129                             |       | 4,510 |   | 504 |   |
| **Net interest income after provision for  losses on loans and leases** |       | 5,964                            |       | 6,153                           |       | 14,600 |   | 19,122 |   |
|                                                                    |       |                             |       |                            |       |   |   |   |   |
| Noninterest income:                                                     |       |                             |       |                            |       |   |   |   |   |
| Gain on sale of land, net                                               |       | —                           |       | —                          |       | 3,557 |   | — |   |
| Fees on deposits                                                        |       | 1,029                            |       | 1,008                           |       | 3,375 |   | 3,255 |   |
| Loan servicing income                                                   |       | 118                              |       | 308                             |       | 805 |   | 963 |   |
| Gain on sale of loans, net                                              |       | 280                              |       | 207                             |       | 688 |   | 669 |   |
| Trust income                                                            |       | 214                              |       | 179                             |       | 609 |   | 510 |   |
| Gain on sale of securities, net                                         |       | 2                                |       | —                          |       | 2 |   | 13 |   |
| Other                                                                   |       | 434                              |       | 424                             |       | 1,415 |   | 1,253 |   |
|                                                                    |       | 2,077                            |       | 2,126                           |       | 10,451 |   | 6,663 |   |
| Noninterest expense:                                                    |       |                             |       |                            |       |   |   |   |   |
| Compensation and employee benefits                                      |       | 4,044                            |       | 3,924                           |       | 12,559 |   | 12,051 |   |
| Occupancy and equipment                                                 |       | 861                              |       | 766                             |       | 2,470 |   | 2,315 |   |
| Other                                                                   |       | 1,520                            |       | 1,613                           |       | 4,762 |   | 4,707 |   |
|                                                                    |       | 6,425                            |       | 6,303                           |       | 19,791 |   | 19,073 |   |
| **Income before income taxes**                                          |       | 1,616                            |       | 1,976                           |       | 5,260 |   | 6,712 |   |
| Income tax expense                                                      |       | 366                              |       | 632                             |       | 1,688 |   | 2,260 |   |
| **Net income**                                                          |       | $                                | 1,250      |                            | $          | 1,344 |   | $ | 3,572 |   | $ | 4,452 |   |
| **Comprehensive income**                                                |       | $                                | 799        |                            | $          | 860 |   | $ | 2,375 |   | $ | 4,686 |   |
| **Cash dividends declared per share**                                   |       | $                                | 0.1023     |                            | $          | 0.1000 |   | $ | 0.3045 |   | $ | 0.2977 |   |
|                                                                    |       |                             |       |                            |       |   |   |   |   |
| **Earnings per share:(1)**                                              |       |                             |       |                            |       |   |   |   |   |
| Basic                                                                   |       | $                                | 0.32       |                            | $          | 0.35 |   | $ | 0.91 |   | $ | 1.14 |   |
| Diluted                                                                 |       | $                                | 0.31       |                            | $          | 0.33 |   | $ | 0.89 |   | $ | 1.11 |   |

 

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(1) Retroactively adjustedfor the 10% stock dividend paid on April 24, 2006 to shareholders of record asof April 10, 2006

 

*Seeaccompanying notes to unaudited consolidated financial statements.*

 

2

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**HF FINANCIAL CORP. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Dollars inThousands)**

**(Unaudited)**

 
| ** **                                                                                    | ** ** | **Nine Months Ended March 31,** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                    | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
| **Cash flows from operating activities**                                                      |       |                                                |       |   |   |
| Net income                                                                                    |       | $                                                   | 3,572      |   | $ | 4,452 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities:            |       |                                                |       |   |   |
| Provision for losses on loans and leases                                                      |       | 4,510                                               |       | 504 |   |
| Depreciation                                                                                  |       | 1,127                                               |       | 1,061 |   |
| Amortization of discounts and premiums on  securities and other                               |       | 1,446                                               |       | 1,124 |   |
| Stock based compensation                                                                      |       | 409                                                 |       | 281 |   |
| Deferred income taxes (credits)                                                               |       | (544                                                | )          | 110 |   |
| Loans originated for resale                                                                   |       | (71,516                                             | )          | (57,825 | ) |
| Proceeds from the sale of loans                                                               |       | 73,199                                              |       | 60,903 |   |
| (Gain) on sale of loans, net                                                                  |       | (688                                                | )          | (669 | ) |
| Realized (gain) on sale of securities, net                                                    |       | (2                                                  | )          | (13 | ) |
| (Gain) on sale of land                                                                        |       | (3,557                                              | )          | — |   |
| Losses and provision for losses on sales of  foreclosed real estate and other properties, net |       | 33                                                  |       | 24 |   |
| Loss on disposal of office properties and  equipment, net                                     |       | 20                                                  |       | 6 |   |
| Change in other assets and liabilities                                                        |       | (2,541                                              | )          | (153 | ) |
| Net cash provided by operating activities                                                     |       | 5,468                                               |       | 9,805 |   |
| **Cash flows from investing activities**                                                      |       |                                                |       |   |   |
| Loan participations purchased                                                                 |       | (2                                                  | )          | (12,801 | ) |
| Loan participations sold                                                                      |       | 6,123                                               |       | — |   |
| Loans and leases originated and held                                                          |       | (291,782                                            | )          | (153,955 | ) |
| Principal collected on loans and leases                                                       |       | 258,009                                             |       | 164,282 |   |
| Proceeds from sale of land                                                                    |       | 4,863                                               |       | — |   |
| Securities available for sale:                                                                |       |                                                |       |   |   |
| Sales and maturities and repayments                                                           |       | 35,816                                              |       | 40,123 |   |
| Purchases                                                                                     |       | (39,362                                             | )          | (45,397 | ) |
| Purchase of Federal Home Loan Bank stock                                                      |       | (3,031                                              | )          | (3,541 | ) |
| Redemption of Federal Home Loan Bank stock                                                    |       | 4,241                                               |       | 3,381 |   |
| Proceeds from sale of office properties and  equipment                                        |       | 2                                                   |       | 2 |   |
| Purchase of office properties and equipment                                                   |       | (2,118                                              | )          | (1,185 | ) |
| Purchase of servicing rights                                                                  |       | (840                                                | )          | (766 | ) |
| Proceeds from sale of foreclosed real  estate and other properties, net                       |       | 580                                                 |       | 568 |   |
| Net cash (used in) investing activities                                                       |       | (27,501                                             | )          | (9,289 | ) |
|                                                                                               |            |                                                     |            |  |  |  |  |

 

*See accompanying notes to unauditedconsolidated financial statements.*

 

3

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**HF FINANCIAL CORP. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)**

**(Dollars inThousands)**

**(Unaudited)**

 
| ** **                                                             | ** ** | **Nine Months Ended March 31,** | ** ** |
|------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                             | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
|                                                                   |       |                                                |       |   |   |
| **Cash flows from financing activities**                               |       |                                                |       |   |   |
| Net increase (decrease) in deposit accounts                            |       | $                                                   | 24,049     |   | $ | (7,991 | ) |
| Proceeds of advances from Federal Home Loan  Bank and other borrowings |       | 366,973                                             |       | 402,383 |   |
| Payments on advances from Federal Home Loan  Bank and other borrowings |       | (372,122                                            | )          | (391,923 | ) |
| Increase in advances by borrowers                                      |       | 3,040                                               |       | 2,167 |   |
| Purchase of treasury stock                                             |       | —                                              |       | (2,007 | ) |
| Proceeds from issuance of common stock                                 |       | 460                                                 |       | 456 |   |
| Cash dividends paid                                                    |       | (1,189                                              | )          | (1,163 | ) |
| Net cash provided by financing activities                              |       | 21,211                                              |       | 1,922 |   |
|                                                                   |       |                                                |       |   |   |
| Increase (decrease) in cash and cash  equivalents                      |       | (822                                                | )          | 2,438 |   |
|                                                                   |       |                                                |       |   |   |
| Cash and cash equivalents                                              |       |                                                |       |   |   |
| Beginning                                                              |       | 18,248                                              |       | 20,474 |   |
| Ending                                                                 |       | $                                                   | 17,426     |   | $ | 22,912 |   |
|                                                                   |       |                                                |       |   |   |
| Supplemental Disclosures of Cash Flows  Information                    |       |                                                |       |   |   |
| Cash payments for interest                                             |       | $                                                   | 18,777     |   | $ | 13,109 |   |
| Cash payments for income and franchise  taxes, net                     |       | 3,513                                               |       | 1,326 |   |

 

*See accompanying notes to unauditedconsolidated financial statements.*

 

4

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**HF FINANCIAL CORP. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

For The Three and NineMonths Ended March 31, 2006 and 2005

(Unaudited)

 

**NOTE 1.                SELECTEDACCOUNTING POLICIES**

 

*Basis of presentation:*

 

The consolidated financial information of HF Financial Corp. (the“Company”) and its wholly-owned subsidiaries included in this Quarterly Reporton Form 10-Q is unaudited. However, in the opinion of management, adjustments(consisting of normal recurring adjustments) necessary for a fair presentationfor the interim periods have been included. Results for any interim period arenot necessarily indicative of results to be expected for the fiscal year.Interim consolidated financial statements and the notes thereto should be readin conjunction with the consolidated financial statements and notes theretoincluded in the Company’s Annual Report on Form 10-K for the fiscal year endedJune 30, 2005 (“Fiscal 2005”), filed with the Securities and ExchangeCommission. The accounting and reporting policies of the Company and itssubsidiaries conform to accounting principles generally accepted in the UnitedStates of America (“GAAP”) and to general practice within the industry.

 

The interim consolidated financial statements include the accounts ofthe Company, its wholly-owned subsidiaries, Home Federal Bank (the “Bank”), HFFinancial Group, Inc. (“HF Group”) and HomeFirst Mortgage Corp. (the “MortgageCorp.”), and the Bank’s wholly-owned subsidiaries, Mid America CapitalServices, Inc. (“Mid America Capital”), Hometown Insurors, Inc. (“Hometown”),Home Federal Securitization Corp. (“HFSC”), Mid-America Service Corporation andPMD, Inc. The interim consolidated financial statements reflect thedeconsolidation of the subsidiary trusts of the Company, HF Financial CapitalTrust I (“Trust I”), HF Financial Capital Trust II (“Trust II”), HF FinancialCapital Trust III (“Trust III”) and HF Financial Capital Trust IV (“Trust IV”).All intercompany balances and transaction have been eliminated inconsolidation.

 

Stock-based compensation:  In December 2004, the Financial AccountingStandards Board (“FASB”) issued Statement of Financial Accounting Standards(“SFAS”) No. 123R, *“Share-Based Payment,”*which requires all companies to measure compensation cost for all share-basedpayments (including stock options) at fair value and to record such expense intheir consolidated financial statements. SFAS No. 123R is a revision of SFASNo. 123, *“Accounting for Stock-BasedCompensation,”*and supersedes Accounting Principles Board (“APB”)Opinion No. 25, *“Accounting for Stock Issuedto Employees”*.

 

The Companyadopted SFAS No. 123R effective as of July 1, 2005, using the Black-Scholesoption-pricing model and the modified prospective method in which compensationcost is recognized for all awards granted subsequent to the Company’s adoptionof this statement as well as for the unvested portion of awards outstanding asof the Company’s adoption of this statement. Prior to July 1, 2005, the Companyaccounted for stock-based compensation in accordance with APB No. 25 andrelated interpretations. As such, no stock-based employee compensation cost wasrecognized for grants under the Company’s stock option and incentive plans, asall options granted under those plans had an exercise price equal to the marketvalue of the underlying common stock on the date of grant. 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 2005, under Note 17 of “Notes to Consolidated Financial Statements.”

 

5

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The followingtable illustrates the effect on net income and earnings per share if theCompany had applied the fair value recognition provisions of SFAS 123R tostock-based employee compensation for the three and nine months ended March 31,2005.

 
| ** **                                                                                                                                        | ** ** | **Three Months Ended March 31,** | ** ** | **Nine Months Ended March 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                                                                        | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                                                                                        | ** ** | ** **                                           | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income, as reported (1)                                                                                                                       |       | $                                                    | 1,250      |                                                | $          | 1,344 |   | $ | 3,572 |   | $ | 4,452 |   |
| Add: Total stock-based employee  compensation expense included in reported net income, net of related tax  effects                                |       |                                                 |       | 61                                                  |       |   |   | 158 |   |
| Deduct: Total stock-based employee  compensation expense determined under fair value based method for all awards,  net of related tax effects (2) |       |                                                 |       | (125                                                | )          |   |   | (326 | ) |
| Pro forma net income                                                                                                                              |       | $                                                    | 1,250      |                                                | $          | 1,280 |   | $ | 3,572 |   | $ | 4,284 |   |
|                                                                                                                                              |       |                                                 |       |                                                |       |   |   |   |   |
| Basic earnings per share: (3)                                                                                                                     |       |                                                 |       |                                                |       |   |   |   |   |
| As reported                                                                                                                                       |       | $                                                    | 0.32       |                                                | $          | 0.35 |   | $ | 0.91 |   | $ | 1.14 |   |
| Pro forma                                                                                                                                         |       |                                                 |       | 0.33                                                |       |   |   | 1.10 |   |
|                                                                                                                                              |       |                                                 |       |                                                |       |   |   |   |   |
| Diluted earnings per share: (3)                                                                                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| As reported                                                                                                                                       |       | 0.31                                                 |       | 0.33                                                |       | 0.89 |   | 1.11 |   |
| Pro forma                                                                                                                                         |       |                                                 |       | 0.32                                                |       |   |   | 1.07 |   |

 

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(1)          Includes expense related to stock-basedemployee compensation for the three and nine months ended March 31, 2006 due tothe adoption of SFAS No. 123R. 

(2)          Includes expense related to restricted stockreported in net income.

(3)          Retroactively adjusted for the 10% stockdividend paid on April 24, 2006 to shareholders of record on April 10, 2006.

 

**NOTE 2.                REGULATORYCAPITAL**

 

Thefollowing table sets forth the Bank’s compliance with its minimum capitalrequirements for a well-capitalized institution at March 31, 2006:

 
| ** **                                         | ** ** | **Amount**                           | ** ** | **Percent** | ** ** |
|----------------------------------------------------|------------|--------------------------------------|------------|-------------|------------|
| ** **                                         | ** ** | **(Dollars in Thousands)** | ** ** |
| Tier I (core) capital (to adjusted total  assets): |       |                                 |       |        |       |
| Required                                           |       | $                                    | 45,885     |        | 5.00       | % |
| Actual                                             |       | 75,698                               |       | 8.25        |       |
| Excess over required                               |       | 29,813                               |       | 3.25        |       |
|                                               |       |                                 |       |        |       |
| Risk-based capital (to risk-weighted  assets):     |       |                                 |       |        |       |
| Required                                           |       | $                                    | 75,014     |        | 10.00      | % |
| Actual                                             |       | 81,067                               |       | 10.81       |       |
| Excess over required                               |       | 6,053                                |       | 0.81        |       |

 

6

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**NOTE 3.                EARNINGS PER SHARE**

 

Basic earnings per shareis 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 duringthe period are weighted for the portion of the period that they wereoutstanding. The weighted average number of basic common shares outstanding forthe three months ended March 31, 2006 and 2005 was 3,937,219 and 3,893,863,respectively. The weighted average number of basic common shares outstanding forthe nine months ended March 31, 2006 and 2005 was 3,904,871 and 3,896,614,respectively.

 

Dilutive earnings pershare is similar to the computation of basic earnings per share except that thedenominator is increased to include the number of additional common shares thatwould have been outstanding if the dilutive options outstanding had beenexercised. The weighted average number of common and dilutive potential commonshares outstanding for the three months ended March 31, 2006 and 2005 was4,025,351 and 4,012,538, respectively. The weighted average number of commonand dilutive potential common shares outstanding for the nine months endedMarch 31, 2006 and 2005 was 3,991,112 and 3,999,380, respectively.

 

All earnings per share data and number of common shares outstandinghave been retroactively adjusted for the 10% stock dividend paid on April 24,2006 to shareholders of record as of April 10, 2006.  See Note 10 of the“Notes to Consolidated Financial Statements.”

 

 **NOTE 4.               CONSUMERAUTOMOBILE LOAN SECURITIZATION**

 

On January 31, 2003, the Bank securitized and sold motor vehicleinstallment loans with principal balances totaling $50.0 million through HFSCand Home Federal Automobile Securitization Trust 2003-A (“AutomobileSecuritization Trust”). As part of the sales transaction, the Bank retainedservicing responsibilities. In addition, the Bank retained the rights to cashflows remaining after investors in the Automobile Securitization Trust receivedtheir contractual payments and pledged a $1.5 million reserve fund to theAutomobile Securitization Trust. These retained interests are subordinated toinvestors’ interests. The investors and Automobile Securitization Trust have norecourse to the Bank’s other assets for failure of debtors to pay when due. Thepass through rate to investors is 2.65%.

 

The gain recognized onthe sale of these loans was determined by allocating the carrying amount of theloans between the loans sold and the interests retained. The Bank determinedthat 50 basis points of the 100 basis points servicing contract represented wasexcess servicing and was capitalized as part of the transaction utilizing amarket discount rate of 10.0%. This asset is amortized in proportion to, andover the period of, estimated net servicing income.

 

The Companyhad the option to execute a cleanup call when the total outstanding balance wasat 10% or less of the original pool balance, or $5.0 million. On November 9,2005, the Bank exercised its option to execute a cleanup call by purchasing theoutstanding principal balances of the securitized motor vehicle installmentloans.

 

7

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**NOTE 5.****                              INVESTMENTSIN SECURITIES**

 

The amortized cost and fair values ofinvestments in securities, all of which are classified as available for saleaccording to management’s intent, are as follows:

 
| ** **                 | ** ** | **March 31, 2006**         | ** ** |
|----------------------------|------------|--------------------------------------|------------|
| ** **                 | ** ** | ** **                           | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                 | ** ** | **Amortized**                        | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **                 | ** ** | **Cost**                             | ** ** | **Gains** | ** ** | **(Losses)** | ** ** | **Value** | ** ** |
| ** **                 | ** ** | **(Dollars in Thousands)** | ** ** |
|                       |       |                                 |       |   |   |   |   |   |   |
| Debt securities:           |       |                                 |       |   |   |   |   |   |   |
| U.S. government agencies   |       | $                                    | 9,513      |   | $ | — |   | $ | (129 | ) | $ | 9,384 |   |
| Federal Home Loan Bank     |       | 8,977                                |       | — |   | (139 | ) | 8,838 |   |
| Municipal bonds            |       | 3,510                                |       | — |   | (75 | ) | 3,435 |   |
| Preferred Term Securities  |       | 11,019                               |       | 73 |   | (123 | ) | 10,969 |   |
|                       |       | 33,019                               |       | 73 |   | (466 | ) | 32,626 |   |
|                       |       |                                 |       |   |   |   |   |   |   |
| Equity securities:         |       |                                 |       |   |   |   |   |   |   |
| FNMA                       |       | 8                                    |       | 12 |   | — |   | 20 |   |
| Federal Ag Mortgage        |       | 7                                    |       | 4 |   | — |   | 11 |   |
| Other Investments          |       | 38                                   |       | — |   | — |   | 38 |   |
|                       |       | 53                                   |       | 16 |   | — |   | 69 |   |
|                       |       |                                 |       |   |   |   |   |   |   |
| Mortgage-backed securities |       | 113,433                              |       | 1 |   | (2,903 | ) | 110,531 |   |
|                       |       | $                                    | 146,505    |   | $ | 90 |   | $ | (3,369 | ) | $ | 143,226 |   |

 
| ** **                 | ** ** | **March 31, 2005**         | ** ** |
|----------------------------|------------|--------------------------------------|------------|
| ** **                 | ** ** | **Gross**                            | ** ** | **Gross** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                 | ** ** | **Amortized**                        | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **                 | ** ** | **Cost**                             | ** ** | **Gains** | ** ** | **(Losses)** | ** ** | **Value** | ** ** |
| ** **                 | ** ** | **(Dollars in Thousands)** | ** ** |
|                       |       |                                 |       |   |   |   |   |   |   |
| Debt securities:           |       |                                 |       |   |   |   |   |   |   |
| U.S. government agencies   |       | $                                    | 5,000      |   | $ | — |   | $ | (59 | ) | $ | 4,941 |   |
| Federal Home Loan Bank     |       | 1,500                                |       | — |   | (18 | ) | 1,482 |   |
| Municipal bonds            |       | 2,650                                |       | 1 |   | (18 | ) | 2,633 |   |
| Preferred Term Securities  |       | 9,000                                |       | 57 |   | — |   | 9,057 |   |
|                       |       | 18,150                               |       | 58 |   | (95 | ) | 18,113 |   |
|                       |       |                                 |       |   |   |   |   |   |   |
| Equity securities:         |       |                                 |       |   |   |   |   |   |   |
| FNMA                       |       | 8                                    |       | 14 |   | — |   | 22 |   |
| Federal Ag Mortgage        |       | 7                                    |       | 1 |   | (2 | ) | 6 |   |
| Other Investments          |       | 25                                   |       | — |   | — |   | 25 |   |
|                       |       | 40                                   |       | 15 |   | (2 | ) | 53 |   |
|                       |       |                                 |       |   |   |   |   |   |   |
| Mortgage-backed securities |       | 111,289                              |       | 14 |   | (1,766 | ) | 109,537 |   |
|                       |       | $                                    | 129,479    |   | $ | 87 |   | $ | (1,863 | ) | $ | 127,703 |   |

 

8

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The following table presents thefair value and age of gross unrealized losses by investment category at March31, 2006 in accordance with Emerging Issues Task Force Issue No. 03-1, “*The Meaning of Other-Than-Temporary Impairment andIts Application to Certain Investments.”*

 
| ** **                 | ** ** | **Less than 12 Months** | ** ** | **12 Months or More** | ** ** | **Total**  | ** ** |
|----------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|------------|------------|
| ** **                 | ** ** | ** **                             | ** ** | **Gross**                            | ** ** | ** ** | ** ** | **Gross** | ** ** | ** ** | ** ** | **Gross** | ** ** |
| ** **                 | ** ** | **Fair**                               | ** ** | **Unrealized**                       | ** ** | **Fair**   | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| ** **                 | ** ** | **Value**                              | ** ** | **(Losses)**                         | ** ** | **Value**  | ** ** | **(Losses)** | ** ** | **Value** | ** ** | **(Losses)** | ** ** |
| ** **                 | ** ** | **(Dollars in Thousands)**   | ** ** |
| Debt securities:           |       |                                   |       |                                 |       |       |       |   |   |   |   |   |   |
| U.S. government agencies   |       | $                                      | 3,985      |                                 | $          | (28        | )          | $ | 5,400 |   | $ | (101 | ) | $ | 9,385 |   | $ | (129 | ) |
| Federal Home Loan Bank     |       | 8,838                                  |       | (139                                 | )          | —     |       | — |   | 8,838 |   | (139 | ) |
| Municipal bonds            |       | 2,106                                  |       | (63                                  | )          | 1,329      |       | (12 | ) | 3,435 |   | (75 | ) |
| Preferred term securities  |       | 1,896                                  |       | (123                                 | )          |       |       |   |   | 1,896 |   | (123 | ) |
| Mortgage-backed securities |       | 43,745                                 |       | (940                                 | )          | 66,698     |       | (1,963 | ) | 110,443 |   | (2,903 | ) |
|                       |       | $                                      | 60,570     |                                 | $          | (1,293     | )          | $ | 73,427 |   | $ | (2,076 | ) | $ | 133,997 |   | $ | (3,369 | ) |

 

Management does not believe anyindividual unrealized losses as of March 31, 2006 represent another-than-temporary impairment. The unrealized losses reported formortgage-backed securities relate to securities issued by the Federal NationalMortgage Association (“FNMA”), the Government National Mortgage Association andthe Federal Home Loan Mortgage Corporation (“FHLMC”). These unrealized lossesare primarily attributable to changes in interest rates and as a group wereless than 2.5% of its respective amortized cost basis at March 31, 2006. TheCompany has the ability to hold the securities to maturity or for a timenecessary to recover the amortized cost.

 

The Company invests in investment securitiesissued by FNMA and FHLMC. FNMA and FHLMC are government-sponsored enterprises (“GSEs”).GSE, as defined in the Omnibus Budget Reconciliation Act of 1990, refers to aprivate corporation that operates under a charter granted by Congress. Themajority of the members of the board of directors of a GSE must be elected bythe private shareholders, though some portion may be appointed by Congress orthe President. The central function of a GSE is to serve as a financialintermediary, making loans or issuing loan guarantees to borrowers or sectorsidentified in the enabling legislation. A GSE may raise funds in a variety ofways, but in no case are the liabilities of the GSE to be backed by the fullfaith and credit of the federal government. The legislation specifically statesthat a GSE does not have the power to tax or regulate and cannot make financialcommitments in the name of the federal government and that members of its staffare not employees of the federal government. However, management believes thatGSEs are generally perceived by the credit markets to have an implicit federalgovernment guarantee backing its obligations.

 

Management cannot predict the role of GSEs inthe future or how Congress would respond to accounting or credit issues thatmay affect GSEs. Management presently expects to continue to invest ininvestment securities issued by FNMA and FHLMC in the normal course ofbusiness. If Congress would ever eliminate the implicit guarantee associatedwith securities issued by GSEs, the outcome would most likely be adverse to theCompany.

 

9

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**NOTE 6.                SEGMENTREPORTING**

 

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

 

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

 
| **Three Months Ended March 31, 2006** | ** ** | **Banking**                          | ** ** | **Other** | ** ** | **Total** | ** ** |
|----------------------------------------------------------------|------------|--------------------------------------|------------|-----------|------------|-----------|------------|
| ** **                                                     | ** ** | **(Dollars in Thousands)** | ** ** |
|                                                           |       |                                 |       |      |       |      |       |
| Net interest income                                            |       | $                                    | 7,171      |      | $          | (789      | )          | $ | 6,382 |   |
| Intersegment interest income                                   |       | (279                                 | )          | 279       |       | —    |       |
| Provision for losses on loans and leases                       |       | (418                                 | )          | —    |       | (418      | )          |
| Noninterest income                                             |       | 2,262                                |       | (185      | )          | 2,077     |       |
| Intersegment noninterest income                                |       | (45                                  | )          | 45        |       | —    |       |
| Noninterest expense                                            |       | (6,347                               | )          | (78       | )          | (6,425    | )          |
| Intersegment noninterest expense                               |       | 1                                    |       | (1        | )          | —    |       |
| Income (loss) before income taxes                              |       | $                                    | 2,345      |      | $          | (729      | )          | $ | 1,616 |   |
|                                                           |       |                                 |       |      |       |      |       |
| Total assets at March 31, 2006                                 |       | $                                    | 919,427    |      | $          | 1,822     |       | $ | 921,249 |   |

 
| **Three Months Ended March 31, 2005** | ** ** | **Banking**                          | ** ** | **Other** | ** ** | **Total** | ** ** |
|----------------------------------------------------------------|------------|--------------------------------------|------------|-----------|------------|-----------|------------|
| ** **                                                     | ** ** | **(Dollars in Thousands)** | ** ** |
|                                                           |       |                                 |       |      |       |      |       |
| Net interest income                                            |       | $                                    | 7,021      |      | $          | (739      | )          | $ | 6,282 |   |
| Intersegment interest income                                   |       | (315                                 | )          | 315       |       | —    |       |
| Provision for losses on loans and leases                       |       | (129                                 | )          | —    |       | (129      | )          |
| Noninterest income                                             |       | 2,141                                |       | (15       | )          | 2,126     |       |
| Intersegment noninterest income                                |       | (73                                  | )          | 73        |       | —    |       |
| Noninterest expense                                            |       | (6,117                               | )          | (186      | )          | (6,303    | )          |
| Intersegment noninterest expense                               |       | 1                                    |       | (1        | )          | —    |       |
| Income (loss) before income taxes                              |       | $                                    | 2,529      |      | $          | (553      | )          | $ | 1,976 |   |
|                                                           |       |                                 |       |      |       |      |       |
| Total assets at March 31, 2005                                 |       | $                                    | 850,394    |      | $          | 3,616     |       | $ | 854,010 |   |

 

10

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| **Nine Months Ended March 31, 2006** | ** ** | **Banking**                          | ** ** | **Other** | ** ** | **Total** | ** ** |
|---------------------------------------------------------------|------------|--------------------------------------|------------|-----------|------------|-----------|------------|
| ** **                                                    | ** ** | **(Dollars in Thousands)** | ** ** |
|                                                          |       |                                 |       |      |       |      |       |
| Net interest income                                           |       | $                                    | 21,535     |      | $          | (2,425    | )          | $ | 19,110 |   |
| Intersegment interest income                                  |       | (878                                 | )          | 878       |       | —    |       |
| Provision for losses on loans and leases                      |       | (4,510                               | )          | —    |       | (4,510    | )          |
| Noninterest income                                            |       | 7,098                                |       | 3,353     |       | 10,451    |       |
| Intersegment noninterest income                               |       | (141                                 | )          | 141       |       | —    |       |
| Noninterest expense                                           |       | (19,324                              | )          | (467      | )          | (19,791   | )          |
| Intersegment noninterest expense                              |       | 4                                    |       | (4        | )          | —    |       |
| Income (loss) before income taxes                             |       | $                                    | 3,784      |      | $          | 1,476     |       | $ | 5,260 |   |
|                                                          |       |                                 |       |      |       |      |       |
| Total assets at March 31, 2006                                |       | $                                    | 919,427    |      | $          | 1,822     |       | $ | 921,249 |   |

 
| **Nine Months Ended March 31, 2005** | ** ** | **Banking**                          | ** ** | **Other** | ** ** | **Total** | ** ** |
|---------------------------------------------------------------|------------|--------------------------------------|------------|-----------|------------|-----------|------------|
| ** **                                                    | ** ** | **(Dollars in Thousands)** | ** ** |
|                                                          |       |                                 |       |      |       |      |       |
| Net interest income                                           |       | $                                    | 21,663     |      | $          | (2,037    | )          | $ | 19,626 |   |
| Intersegment interest income                                  |       | (849                                 | )          | 849       |       | —    |       |
| Provision for losses on loans and leases                      |       | (504                                 | )          | —    |       | (504      | )          |
| Noninterest income                                            |       | 6,740                                |       | (77       | )          | 6,663     |       |
| Intersegment noninterest income                               |       | (245                                 | )          | 245       |       | —    |       |
| Noninterest expense                                           |       | (18,337                              | )          | (736      | )          | (19,073   | )          |
| Intersegment noninterest expense                              |       | 3                                    |       | (3        | )          | —    |       |
| Income (loss) before income taxes                             |       | $                                    | 8,471      |      | $          | (1,759    | )          | $ | 6,712 |   |
|                                                          |       |                                 |       |      |       |      |       |
| Total assets at March 31, 2005                                |       | $                                    | 850,394    |      | $          | 3,616     |       | $ | 854,010 |   |

 

11

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**NOTE 7.                DEFINEDBENEFIT PLAN**

 

The Company has a noncontributory (cash balance) defined benefitpension plan covering all employees of the Company and its wholly-ownedsubsidiaries who have attained the age of 21 and have completed 1,000 hours ina plan year. The benefits are based on 6% of each eligible participant’s annualcompensation, plus income earned in the accounts at a rate determined annuallybased 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 vestingoccurs after five years with a normal retirement age of 65. Informationrelative to the components of net periodic benefit cost for the Company’sdefined benefit plan is presented below:

 
| ** **                        | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                        | ** ** | **March 31,**               | ** ** | **March 31,**              | ** ** |
| ** **                        | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
|                              |       |                             |       |                            |       |   |   |   |   |
| Service cost                      |       | $                                | 116,367    |                            | $          | 113,535 |   | $ | 349,101 |   | $ | 340,606 |   |
| Interest cost                     |       | 91,239                           |       | 91,585                          |       | 273,715 |   | 274,754 |   |
| Expected return on plan assets    |       | (93,185                          | )          | (92,629                         | )          | (279,555 | ) | (277,887 | ) |
| Amortization of prior losses      |       | —                           |       | 8,297                           |       | — |   | 24,891 |   |
| Accretion of prior service cost   |       | —                           |       | —                          |       | — |   | — |   |
| Amortization of transition asset  |       | 2,907                            |       | 2,908                           |       | 8,722 |   | 8,723 |   |
| Total costs recognized in expense |       | $                                | 117,328    |                            | $          | 123,696 |   | $ | 351,983 |   | $ | 371,087 |   |

 

The Company previously disclosed in its consolidated financialstatements for Fiscal 2005, which are included in Part II, Item 8 “FinancialStatements and Supplementary Data” of the Company’s Annual Report on Form 10-Kfor Fiscal 2005, that it contributed $662,000 to fund its qualified pensionplan. During the first quarter ended September 30, 2005, the Company madecontributions of $610,000 to fund its qualified pension plan. The Companyanticipates no additional contributions for the fiscal year ending June 30,2006 (“Fiscal 2006”).

 

**NOTE 8.                SELF-INSUREDHEALTHCARE PLAN**

 

The Company has had aself-insured health plan for its employees, subject to certain limits, sinceJanuary 1994. The Bank is named the plan administrator for this plan and hasretained the services of an independent third party administrator to processclaims and handle other duties for this plan. The third party administratordoes not assume liability for benefits payable under this plan.

 

The Company assumes the responsibility for funding the plan benefitsout of general assets, however employees cover some of the costs of coveredbenefits through contributions, deductibles, co-pays and participation amounts.An employee is eligible for coverage upon completion of 30 calendar days ofregular employment. The plan, which is on a calendar year basis, is intended tocomply with, and be governed by, the Employee Retirement Income Security Act of1974, as amended.

 

12

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Total net healthcarecosts are inclusive of health claims expenses and administration fees offset bystop loss and employee reimbursement. Reported below is a summary of nethealthcare costs by quarter for the fiscal years ended June 30, 2003, 2004,2005 and 2006.

 
| ** **                 | ** ** | **Fiscal Years Ended June 30,** | ** ** |
|----------------------------|------------|-----------------------------------------------------|------------|
| ** **                 | ** ** | **2006**                                            | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                 | ** ** | **(Dollars in Thousands)**                | ** ** |
|                       |       |                                                |       |   |   |   |   |   |   |
| Quarter ended September 30 |       | $                                                   | 419        |   | $ | 381 |   | $ | 594 |   | $ | 307 |   |
| Quarter ended December 31  |       | 409                                                 |       | 213 |   | 273 |   | 538 |   |
| Quarter ended March 31     |       | 382                                                 |       | 379 |   | 678 |   | 204 |   |
| Quarter ended June 30      |       |                                                |       | 282 |   | 244 |   | 780 |   |
| Net healthcare costs       |       | $                                                   | 1,210      |   | $ | 1,255 |   | $ | 1,789 |   | $ | 1,829 |   |

 

**NOTE 9.                FASBSTATEMENT NO. 140**

 

Duringthe third quarter of Fiscal 2006, the Company completed a line itemchange of its income recorded on originated mortgage servicing rights forloans sold to South Dakota Housing Development Authority.  Thisprocess was done upon a fuller interpretation of Statement No. 140, *“Accounting for Transfers and Servicing of FinancialAssets and Extinguishments of Liabilities”*as issued by theFASB.  All periods presented have been revised in presentation toreflect this line item and there was no change to netincome, earnings per share, or recorded value of servicing rights asa result of this line item change. The following table reflects theeffects of the line item change on the Company’s consolidated statementsof income for the three and nine months ended March 31, 2006 and 2005.

 
| ** **                 | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended** | ** ** |
|----------------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **                 | ** ** | **March 31,**                   | ** ** | **March 31,**              | ** ** |
| ** **                 | ** ** | **2006**                             | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                 | ** ** | **(Dollars in Thousands)** | ** ** |
|                       |       |                                 |       |                            |       |   |   |   |   |
| Loan servicing income      |       | $                                    | (66        | )                               | $          | (43 | ) | $ | (159 | ) | $ | (169 | ) |
| Gain on sale of loans, net |       | 66                                   |       | 43                              |       | 159 |   | 169 |   |
|                       |       |                                 |       |                            |       |   |   |   |   |
| Net income change          |       | $                                    | —     |                            | $          | — |   | $ | — |   | $ | — |   |

 

**NOTE 10.              PAYMENTOF 10% STOCK DIVIDEND**

 

Duringthe third quarter of Fiscal 2006, the Company declared a 1-1/10-for-1 stocksplit of all of the common stock of the Company outstanding, payable in theform of a 1/10-for-1 stock dividend.  The 10% stock dividend was paid onApril 24, 2006 to stockholders of record as of April 10, 2006.

 

13

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

 

**Forward-Looking Statements**

 

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

 

•                  Projectionsof income, loss, revenues, earnings or losses per share, dividends, capitalexpenditures, capital structure, tax benefit or other financial items.

•                  Descriptionsof plans or objectives of management for future operations, products orservices, transactions, investments and use of subordinated debentures payableto trusts.

•                  Forecastsof future economic performance.

•                  Useand descriptions of assumptions and estimates underlying or relating to suchmatters.

 

Forward-looking statements can be identifiedby the fact that they do not relate strictly to historical or current facts.They often include words such as “optimism,” “look-forward,” “bright,”“believe,” “expect,” “anticipate,” “intend,” “plan,” “estimate” or words ofsimilar meaning, or future or conditional verbs such as “will,” “would,”“should,” “could” or “may.”

 

Forward-lookingstatements about the Company’s expected financial results and other plans aresubject to certain risks, uncertainties and assumptions. These include, but arenot limited to the following: possible legislative changes and adverseeconomic, business and competitive conditions and developments (such asshrinking interest margins and continued short-term rate environments); depositoutflows; reduced demand for financial services and loan products; changes inaccounting policies or guidelines, or in monetary and fiscal policies of thefederal government; changes in credit and other risks posed by the Company’sloan portfolios; the ability or inability of the Company to manage interestrate and other risks; unexpected or continuing claims against the Company’sself-insured health plan; the Company’s use of trust preferred securities; theability or inability of the Company to successfully enter into a definitiveagreement for and close anticipated transactions; technological,computer-related or operational difficulties; adverse changes in securitiesmarkets; results of litigation; or other significant uncertainties.

 

Forward-lookingstatements speak only as of the date they are made. The Company does notundertake to update forward-looking statements to reflect circumstances orevents that occur after the date the forward-looking statements are made.

 

14

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**Executive Summary**

 

The Company’s net incomefor the third quarter of Fiscal 2006 was $1.3 million, or $0.31 per dilutedshare, compared to $1.3 million, or $0.33 per diluted share, for the thirdquarter of Fiscal 2005. For the first nine months of Fiscal 2006, net incomewas $3.6 million, or $0.89 per diluted share, compared to $4.5 million, or$1.11 per diluted share, for the first nine months of Fiscal 2005. On a proforma basis, if the Company had applied the fair value recognition provisions ofSFAS 123R to stock-based employee compensation in Fiscal 2005, the Company’snet income per diluted share for the third quarter of Fiscal 2005 and the firstnine months of Fiscal 2005 would have been $0.32 and $1.07, respectively.Return on average equity was 8.74% at March 31, 2006 compared to 11.12% atMarch 31, 2005.

 

The Company adopted SFAS123R effective as of July 1, 2005. As a result, the Company recognized $138,000in stock option expense for the nine months ended March 31, 2006 compared to noexpense recognized for stock options granted under the Company’s stock optionand incentive plans for the same period a year ago. The Company also recognized$313,000 in restricted stock expense for the nine months ended March 31, 2006,compared to $159,000 for the same period a year ago.

 

On March 24, 2006, the Company announced a 10% stock dividend paid onApril 24, 2006 to stockholders of record as of April 10, 2006. The Companyexpects this stock dividend, along with its ongoing business strategies, to enhancelong-term stockholder value and liquidity. The Board of Directors believes theincrease in market value for the Company over the last two years warrants thepayment of this stock dividend.

 

The allowance for loan and lease losses increased to $5.4 million atMarch 31, 2006, compared to $5.1 million at June 30, 2005, an increase of$293,000 or 5.8%. The ratio of allowance for loan and lease losses to totalloans and leases was 0.76% as of March 31, 2006 compared to 0.74% at June 30,2005. Total nonperforming assets at March 31, 2006 were $4.7 million ascompared to $7.0 million at June 30, 2005. The ratio of nonperforming assets tototal assets decreased to 0.51% at March 31, 2006, compared to 0.78% at June30, 2005. The allowance for loan and lease losses is calculated based on loanand lease levels, loan and lease loss history, credit quality of the loan andlease portfolio, and environmental factors such as economic health of theregion 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.

 

As of March31, 2006, the Company continued to record a receivable in the amount of$659,000 from the sale of certain loan participation interests in December2005. The balance of this receivable represents the remaining amount theCompany expects to be paid by the lead bank. The Company requested payment fromthe lead bank and currently is expecting to receive such payment over the nextfew months.

 

The net interest margin for the three months ended March 31, 2006 was3.03%, compared to 3.28% for the same period a year ago. For the first ninemonths of Fiscal 2006, the net interest margin was 3.01%, compared to 3.33% forthe same period a year ago. The flattening of the treasury yield curve causedby increasing short-term rates and lagging long-term rates continued to affectthe Company’s net interest margin ratio during the quarter. Variability of thenet interest margin ratio may be affected by many aspects, including FederalReserve policies for short-term interest rates, competitive and global economicfactors and customer preferences for various products and services. From March31, 2005 to March 31, 2006, the Federal Reserve increased short-term interestrates eight times at 25 basis points each, for a total increase of 200 basispoints.

 

Net interestmargin in dollars for the first nine months of Fiscal 2006 was $19.1 million,which decreased by $516,000, or 2.6%, over the same period a year ago. Netinterest margin in dollars increased $100,000, or 1.6%, to $6.4 million for thethree months ended March 31, 2006 from $6.3 million for same period in theprior fiscal year. The change in net interest margin in dollars for the threeand nine months

 

15

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ended March 31, 2006 ascompared to the same period a year ago was due in large part to the recentincreases in the national prime rate. In addition, the Company’s averageinterest-earning assets in volume through the first nine months of Fiscal 2006have increased 8.0% from the same period a year ago. For the same time period,average interest-bearing liabilities increased in volume by 8.6%.

 

Total deposits at March 31, 2006 were $705.3 million, an increase of$54.5 million, or 8.4%, from $650.7 million at March 31, 2005. Interest expenseon these deposits was $14.3 million for the nine months ended March 31, 2006,an increase of $5.4 million, or 59.7%, over the same period a year ago. In-marketdeposits increased from $632.2 million at March 31, 2005 to $661.6 million atMarch 31, 2006, an increase of $29.4 million, or 4.7%. For the same period,out-of-market deposits increased from $18.5 million to $43.7 million,respectively. Out-of-market deposits are used as a funding source along withother funding when there is a gap in the availability of in-market deposits tofund asset growth. The primary factor affecting interest expense has been theincrease in volume of money market accounts. The volume of money marketaccounts increased by $15.0 million, or 7.1%, from March 31, 2005, to March 31,2006. Interest expense for these accounts, which are primarily indexed to the91-day Treasury bill, also increased by $2.3 million, or 76.6%, compared to thesame period in the prior fiscal year. With the actions taken by the FederalReserve, the 91-day Treasury bill has risen significantly from 2.77% at March31, 2005 to 4.60% at March 31, 2006, an increase of 183 basis points.

 

In April 2006, the Company announced the renewal of its annual stockbuyback program for the period of May 2006 through April 2007. During the thirdquarter ended March 31, 2006, the Company acquired no shares under its stockbuyback program which expired on April 30, 2006. Through the first nine monthsof Fiscal 2006, the Company acquired no shares under such stock buybackprogram. A total of 47,300 shares of common stock were purchased pursuant tosuch program, all of which were purchased in the open market during May andJune 2005.

 

The total risk-based capital ratio of 10.81% at March 31, 2006 is belowthe 11.02% at March 31, 2005, a decrease of 21 basis points. Despite thedecrease, this ratio remains above the 10.66% at the end of Fiscal 2005. Thisperformance continues to place the Bank in the “well capitalized” categorywithin OTS regulation at March 31, 2006 and is consistent within the “wellcapitalized” OTS category in which the Company plans to operate. The Companyhistorically has been able to manage the size of its assets through secondarymarket loan sales of single-family mortgages and student loans and a loansecuritization.

 

The Company focuses on balancing operating costs with operating revenuelevels in order to provide better efficiency ratios over time and continues toreview its operations for ways to reduce its cost structure while continuing tosupport long-term revenue enhancements. Noninterest expense was $6.4 millionfor the quarter ended March 31, 2006 compared to $6.3 million at March 31,2005, an increase of $122,000 or 1.9%. Compensation and employee benefitsexpense accounted for an increase of $120,000 due to increases in employeecompensation and net healthcare costs. In addition, noninterest income was $2.1million for the quarter ended March 31, 2006 compared to $2.1 million for thequarter ended March 31, 2005, a decrease of $49,000 or 2.3%. This decrease wasprimarily attributable to lower volume activity on servicing of loans.

 

The operatingefficiency ratio at March 31, 2006 was 71.63%, compared to 69.36% for the sametime period a year ago, an increase of 227 basis points. The operatingefficiency ratio excludes the impact of interest expense on the variable pricedtrust preferred securities and the one-time gain on sale of land. The Companyhas issued trust preferred securities primarily to provide funding for stockrepurchases and to repay other borrowings. Interest expense on the $27.8million of trust preferred securities outstanding increased to $1.6 million forthe nine months ended March 31, 2006, compared to $1.2 million for the sameperiod a year ago, an increase of $418,000 or 34.6%. The average rate paid onthese securities increased 200 basis points, from 5.78% at March 31, 2005 to7.78% at March 31, 2006. The total efficiency ratio was 66.95% at March 31,2006. Excluding the gain from sale of land, the total efficiency ratio at March31, 2006 was 76.11%, compared to 72.55% for the same period a year ago, anincrease of 356 basis points. Factors contributing to this increase in theefficiency ratio from a year ago include a $516,000 reduction in net interestincome and an increase of $718,000 in noninterest expenses for the nine monthsended March 31, 2006 compared to the same period in the prior fiscal year.

 

16

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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 incomeinclude credit risk, liquidity risk, operational risk, regulatory compliancerisk and reputation risk. The Company’s net income is derived by managing netinterest margin, the ability to collect fees from services provided, bycontrolling the costs of delivering services and the management of loan andlease losses. The primary source of revenues comes from the net interestmargin, which represents the difference between income on interest-earningassets (i.e. loans and investment securities) and expense on interest-bearingliabilities (i.e. deposits and borrowed funding). The net interest margin isaffected by regulatory, economic and competitive factors that influenceinterest rates, loan demand and deposit flows. Fees earned include charges fordeposit services, trust services and loan services. Personnel costs are theprimary expenses required to deliver the services to customers. Other costsinclude occupancy and equipment and general and administrative expenses.

 

**Financial Condition Data**

 

At March 31, 2006, the Company had total assets of $921.2 million, anincrease of $23.4 million from the level at June 30, 2005. The increase inassets was due primarily to increases in net loans and leases receivable of$22.9 million, office properties and equipment of $969,000 and securitiesavailable for sale of $797,000 offset by a decrease in stock in the FederalHome Loan Bank of Des Moines (“FHLB”) of $1.2 million. The increase inliabilities of $21.3 million from June 30, 2005 to March 31, 2006 was primarilydue to an increase in deposits of $24.0 million offset by a decrease inadvances from the FHLB and other borrowings of $5.1 million. In addition,stockholders’ equity increased $2.1 million to $55.7 million at March 31, 2006from $53.6 million at June 30, 2005, primarily due to net income of $3.6million.

 

The increasein net loans and leases receivable of $22.9 million was due primarily to anincrease in purchases and originations over sales, amortization and repaymentsof principal**.**In addition, netdeferred (fees), costs and discounts decreased $257,000 from the levels at June30, 2005 to $1.0 million at March 31, 2006. This decrease was primarily due toa decrease of $274,000 in indirect automobile loan costs that include prepaiddealer reserves offset by a decrease in multi-family deferred loan fees.

 

The increase in office properties and equipment of $969,000 wasprimarily due to improvements to the main branch offices. In addition, a$192,000 increase was the result of land purchased for a new branch location.

 

The increase in securities available for sale of $797,000 was primarilythe result of purchases of $39.4 million exceeding sales, maturities andrepayments of $35.8 million. The purchases of $39.4 million includedvariable-rate, mortgage-backed securities of $12.1 million.

 

The decrease in stock in the FHLB of $1.2 million was primarily theresult of a $5.1 million decrease in advances from the FHLB and otherborrowings.

 

The $24.0 million increase in deposits was due to increases inin-market certificates of deposit of $23.3 million, money market accounts of $18.2million, out-of-market certificates of deposit of $7.9 million andinterest-bearing checking accounts of $4.1 million offset by decreases insavings accounts of $19.1 million and noninterest-bearing checking accounts of$10.4 million.

 

Advances from the FHLBand other borrowings decreased $5.1 million, which was primarily due topaydowns of FHLB borrowings of $371.4 million exceeding new borrowings of$367.0 million. The overall decrease in FHLB borrowings was primarily theresult of a $24.0 million increase in deposits.

 

17

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The following tablesshow the composition of the Company’s loan and lease portfolio and depositaccounts.

 
| ** **                                  | ** ** | **At March 31, 2006** | ** ** | **At June 30, 2005** | ** ** |
|---------------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| ** **                                  | ** ** | ** **                           | ** ** | **Percent of**                 | ** ** | ** ** | ** ** | **Percent of** | ** ** |
| ** **                                  | ** ** | ** **                           | ** ** | **Loans in**                   | ** ** | ** ** | ** ** | **Loans in** | ** ** |
| ** **                                  | ** ** | **Amount**                           | ** ** | **Each Category**              | ** ** | **Amount** | ** ** | **Each Category** | ** ** |
| ** **                                  | ** ** | **(Dollars in Thousands)** | ** ** |
| One-to four-family (1)                      |       | $                                    | 96,264     |                                | 13.78      | % | $ | 96,496 |   | 14.28 | % |
| Commercial business and real estate (2) (3) |       | 233,215                              |       | 33.37                               | %          | 223,638 |   | 33.10 | % |
| Multi-family real estate                    |       | 33,175                               |       | 4.75                                | %          | 34,123 |   | 5.05 | % |
| Equipment finance leases                    |       | 31,983                               |       | 4.58                                | %          | 33,170 |   | 4.91 | % |
| Consumer Direct (4) (5)                     |       | 110,796                              |       | 15.85                               | %          | 111,210 |   | 16.46 | % |
| Consumer Indirect                           |       | 91,458                               |       | 13.09                               | %          | 93,984 |   | 13.91 | % |
| Agricultural                                |       | 82,486                               |       | 11.80                               | %          | 74,010 |   | 10.95 | % |
| Construction and development                |       | 19,461                               |       | 2.78                                | %          | 9,026 |   | 1.34 | % |
| Total Loans and Leases Receivable (6)       |       | $                                    | 698,838    |                                | 100.00     | % | $ | 675,657 |   | 100.00 | % |

 

----

(1) Excludes $5,294 and$9,838 loans held for sale at March 31, 2006 and June 30, 2005, respectively.

(2) Includes $3,477 and$3,563 tax exempt leases at March 31, 2006 and June 30, 2005, respectively.

(3)Excludes $659 commercial loans held for sale at March 31, 2006.

(4)Includes mobile home loans.

(5) Excludes $3,290 and $400student loans held for sale at March 31, 2006 and June 30, 2005, respectively.

(6)Includes deferred loan fees and discounts and undisbursed portion of loans inprocess.

 
| ** **                            | ** ** | **At March 31, 2006** | ** ** | **At June 30, 2005** | ** ** |
|---------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| ** **                            | ** ** | ** **                           | ** ** | **Percent of**                 | ** ** | ** ** | ** ** | **Percent of** | ** ** |
| ** **                            | ** ** | ** **                           | ** ** | **Deposits in**                | ** ** | ** ** | ** ** | **Deposits in** | ** ** |
| ** **                            | ** ** | **Amount**                           | ** ** | **Each Category**              | ** ** | **Amount** | ** ** | **Each Category** | ** ** |
| ** **                            | ** ** | **(Dollars in Thousands)** | ** ** |
|                                  |       |                                 |       |                                |       |   |   |   |   |
| Noninterest bearing checking accounts |       | $                                    | 75,291     |                                | 10.68      | % | $ | 85,705 |   | 12.58 | % |
| Interest bearing accounts             |       | 54,191                               |       | 7.68                                | %          | 50,120 |   | 7.36 | % |
| Money market accounts                 |       | 227,302                              |       | 32.23                               | %          | 209,116 |   | 30.70 | % |
| Savings accounts                      |       | 44,175                               |       | 6.26                                | %          | 63,235 |   | 9.28 | % |
| Certificates of deposit               |       | 304,306                              |       | 43.15                               | %          | 273,040 |   | 40.08 | % |
| Total Deposits                        |       | $                                    | 705,265    |                                | 100.00     | % | $ | 681,216 |   | 100.00 | % |

 

18

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**Analysisof Net Interest Income**

 

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

 

*Average Balances, Interest Rates and Yields.*Thefollowing table presents for the periods indicated, the total dollar amount ofinterest income from average interest-earning assets and the resulting yields,as well as the interest expense on average interest-bearing liabilities,expressed both in dollars and rates, and the net interest margin. The tabledoes not reflect any effect of income taxes. Average balances consist of dailyaverage balances for the Bank with simple average balances for all othercompanies. The average balances include nonaccruing loans and leases. Theyields on loans and leases include origination fees, net of costs, which areconsidered adjustments to yield.

 
| ** **                                     | ** ** | **THREE MONTHS ENDED MARCH 31,**  | ** ** |
|------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                     | ** ** | **2006**                          | ** ** | **2005** | ** ** |
| ** **                                     | ** ** | **Average  Outstanding  Balance** | ** ** | **Interest  Earned/  Paid** | ** ** | **Yield/  Rate** | ** ** | **Average  Outstanding  Balance** | ** ** | **Interest  Earned/  Paid** | ** ** | **Yield/  Rate** | ** ** |
| ** **                                     | ** ** | **(Dollars in Thousands)**        | ** ** |
| Interest-earning  assets:                      |       |                              |       |   |   |   |   |   |   |   |   |   |   |
| Loans and leases receivable (1) (3)            |       | $                                 | 701,325    |   | $ | 11,829 |   | 6.84 | % | $ | 652,245 |   | $ | 9,882 |   | 6.14 | % |
| Investment securities (2) (3)                  |       | 147,910                           |       | 1,589 |   | 4.36 | % | 118,375 |   | 1,059 |   | 3.63 | % |
| FHLB stock                                     |       | 6,334                             |       | 48 |   | 3.07 | % | 5,633 |   | 49 |   | 3.53 | % |
|                                           |       |                              |       |   |   |   |   |   |   |   |   |   |   |
| Total  interest-earning assets                 |       | 855,569                           |       | $ | 13,466 |   | 6.38 | % | 776,253 |   | $ | 10,990 |   | 5.74 | % |
| Noninterest-earning assets                     |       | 68,562                            |       |   |   |   |   | 63,507 |   |   |   |   |   |
| Total assets                                   |       | $                                 | 924,131    |   |   |   |   |   | $ | 839,760 |   |   |   |   |   |
|                                           |       |                              |       |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:                 |       |                              |       |   |   |   |   |   |   |   |   |   |   |
| Deposits:                                      |       |                              |       |   |   |   |   |   |   |   |   |   |   |
| Checking and money market                      |       | $                                 | 274,445    |   | $ | 2,111 |   | 3.12 | % | $ | 263,712 |   | $ | 1,330 |   | 2.05 | % |
| Savings                                        |       | 53,818                            |       | 320 |   | 2.41 | % | 51,321 |   | 173 |   | 1.37 | % |
| Certificates of deposit                        |       | 306,466                           |       | 2,808 |   | 3.72 | % | 254,828 |   | 1,756 |   | 2.79 | % |
| Total interest-bearing deposits                |       | 634,729                           |       | 5,239 |   | 3.35 | % | 569,861 |   | 3,259 |   | 2.32 | % |
| FHLB  advances and other borrowings            |       | 111,937                           |       | 1,274 |   | 4.62 | % | 97,509 |   | 1,016 |   | 4.23 | % |
| Subordinated  debentures payable to trusts     |       | 27,837                            |       | 571 |   | 8.32 | % | 27,837 |   | 433 |   | 6.31 | % |
|                                           |       |                              |       |   |   |   |   |   |   |   |   |   |   |
| Total  interest-bearing liabilities            |       | 774,503                           |       | 7,084 |   | 3.71 | % | 695,207 |   | 4,708 |   | 2.75 | % |
| Noninterest-bearing deposits                   |       | 74,359                            |       |   |   |   |   | 72,900 |   |   |   |   |   |
| Other liabilities                              |       | 19,907                            |       |   |   |   |   | 17,438 |   |   |   |   |   |
| Total  liabilities                             |       | 868,769                           |       |   |   |   |   | 785,545 |   |   |   |   |   |
| Equity                                         |       | 55,362                            |       |   |   |   |   | 54,215 |   |   |   |   |   |
| Total  liabilities and equity                  |       | $                                 | 924,131    |   |   |   |   |   | $ | 839,760 |   |   |   |   |   |
|                                           |       |                              |       |   |   |   |   |   |   |   |   |   |   |
| Net interest  income; interest rate spread (4) |       |                              |       | $ | 6,382 |   | 2.67 | % |   |   | $ | 6,282 |   | 2.99 | % |
|                                           |       |                              |       |   |   |   |   |   |   |   |   |   |   |
| Net interest  margin (4) (5)                   |       |                              |       |   |   | 3.03 | % |   |   |   |   | 3.28 | % |
|                                           |       |                              |       |   |   |   |   |   |   |   |   |   |   |
| Net interest  margin, TE (6)                   |       |                              |       |   |   | 3.06 | % |   |   |   |   | 3.32 | % |

 

----

(1)Includes loan fees and interest on accruing loans and leases past due 90 daysor more.

(2)Includes federal funds sold.

(3)Yields do not reflect the tax-exempt nature of loans, equipment leases andmunicipal securities.

(4)Percentages for the three months ended March 31, 2006 and March 31, 2005 havebeen annualized.

(5)Net interest margin is net interest income divided by average interest-earningassets.

(6)Net interest margin expressed on a fully taxable equivalent basis.

 

19

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| ** **                                     | ** ** | **NINE MONTHS ENDED MARCH 31,**   | ** ** |
|------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                     | ** ** | **2006**                          | ** ** | **2005** | ** ** |
| ** **                                     | ** ** | **Average  Outstanding  Balance** | ** ** | **Interest  Earned/  Paid** | ** ** | **Yield/  Rate** | ** ** | **Average  Outstanding  Balance** | ** ** | **Interest  Earned/  Paid** | ** ** | **Yield/  Rate** | ** ** |
| ** **                                     | ** ** | **(Dollars in Thousands)**        | ** ** |
| Interest-earning  assets:                      |       |                              |       |   |   |   |   |   |   |   |   |   |   |
| Loans and leases receivable (1) (3)            |       | $                                 | 692,707    |   | $ | 34,543 |   | 6.64 | % | $ | 662,446 |   | $ | 29,820 |   | 6.00 | % |
| Investment securities (2) (3)                  |       | 147,542                           |       | 4,423 |   | 3.99 | % | 116,137 |   | 2,976 |   | 3.41 | % |
| FHLB stock                                     |       | 6,866                             |       | 115 |   | 2.23 | % | 6,029 |   | 133 |   | 2.94 | % |
|                                           |       |                              |       |   |   |   |   |   |   |   |   |   |   |
| Total  interest-earning assets                 |       | 847,115                           |       | $ | 39,081 |   | 6.15 | % | 784,612 |   | $ | 32,929 |   | 5.59 | % |
| Noninterest-earning assets                     |       | 69,433                            |       |   |   |   |   | 64,808 |   |   |   |   |   |
| Total assets                                   |       | $                                 | 916,548    |   |   |   |   |   | $ | 849,420 |   |   |   |   |   |
|                                           |       |                              |       |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:                 |       |                              |       |   |   |   |   |   |   |   |   |   |   |
| Deposits:                                      |       |                              |       |   |   |   |   |   |   |   |   |   |   |
| Checking and money market                      |       | $                                 | 271,898    |   | $ | 5,885 |   | 2.88 | % | $ | 262,884 |   | $ | 3,302 |   | 1.67 | % |
| Savings                                        |       | 51,325                            |       | 817 |   | 2.12 | % | 49,095 |   | 390 |   | 1.06 | % |
| Certificates of deposit                        |       | 293,528                           |       | 7,626 |   | 3.46 | % | 259,397 |   | 5,279 |   | 2.71 | % |
| Total interest-bearing deposits                |       | 616,751                           |       | 14,328 |   | 3.09 | % | 571,376 |   | 8,971 |   | 2.09 | % |
| FHLB  advances and other borrowings            |       | 121,392                           |       | 4,017 |   | 4.41 | % | 106,422 |   | 3,124 |   | 3.91 | % |
| Subordinated  debentures payable to trusts     |       | 27,837                            |       | 1,626 |   | 7.78 | % | 27,837 |   | 1,208 |   | 5.78 | % |
| Total  interest-bearing liabilities            |       | 765,980                           |       | 19,971 |   | 3.47 | % | 705,635 |   | 13,303 |   | 2.51 | % |
| Noninterest-bearing deposits                   |       | 76,791                            |       |   |   |   |   | 73,145 |   |   |   |   |   |
| Other liabilities                              |       | 19,278                            |       |   |   |   |   | 17,272 |   |   |   |   |   |
| Total  liabilities                             |       | 862,049                           |       |   |   |   |   | 796,052 |   |   |   |   |   |
| Equity                                         |       | 54,499                            |       |   |   |   |   | 53,368 |   |   |   |   |   |
| Total  liabilities and equity                  |       | $                                 | 916,548    |   |   |   |   |   | $ | 849,420 |   |   |   |   |   |
|                                           |       |                              |       |   |   |   |   |   |   |   |   |   |   |
| Net interest  income; interest rate spread (4) |       |                              |       | $ | 19,110 |   | 2.68 | % |   |   | $ | 19,626 |   | 3.08 | % |
|                                           |       |                              |       |   |   |   |   |   |   |   |   |   |   |
| Net interest  margin (4) (5)                   |       |                              |       |   |   | 3.01 | % |   |   |   |   | 3.33 | % |
|                                           |       |                              |       |   |   |   |   |   |   |   |   |   |   |
| Net interest  margin, TE (6)                   |       |                              |       |   |   | 3.04 | % |   |   |   |   | 3.36 | % |

 

----

(1)Includes loan fees and interest on accruing loans and leases past due 90 daysor more.

(2)Includes federal funds sold.

(3)Yields do not reflect the tax-exempt nature of loans, equipment leases andmunicipal securities.

(4)Percentages for the nine months ended March 31, 2006 and March 31, 2005 havebeen annualized.

(5)Net interest margin is net interest income divided by average interest-earningassets.

(6)Net interest margin expressed on a fully taxable equivalent basis.

 

20

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**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 between the increases and decreases due tofluctuating outstanding balances that are due to the levels and volatility ofinterest rates. For each category of interest-earning assets andinterest-bearing liabilities, information is provided on changes attributableto (i) changes in volume (i.e., changes in volume multiplied by old rate) and(ii) changes in rate (i.e., changes in rate multiplied by old volume). Forpurposes of this table, changes attributable to both rate and volume, whichcannot be segregated, have been allocated proportionately to the change due tovolume and the change due to rate.

 
| ** **                                 | ** ** | **Three Months Ended March 31,** | ** ** | **Nine Months Ended March 31,**        | ** ** |
|--------------------------------------------|------------|----------------------------------|------------|----------------------------------------|------------|
| ** **                                 | ** ** | **2006 vs 2005**                 | ** ** | **2006 vs 2005**                       | ** ** |
| ** **                                 | ** ** | **Increase  Due to  Volume**     | ** ** | **Increase  (Decrease)  Due to  Rate** | ** ** | **Total  Increase  (Decrease)** | ** ** | **Increase  Due to  Volume** | ** ** | **Increase  (Decrease)  Due to  Rate** | ** ** | **Total  Increase  (Decrease)** | ** ** |
| ** **                                 | ** ** | **(Dollars in Thousands)**       | ** ** |
| Interest-earning  assets:                  |       |                             |       |                                   |       |   |   |   |   |   |   |   |   |
| Loans and leases receivable (1)            |       | $                                | 744        |                                   | $          | 1,203 |   | $ | 1,947 |   | $ | 1,362 |   | $ | 3,361 |   | $ | 4,723 |   |
| Investment securities (2)                  |       | 264                              |       | 266                                    |       | 530 |   | 805 |   | 642 |   | 1,447 |   |
| FHLB stock                                 |       | 6                                |       | (7                                     | )          | (1 | ) | 18 |   | (36 | ) | (18 | ) |
|                                       |       |                             |       |                                   |       |   |   |   |   |   |   |   |   |
| Total  interest-earning assets             |       | $                                | 1,014      |                                   | $          | 1,462 |   | $ | 2,476 |   | $ | 2,185 |   | $ | 3,967 |   | $ | 6,152 |   |
|                                       |       |                             |       |                                   |       |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:             |       |                             |       |                                   |       |   |   |   |   |   |   |   |   |
| Deposits:                                  |       |                             |       |                                   |       |   |   |   |   |   |   |   |   |
| Checking and money market                  |       | $                                | 54         |                                   | $          | 727 |   | $ | 781 |   | $ | 113 |   | $ | 2,470 |   | $ | 2,583 |   |
| Savings                                    |       | 8                                |       | 139                                    |       | 147 |   | 18 |   | 409 |   | 427 |   |
| Certificates of deposit                    |       | 356                              |       | 696                                    |       | 1,052 |   | 695 |   | 1,652 |   | 2,347 |   |
| Total interest-bearing deposits            |       | 418                              |       | 1,562                                  |       | 1,980 |   | 826 |   | 4,531 |   | 5,357 |   |
| FHLB  advances and other borrowings        |       | 150                              |       | 108                                    |       | 258 |   | 439 |   | 454 |   | 893 |   |
| Subordinated  debentures payable to trusts |       | —                           |       | 138                                    |       | 138 |   | — |   | 418 |   | 418 |   |
|                                       |       |                             |       |                                   |       |   |   |   |   |   |   |   |   |
| Total  interest-bearing liabilities        |       | $                                | 568        |                                   | $          | 1,808 |   | $ | 2,376 |   | $ | 1,265 |   | $ | 5,403 |   | $ | 6,668 |   |
|                                       |       |                             |       |                                   |       |   |   |   |   |   |   |   |   |
| Net interest  income (decrease)            |       |                             |       |                                   |       | $ | 100 |   |   |   |   |   | $ | (516 | ) |

 

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(1)Includes loan fees and interest on accruing loans and leases past due 90 daysor more.

(2)Includes federal funds sold.

 

21

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**Applicationof Critical Accounting Policies**

 

GAAP requires management toutilize estimates when reporting financial results. The Company has identifiedthe policies discussed below as Critical Accounting Policies because theaccounting estimates require management to make certain assumptions aboutmatters that may be uncertain at the time the estimate was made and a differentmethod of estimating could have been reasonably made that could have a materialimpact on the presentation of the Company’s financial condition, changes infinancial condition or results of operations.

 

*Allowancefor Loan and Lease Losses* – GAAP requires the Company to set aside reserves or maintain anallowance against probable loan and lease losses in the loan and leaseportfolio. Management must develop a consistent and systematic approach toestimate the appropriate balances that will cover the probable losses. Due tothe uncertainty of future events, the approach includes a process that maydiffer significantly from other methodologies and still produce an estimatethat is in accordance with GAAP.

 

The allowanceis compiled by utilizing the Company’s loan and lease risk rating system, whichis structured to identify weaknesses in the loan and lease portfolio. The riskrating system has evolved to a process whereby management believes the systemwill properly identify the credit risk associated with the loan and leaseportfolio. Due to the stratification of loans and leases for the allowancecalculation, the estimate of the allowance for loan and lease losses couldchange materially if the loan and lease risk rating system would not properlyidentify the strength of a large or a few large loan and lease customers.Although management believes that it uses the best information available todetermine the allowance, unforeseen market or borrower conditions could resultin adjustments and net earnings being significantly affected if circumstancesdiffer substantially from the assumptions used in making the finaldeterminations.

 

*Mortgage Servicing Rights (“MSR”)* – TheCompany records a servicing asset for contractually separated servicing fromthe underlying mortgage loans. The asset is initially recorded at fair valueand represents an intangible asset backed by an income stream from the servicedassets. The asset is amortized in proportion to and over the period ofestimated net servicing income.

 

At eachbalance sheet date, the MSRs are analyzed for impairment, which occurs when thefair value of the MSRs is lower than the amortized book value. The Company’sMSRs are primarily servicing rights acquired on South Dakota HousingDevelopment Authority first time home buyers program. Due to the lack of quotedmarkets for the Company’s servicing portfolio, the Company estimates the fairvalue of the MSRs using present value of future cash flow analysis. If theanalysis produces a fair value that is greater than or equal to the amortizedbook value of the MSRs, no impairment is recognized. If the fair value is lessthan the book value, an expense for the difference is charged to earnings byinitiating a MSR valuation account. If the Company determines this impairmentis temporary, any future changes in fair value are recorded as a change inearnings and the valuation. If the Company determines the impairment to bepermanent, the valuation is written off against the MSRs, which results in anew amortized balance.

 

Due to thesubstantial decline in interest rates over the last several fiscal years, theCompany has included MSRs as a critical accounting policy because the use ofestimates for determining fair value using present value concepts may produceresults which may significantly differ from other fair value analysis perhapseven to the point of recording impairment. The risk to earnings is when theunderlying mortgages payoff significantly faster than the assumptions used inthe previously recorded amortization. Estimating future cash flows on theunderlying mortgages is a difficult analysis and requires judgment based on thebest information available. The Company looks at alternative assumptions andprojections when preparing a reasonable and supportable analysis. Based on the Company’squarterly analysis of MSRs, there was no impairment to the MSRs at March 31,2006.

 

*Retained Interest from Securitization* –The Company recorded an asset as a result of the automobile securitization. SeeNote 4 of the “Notes to Unaudited Consolidated Financial Statements” which isincluded

 

22

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in Part I,Item I “Financial Statements” of this Quarterly Report on Form 10-Q. This assetwas recorded based on present value concepts of future expected cash flows. Theassumptions used to calculate the initial retained interest value andsubsequent assumptions were based on the best information available. OnNovember 9, 2005, the Bank exercised its option to execute a cleanup call bypurchasing the outstanding principal balances of the securitized motor vehicleinstallment loans.

 

*Self-Insurance*- The Company has aself-insured health plan for its employees up to certain limits. To mitigate aportion of these risks, the Company has a stop-loss insurance policy through acommercial insurance carrier for coverage in excess of $65,000 per individualoccurrence with a maximum aggregate limitation of $2.0 million. The estimate ofself-insurance liability is based upon known claims and an estimate ofincurred, but not reported (“IBNR”) claims. IBNR claims are estimated usinghistorical claims lag information received by a third party claimsadministrator. Due to the uncertainty of health claims, the approach includes aprocess that may differ significantly from other methodologies and stillproduce an estimate that is in accordance with GAAP. Although managementbelieves that it uses the best information available to determine the accrual,unforeseen health claims could result in adjustments to the accrual. These adjustmentscould significantly affect net earnings if circumstances differ substantiallyfrom the assumptions used in estimating the accrual.

 

**AssetQuality and Potential Problem Loans and Leases**

 

Nonperformingassets (nonaccrual loans and leases, accruing loans and leases delinquent morethan 90 days and foreclosed assets) decreased to $4.7 million at March 31, 2006from $7.0 million at June 30, 2005, a decrease of $2.3 million, or 32.5%.Nonaccruing loans and leases decreased $3.5 million to $1.8 million at March31, 2006 from $5.3 million at June 30, 2005. In addition, the ratio ofnonperforming assets to total assets, which is one indicator of credit riskexposure, decreased to 0.51% at March 31, 2006 from 0.78% at June 30, 2005.

 

Nonaccruingloans and leases decreased 65.3%, or $3.5 million, to $1.8 million at March 31,2006 compared to $5.3 million at June 30, 2005. Included in nonaccruing loansand leases at March 31, 2006 were two loans totaling $371,000 secured by one-to four-family real estate, eight loans totaling $846,000 secured by commercialbusiness, one lease totaling $116,000, 32 consumer loans totaling $391,000 andone agriculture loan totaling $125,000.

 

The riskrating system in place is designed to identify and manage the nonperformingloans and leases. Commercial and agricultural loans and equipment financeleases will have specific reserve allocations based on collateral values orbased on the present value of expected cash flows if the loans and leases aredeemed impaired. Loans and leases that are not performing do not necessarilyresult in a loss.

 

As of March31, 2006, the Company had $126,000 of foreclosed assets. The balance offoreclosed assets at March 31, 2006 consisted of $1,000 of single-familycollateral owned and $125,000 of consumer collateral owned.

 

At March 31,2006, the Company had designated $9.8 million of its assets as special mentionand classified $6.1 million of its assets that management has determined needto be closely monitored because of possible credit problems of the borrowers orthe cash flows of the secured properties. At March 31, 2006 the Company had$10.0 million in multi-family, commercial business, commercial real estate andagricultural participation loans purchased, of which $679,000 were classifiedas of March 31, 2006. These loans and leases were considered in determining theadequacy of the allowance for loan and lease losses. The allowance for loan andlease losses is established based on management’s evaluation of the risksprobable in the loan and lease portfolio and changes in the nature and volumeof loan and lease activity. Such evaluation, which includes a review of allloans and leases for which full collectibility may not be reasonably assured,considers the estimated fair market value of the underlying collateral, presentvalue of expected principal and interest payments, economic conditions,historical loss experience and other factors that warrant recognition inproviding for an adequate loan and lease loss allowance.

 

23

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Although the Company’smanagement believes that the March 31, 2006 recorded allowance for loan andlease losses was adequate to provide for probable losses on the related loansand leases, there can be no assurance that the allowance existing at March 31,2006 will be adequate in the future.

 

In accordance with theCompany’s internal classification of assets policy, management evaluates theloan and lease portfolio on a monthly basis to identify loss potential anddetermines the adequacy of the allowance for loan and lease losses quarterly.Loans and leases are placed on nonaccrual status when the collection ofprincipal and/or interest become doubtful. Foreclosed assets include assetsacquired in settlement of loans. The following table sets forth the amounts andcategories of the Company’s nonperforming assets for the periods indicated.

 
| ** **                                                                 | ** ** | **Nonperforming Assets As Of** | ** ** |
|----------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                 | ** ** | **March 31,  2006**            | ** ** | **June 30,  2005** | ** ** |
| ** **                                                                 | ** ** | **(Dollars in Thousands)**     | ** ** |
| Nonaccruing  loans and leases:                                             |       |                           |       |   |   |
| One- to four-family                                                        |       | $                              | 371        |   | $ | 263 |   |
| Commercial real estate                                                     |       | —                         |       | 70 |   |
| Commercial business                                                        |       | 846                            |       | 4,518 |   |
| Equipment finance leases                                                   |       | 116                            |       | 130 |   |
| Consumer (1)                                                               |       | 391                            |       | 341 |   |
| Agricultural                                                               |       | 125                            |       | — |   |
| Total                                                                      |       | 1,849                          |       | 5,322 |   |
|                                                                       |       |                           |       |   |   |
| Accruing  loans and leases delinquent more than 90 days:                   |       |                           |       |   |   |
| One- to four-family                                                        |       | 543                            |       | 98 |   |
| Commercial real estate                                                     |       | 25                             |       | 292 |   |
| Commercial business                                                        |       | 859                            |       | 1,052 |   |
| Equipment finance leases                                                   |       | 707                            |       | 71 |   |
| Consumer (1)                                                               |       | 2                              |       | — |   |
| Agricultural                                                               |       | 626                            |       | 96 |   |
| Total                                                                      |       | 2,762                          |       | 1,609 |   |
|                                                                       |       |                           |       |   |   |
| Foreclosed  assets: (2)                                                    |       |                           |       |   |   |
| One- to four-family                                                        |       | 1                              |       | 39 |   |
| Equipment finance leases                                                   |       | —                         |       | — |   |
| Consumer (1)                                                               |       | 125                            |       | 50 |   |
| Total                                                                      |       | 126                            |       | 89 |   |
|                                                                       |       |                           |       |   |   |
| Total  nonperforming assets                                                |       | $                              | 4,737      |   | $ | 7,020 |   |
|                                                                       |       |                           |       |   |   |
| Ratio of  nonperforming assets to total assets                             |       | 0.51                           | %          | 0.78 | % |
|                                                                       |       |                           |       |   |   |
| Ratio of  nonperforming loans and leases to total loans and leases (3) (4) |       | 0.65                           | %          | 1.01 | % |

 

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(1)Includes mobile home loans.

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

(3) Nonperforming loans andleases include both nonaccruing and accruing loans and leases delinquent morethan 90 days.

(4)Total loans and leases include loans held for sale.

 

24

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The following table setsforth information with respect to activity in the Company’s allowance for loanand lease losses during the periods indicated.

 
| ** **                                                                                              | ** ** | **Nine Months Ended March 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                              | ** ** | **2006**                        | ** ** | **2005** | ** ** |
| ** **                                                                                              | ** ** | **(Dollars in Thousands)**      | ** ** |
|                                                                                                    |       |                            |       |   |   |
| Balance at  beginning of period                                                                         |       | $                               | 5,076      |   | $ | 3,605 |   |
| Charge-offs:                                                                                            |       |                            |       |   |   |
| One- to four-family                                                                                     |       | (1                              | )          | — |   |
| Commercial real estate                                                                                  |       | —                          |       | (31 | ) |
| Commercial business                                                                                     |       | (3,290                          | )          | (179 | ) |
| Equipment finance leases                                                                                |       | (17                             | )          | (11 | ) |
| Consumer (1)                                                                                            |       | (764                            | )          | (822 | ) |
| Agriculture                                                                                             |       | (377                            | )          | (14 | ) |
| Total charge-offs                                                                                       |       | (4,449                          | )          | (1,057 | ) |
|                                                                                                    |       |                            |       |   |   |
| Recoveries:                                                                                             |       |                            |       |   |   |
| One- to four-family                                                                                     |       | 1                               |       | 8 |   |
| Commercial real estate                                                                                  |       | —                          |       | — |   |
| Commercial business                                                                                     |       | 14                              |       | 30 |   |
| Equipment finance leases                                                                                |       | 40                              |       | 1 |   |
| Consumer (1)                                                                                            |       | 177                             |       | 170 |   |
| Agriculture                                                                                             |       | —                          |       | 78 |   |
| Total recoveries                                                                                        |       | 232                             |       | 287 |   |
|                                                                                                    |       |                            |       |   |   |
| Net (charge-offs)                                                                                       |       | (4,217                          | )          | (770 | ) |
|                                                                                                    |       |                            |       |   |   |
| Additions  charged to operations                                                                        |       | 4,510                           |       | 504 |   |
|                                                                                                    |       |                            |       |   |   |
| Balance at  end of period                                                                               |       | $                               | 5,369      |   | $ | 3,339 |   |
|                                                                                                    |       |                            |       |   |   |
| Ratio of net (charge-offs) during the  period to average loans and leases outstanding during the period |       | (0.61                           | )%         | (0.12 | )% |
|                                                                                                    |       |                            |       |   |   |
| Ratio of  allowance for loan and lease losses to total loans and leases at end of  period (2)           |       | 0.76                            | %          | 0.51 | % |
|                                                                                                    |       |                            |       |   |   |
| Ratio of allowance for loan and lease  losses to nonperforming loans and leases at end of  period (3)   |       | 116.44                          | %          | 137.35 | % |
|                                                                                                         |            |                                 |            |  |  |  |  |  |

 

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(1)Includes mobile home loans.

(2)Total loans and leases include loans held for sale.

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

 

25

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Thedistribution of the Company’s allowance for loan and lease losses and impairedloss summary as required by FASB Statement No. 114, “Accounting by Creditorsfor Impairment of a Loan” are summarized in the following tables. Thecombination of FASB Statement No. 5 “Accounting for Contingencies” and FASBStatement No. 114 calculations comprise the Company’s allowance for loan andlease losses.

 
| ** **                | ** ** | **FASB 5  Allowance  for Loan and  Lease Losses** | ** ** | **FASB 114  Impaired Loan  Valuation  Allowance** | ** ** | **FASB 5  Allowance  for Loan and  Lease Losses** | ** ** | **FASB 114  Impaired Loan  Valuation  Allowance** | ** ** |
|---------------------------|------------|---------------------------------------------------|------------|---------------------------------------------------|------------|---------------------------------------------------|------------|---------------------------------------------------|------------|
| **Loan Type**             | ** ** | **At March 31, 2006**                             | ** ** | **At June 30, 2005**                              | ** ** |
| ** **                | ** ** | **(Dollars in Thousands)**                        | ** ** |
|                      |       |                                              |       |                                              |       |                                              |       |                                              |       |
| One- to  four-family      |       | $                                                 | 191        |                                              | $          | —                                            |       | $                                                 | 186        |   | $ | — |   |
| Commercial  real estate   |       | 291                                               |       | —                                            |       | 200                                               |       | —                                            |       |
| Multi-family  real estate |       | 75                                                |       | —                                            |       | 61                                                |       | —                                            |       |
| Commercial  business      |       | 2,324                                             |       | —                                            |       | 844                                               |       | 1,750                                             |       |
| Equipment  finance leases |       | 603                                               |       | —                                            |       | 359                                               |       | —                                            |       |
| Consumer (1)              |       | 1,467                                             |       | —                                            |       | 1,343                                             |       | —                                            |       |
| Agricultural              |       | 418                                               |       | —                                            |       | 333                                               |       | —                                            |       |
| Total                     |       | $                                                 | 5,369      |                                              | $          | —                                            |       | $                                                 | 3,326      |   | $ | 1,750 |   |

 

----

(1)Includes mobile home loans.

 

**FASB 114 Impaired Loan Summary**

 
| ** **           | ** ** | **Number  of Loan  Customers** | ** ** | **Loan  Balance**          | ** ** | **Impaired  Loan  Valuation  Allowance** | ** ** | **Number  of Loan  Customers** | ** ** | **Loan  Balance** | ** ** | **Impaired  Loan  Valuation  Allowance** | ** ** |
|----------------------|------------|--------------------------------|------------|----------------------------|------------|------------------------------------------|------------|--------------------------------|------------|-------------------|------------|------------------------------------------|------------|
| **Loan Type**        | ** ** | **At March 31, 2006**          | ** ** | **At June 30, 2005**       | ** ** |
| ** **           | ** ** | **(Dollars in Thousands)**     | ** ** | **(Dollars in Thousands)** | ** ** |
| Commercial  business |       | 8                              |       | $                          | 830        |                                     | $          | —                         |       | 4                 |       | $                                        | 4,152      |   | $ | 1,750 |   |
| Agricultural         |       | 1                              |       | 125                        |       | —                                   |       | —                         |       | —            |       | —                                   |       |
| Total                |       | 9                              |       | $                          | 955        |                                     | $          | —                         |       | 4                 |       | $                                        | 4,152      |   | $ | 1,750 |   |

 

26

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The allowancefor loan and lease losses was $5.4 million at March 31, 2006 as compared to$3.3 million at March 31, 2005. The ratio of the allowance for loan and leaselosses to total loans and leases was 0.76% at March 31, 2006 compared to 0.51%at March 31, 2005. The Company’s management has considered nonperforming loansand leases and potential problem loans and leases in establishing the allowancefor loan and lease losses. The Company continues to monitor its allowance forprobable loan and lease losses and make future additions or reductions in lightof the level of loans and leases in its portfolio and as economic conditionsdictate. The current level of the allowance for loan and lease losses isa result of management’s assessment of the risks within the portfolio based onthe information 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 is performed on all types of loans and leasesto establish the necessary reserve based on the estimated risk within theportfolio. This assessment of risk takes into account the composition of theloan and lease portfolio, historical loss experience for each loan and leasecategory, previous loan and lease experience, concentrations of credit, currenteconomic conditions and other factors that in management’s judgment deserverecognition.

 

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

 

Althoughmanagement believes that it uses the best information available to determinethe allowances, unforeseen market conditions could result in adjustments andnet earnings being significantly affected if circumstances differ substantiallyfrom the assumptions used in making the final determinations. Future additionsto the Company’s allowances result from periodic loan, property and collateralreviews and thus cannot be predicted in advance.

 

27

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**Comparisonof the Three Months Ended March 31, 2006 and March 31, 2005**

 

*General*. The Company’s net income was $1.3 million,or $0.32 for basic and $0.31 for diluted earnings per share for the threemonths ended March 31, 2006, a $94,000 decrease in earnings compared to $1.3million, or $0.35 for basic and $0.33 for diluted earnings per share for thesame period in the prior fiscal year. For the three months ended March 31,2006, the return on average equity was 9.03%, a 9.0% decrease compared to 9.92%for the same period in the prior fiscal year. For the three months ended March31, 2006, the return on average assets was 0.54%, a 15.6% decrease compared to0.64% for the same period in the prior fiscal year. As discussed in more detailbelow, the decreases were due to a variety of key factors, including a decreasein noninterest income of $49,000 and increases in provision for losses on loansand leases of $289,000 and noninterest expense of $122,000 offset by anincrease in net interest income of $100,000.

 

*Interest,Dividend and Loan Fee Income.*Interest, dividend and loan fee income was $13.5 million for the threemonths ended March 31, 2006 as compared to $11.0 million for the same period inthe prior fiscal year, an increase of $2.5 million or 22.5%. A $1.2 millionincrease in interest, dividend and loan fee income was the result of anincrease in the average yield on loans and leases receivable from 6.14% for thethree months ended March 31, 2005 to 6.84% for the three months ended March 31,2006 and a $744,000 increase in interest, dividend and loan fee income was dueto a 7.5% increase in the average volume of loans and leases receivable. Theaverage yield on total interest-earning assets was 6.38% for the three monthsended March 31, 2006 as compared to 5.74% for the same period in the priorfiscal year.

 

*Interest Expense.*Interest expense was $7.1million for the three months ended March 31, 2006 as compared to $4.7 millionfor the same period in the prior fiscal year, an increase of $2.4 million or50.5%. A $1.6 million increase in interest expense was the result of anincrease in average rate paid on interest-bearing deposits from 2.32% for thethree months ended March 31, 2005 to 3.35% for the three months ended March 31,2006. A $150,000 increase in interest expense was the result of a 14.8%increase in the average balance of FHLB advances and other borrowings and a$108,000 increase in interest expense was a result of the average rate paid onFHLB advances and other borrowings increasing from 4.23% for the three monthsended March 31, 2005 to 4.62% for the three months ended March 31, 2006. Anincrease of $1.8 million in interest expense was the result of an increase inthe average rate paid on total interest-bearing liabilities from 2.75% for thethree months ended March 31, 2005 to 3.71% for the three months ended March 31,2006.

 

*Net Interest Income.* The Company’s netinterest income for the three months ended March 31, 2006 increased $100,000,or 1.6%, to $6.4 million compared to $6.3 million for the same period in theprior fiscal year. The increase in net interest income was due primarily toincreases in the average yield on interest-earning assets and in the averagebalance of interest-earning assets for the three months ended March 31, 2006compared to the same period in the prior fiscal year offset by an increase inthe average rate paid on interest-bearing liabilities for the three monthsended March 31, 2006 compared to the same period in the prior fiscal year. TheCompany’s net interest margin was 3.03% for the third quarter of Fiscal 2006 ascompared to 3.28% for the same period in the prior fiscal year.

 

*Provision for Losses on Loans and Leases.*Theallowance for loan and lease losses is maintained at a level which isconsidered by management to be adequate to absorb probable losses on existingloans and leases that may become uncollectible, based on an evaluation of thecollectibility of loans and leases and prior loan and lease loss experience.The evaluation takes into consideration such factors as changes in the natureand volume of the loan and lease portfolio, overall portfolio quality, reviewof specific problem loans and leases, and current economic conditions that mayaffect the borrower’s ability to pay. The allowance for loan and lease lossesis established through a provision for losses on loans and leases charged toexpense.

 

28

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During the threemonths ended March 31, 2006, the Company recorded a provision for losses onloans and leases of $418,000 compared to $129,000 for the three months endedMarch 31, 2005, an increase of $289,000. See “Asset Quality” for furtherdiscussion.

 

*Noninterest Income.*Noninterest income was$2.1 million for the three months ended March 31, 2006 as compared to $2.1million for the same period in the prior fiscal year, a decrease of $49,000, or2.3%. The decrease in noninterest income was primarily due to a decrease inloan servicing income of $190,000 offset by increases in gain on sale of loansof $73,000, trust income of $35,000 and fees on deposits of $21,000.

 

Loan servicingincome decreased $190,000 from $351,000 for the three months ended March 31,2005 to $184,000 for the three months ended March 31, 2006 primarily due to adecrease in the number of loans serviced by the Bank.

 

Trust income increased$35,000 primarily due to assets under management increasing from $93.7 millionat March 31, 2005 to $110.7 million at March 31, 2006.

 

Fees on deposits increased$21,000 primarily due to an increase in fees collected on point-of-salepurchases by customers. The remaining increase in fees on deposits is comprisedof various other deposit fee income.

 

*Noninterest Expense.*Noninterest expense was$6.4 million for the three months ended March 31, 2006 as compared to $6.3million for the three months ended March 31, 2005, an increase of $122,000, or1.94%. The increase in noninterest expense was primarily due to increases incompensation and employee benefits of $120,000 and occupancy and equipment of$95,000 offset by a decrease in other noninterest expense of $93,000.

 

Compensationand employee benefits increased $120,000, or 3.1%, to $4.0 million for thethree months ended March 31, 2006 as compared to $3.9 million for the threemonths ended March 31, 2005. Net healthcare costs, inclusive of health claimsand administration fees offset by stop loss and employee reimbursement underthe Company’s self-insured health plan were $382,000 for the three months endedMarch 31, 2006, an increase of $3,000 compared to the same period in the priorfiscal year. The remainder of the increase in compensation and employeebenefits was primarily due to merit increases, bonuses and additional staffingover the prior year.

 

Occupancy andequipment expense increased $95,000 for the three months ended March 31, 2006compared to the same period in the prior fiscal year primarily due to increasesin depreciation expense of $37,000, utilities expense of $23,000 and rentexpense of  $19,000.

 

Othernoninterest expense decreased $93,000 for the three months ended March 31, 2006compared to the same period in the prior fiscal year primarily due to adecrease in advertising of $189,000 offset by increases in communitycontributions for reinvestment in the communities we serve of $47,000 and legalexpense of $44,000.

 

*Income taxexpense.*The Company’sincome tax expense for the three months ended March 31, 2006 decreased $266,000or 42.1% to $366,000 compared to $632,000 for the same period in the priorfiscal year. The effective tax rate was 22.6% and 32.0% for the three monthsended March 31, 2006 and March 31, 2005, respectively. The decrease in theeffective tax rate for the quarter was the result of an increase inpermanent tax differences primarily due to an increase in tax-exemptinterest income.

 

29

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**Comparisonof the Nine Months Ended March 31, 2006 and March 31, 2005**

 

*General*. The Company’s net income was $3.6 million,or $0.91 for basic and $0.89 for diluted earnings per share for the nine monthsended March 31, 2006, a $880,000 decrease in earnings compared to $4.5 million,or $1.14 for basic and $1.11 for diluted earnings per share for the same periodin the prior fiscal year. For the nine months ended March 31, 2006, the returnon average equity was 8.74%, a 21.4% decrease compared to 11.12% for the sameperiod in the prior fiscal year. For the nine months ended March 31, 2006, thereturn on average assets was 0.52%, a 25.7% decrease compared to 0.70% for thesame period in the prior fiscal year. As discussed in more detail below, thedecreases were due to a variety of key factors, including a decrease in netinterest income of $516,000 and increases in provision for losses on loans andleases of $4.0 million and noninterest expense of $718,000 offset by anincrease in noninterest income of $3.8 million and a decrease in income taxexpense of $572,000.

 

*Interest,Dividend and Loan Fee Income.*Interest, dividend and loan fee income was $39.1 million for the ninemonths ended March 31, 2006 as compared to $32.9 million for the same period inthe prior fiscal year, an increase of $6.2 million or 18.7%. A $3.4 millionincrease in interest, dividend and loan fee income was the result of anincrease in the average yield on loans and leases receivable from 6.00% for thenine months ended March 31, 2005 to 6.64% for the nine months ended March 31,2006 and a $1.4 million increase in interest, dividend and loan fee income wasdue to a 4.6% increase in the average volume of loans and leases receivable.The average yield on total interest-earning assets was 6.15% for the ninemonths ended March 31, 2006 as compared to 5.59% for the same period in theprior fiscal year.

 

*Interest Expense.*Interest expense was $20.0million for the nine months ended March 31, 2006 as compared to $13.3 millionfor the same period in the prior fiscal year, an increase of $6.7 million or50.1%. A $4.5 million increase in interest expense was the result of anincrease in average rate paid on interest-bearing deposits from 2.09% for thenine months ended March 31, 2005 to 3.09% for the nine months ended March 31,2006. A $454,000 increase in interest expense was a result of the average ratepaid on FHLB advances and other borrowings increasing from 3.91% for the ninemonths ended March 31, 2005 to 4.41% for the nine months ended March 31, 2006and a $439,000 increase in interest expense was the result of a 14.1% increasein the average balance of FHLB advances and other borrowings. An increase of$5.4 million in interest expense was the result of an increase in the averagerate paid on total interest-bearing liabilities from 2.51% for the nine monthsended March 31, 2005 to 3.47% for the nine months ended March 31, 2006.

 

*Net Interest Income.* The Company’s netinterest income for the nine months ended March 31, 2006 decreased $516,000, or2.6%, to $19.1 million compared to $19.6 million for the same period in theprior fiscal year. The decrease in net interest income was due primarily to anincrease in the average rate paid on interest-bearing liabilities for the ninemonths ended March 31, 2006 compared to the same period in the prior fiscalyear offset by an increase in the average yield on interest earning assets forthe nine months ended March 31, 2006 compared to the same period in the priorfiscal year. The Company’s net interest margin was 3.01% for the nine monthsended March 31, 2006 as compared to 3.33% for the same period in the priorfiscal year.

 

*Provision for Losses on Loans and Leases.*Theallowance for loan and lease losses is maintained at a level which isconsidered by management to be adequate to absorb probable losses on existingloans and leases that may become uncollectible, based on an evaluation of thecollectibility of loans and leases and prior loan and lease loss experience.The evaluation takes into consideration such factors as changes in the natureand volume of the loan and lease portfolio, overall portfolio quality, reviewof specific problem loans and leases, and current economic conditions that mayaffect the borrower’s ability to pay. The allowance for loan and lease lossesis established through a provision for losses on loans and leases charged toexpense.

 

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During thenine months ended March 31, 2006, the Company recorded a provision for losseson loans and leases of $4.5 million compared to $504,000 for the nine monthsended March 31, 2005, an increase of $4.0 million. See “Asset Quality” forfurther discussion.

 

*Noninterest Income.*Noninterest income was$10.5 million for the nine months ended March 31, 2006 as compared to $6.7million for the same period in the prior fiscal year, an increase of $3.8 millionor 56.9%. The increase in noninterest income was due primarily to a gain onsale of land of $3.6 million along with increases in fees on deposits of$120,000 and trust income of $99,000 offset by a decrease in loan servicingincome of $158,000.

 

Net gain onsale of land was $3.6 million due to the completion of a land sale transactionin the second quarter of Fiscal 2006.

 

Fees on deposits increased$120,000 primarily due to an increase in fees collected on point-of-salepurchases by customers. The remaining increase in fees on deposits is comprisedof various other deposit fee income.

 

Trust income increased$99,000 primarily due to assets under management increasing from $93.7 millionat March 31, 2005 to $110.7 million at March 31, 2006.

 

Loan servicingincome decreased $158,000 from $963,000 for the nine months ended March 31,2005 to $805,000 for the nine months ended March 31, 2006 primarily due to adecrease in the number of loans serviced by the Bank.

 

*Noninterest Expense.*Noninterest expense was$19.8 million for the nine months ended March 31, 2006 as compared to $19.1million for the nine months ended March 31, 2005. The increase in noninterestexpense was primarily due to increases in compensation and employee benefits$508,000 and occupancy and equipment of $155,000.

 

Compensationand employee benefits increased $508,000, or 4.2%, to $12.6 million for thenine months ended March 31, 2006 as compared to $12.1 million for the ninemonths ended March 31, 2005. Net healthcare costs, inclusive of health claimsand administration fees offset by stop loss and employee reimbursement underthe Company’s self-insured health plan were $1.2 million for the nine monthsended March 31, 2006, an increase of $237,000, or 24.4% compared to the sameperiod in the prior fiscal year. The remainder of the increase in compensationand employee benefits was primarily due to merit increases, bonuses andadditional staffing over the prior year.

 

Occupancy andequipment expense increased $155,000 for the nine months ended March 31, 2006compared to the same period in the prior fiscal year primarily due to increasesin depreciation expense of $66,000, utilities expense of $32,000 and rentexpense of  $30,000.

 

*Income taxexpense.*The Company’sincome tax expense for the nine months ended March 31, 2006 decreased $572,000or 25.3% to $1.7 million compared to $2.3 million for the same period in theprior fiscal year. The effective tax rate was 32.1% and 33.7% for the ninemonths ended March 31, 2006 and March 31, 2005, respectively. The decrease inthe effective tax rate was the result of an increase in permanent taxdifferences primarily due to an increase in tax-exempt interest income.

 

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**Liquidityand Capital Resources**

 

The Bank’sprimary sources of funds are earnings, in-market deposits, FHLB advances andother borrowings, repayments of loan principal, mortgage-backed securities andcallable agency securities and, to a lesser extent, sales of mortgage loans,sales and maturities of securities, out-of-market deposits and short-terminvestments. While scheduled loan payments and maturing securities arerelatively predictable, deposit flows and loan and security prepayments aremore influenced by interest rates, general economic conditions and competition.The Bank attempts to price its deposits to meet its asset/liability objectivesconsistent with local market conditions. Excess balances are invested inovernight funds.

 

Liquiditymanagement is both a daily and long-term responsibility of management. The Bankadjusts its investments in liquid assets based upon management’s assessment of(i) expected loan demand, (ii) projected loan sales, (iii) expected depositflows, (iv) yields available on interest-bearing deposits, and (v) theobjectives of its asset/liability management program. Excess liquidity isinvested generally in interest-bearing overnight deposits and other short-termgovernment and agency obligations.

 

The Bankanticipates that it will have sufficient funds available to meet current loancommitments. At March 31, 2006, the Bank had outstanding commitments tooriginate residential mortgage loans of $28.3 million, commercial real estateloans of $5.1 million and commercial business loans of $11.4 million. Inaddition, the Bank had outstanding commitments to sell residential mortgageloans of $5.3 million, commercial business loans of $659,000 and consumerstudent loans of $3.3 million. Commitments by the Bank to originate loans arenot necessarily executed by the customer. The Bank monitors the ratio ofcommitments to funding for use in liquidity management. At March 31, 2006, theBank had $383,000 commitments to purchase securities available for sale and nocommitments to sell securities available for sale.

 

Although in-market depositsare the Bank’s primary source of funds, the Bank’s policy has been to utilizeborrowings where the funds can be invested in either loans or securities at apositive rate of return or to use the funds for short-term liquidity purposes.The Bank currently has two unsecured lines of federal funds totaling $25.0million with correspondent banks. There were no funds drawn on either line ofcredit at March 31, 2006. Additionally, as of March 31, 2006, the Bank had$43.5 million in out-of-market certificates of deposit. The Bank may also seekother sources of contingent liquidity including additional federal fundspurchased lines with correspondent banks and lines of credit with the FederalReserve Bank.

 

The Company uses its capitalresources to pay dividends to its stockholders, to repurchase Company stockpursuant to Board of Directors approved plans, to support organic growth, tomake acquisitions, to service its debt obligations and to provide funding forinvestment into the Bank of Tier 1 (core) capital.

 

On March 31, 2006, theCompany had in effect a stock buyback program in which up to 10% of the commonstock of the Company outstanding on May 1, 2005 could be acquired through April30, 2006. As of March 31, 2006, a total of 47,300 shares of common stock hadbeen purchased pursuant to that program, all of which were purchased during Mayand June 2005. In addition, the Company approved a new stock buyback program inwhich up to 10% of the common stock of the Company outstanding on May 1, 2006may be acquired through April 30, 2007. See Part II, Item 2 “UnregisteredSales of Equity Securities and Use of Proceeds” of this Form 10-Q.

 

Savings institutions insuredby the Federal Deposit Insurance Corporation are required by the FinancialInstitutions Reform, Recovery and Enforcement Act of 1989 to meet threeregulatory capital requirements. If a requirement is not met, regulatoryauthorities may take legal or administrative actions, including restrictions ongrowth or operations or, in extreme cases, seizure. Institutions not incompliance may apply for an exemption from the requirements and submit arecapitalization plan. At March 31, 2006, the Bank met all current regulatorycapital requirements.

 

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The minimumOTS Tier 1 (core) capital requirement for well-capitalized institutions is5.00% of total adjusted assets for thrifts. The Bank had Tier 1 (core) capitalof 8.24% at March 31, 2006. The minimum OTS total risk-based capitalrequirement for well-capitalized institutions is 10.00% of risk-weightedassets. The Bank had total risk-based capital of 10.81% at March 31, 2006.

 

**Off-BalanceSheet Financing Arrangements**

 

During thefiscal year ended June 30, 2003, the Bank securitized and sold consumer automobileloans in the amount of $50.0 million through HFSC and Automobile SecuritizationTrust. As part of the sales transaction, the Bank retained servicingresponsibilities and a retained interest in the receivables, which issubordinated to third party investors’ interests. The receivables were soldwithout legal recourse. The sale provided the Bank with an additional source ofliquidity at interest rates more favorable than it could receive through otherforms of financing. It also assisted in reducing capital requirements andcredit risk to the Bank, in addition to giving the Bank access to the nationalcapital markets. The Company had the option to execute a cleanup call when thetotal outstanding balance was at 10% or less of the original pool balance, or$5.0 million. On November 9, 2005, the Bank exercised its option to execute acleanup call by purchasing the outstanding principal balances of thesecuritized motor vehicle installment loans. See Note 4 of the “Notes toConsolidated Financial Statements” which is included in Part I, Item 1 “FinancialStatements” of this Form 10-Q for further detail.

 

**Impactof Inflation and Changing Prices**

 

The unaudited consolidatedfinancial statements and notes thereto presented in this Quarterly Report onForm 10-Q have been prepared in accordance with GAAP, which require themeasurement of financial position and operating results in terms of historicaldollars without considering the change in the relative purchasing power ofmoney over time due to inflation. The impact of inflation is reflected in theincreased cost of the Bank’s operations. Unlike most industrial companies,nearly all the assets and liabilities of the Bank are monetary in nature. As aresult, interest rates have a greater impact on the Bank’s performance than dothe effects of general levels of inflation. Interest rates do not necessarilymove in the same direction or to the same extent as the prices of goods andservices.

 

**RecentAccounting Pronouncements**

 

In December 2004, FASBissued SFAS No. 123R, “Share-Based Payment”, which requires all companies tomeasure compensation costs for all share-based payments (including stockoptions) at fair value. The Company adopted SFAS No. 123R effective as of July1, 2005.

 

SFAS No. 123Rprovides two alternatives for adoption: (1) a “modified prospective” method inwhich compensation cost is recognized for all awards granted subsequent to theeffective date of this statement as well as for the unvested portion of awardsoutstanding as of the effective date, and (2) a “modified retrospective” methodwhich follows the approach in the “modified prospective” method, but alsopermits entities to restate prior periods to reflect compensation costcalculated under SFAS No. 123 for pro forma amounts disclosure. The Companyadopted the Black-Scholes option-pricing model and the modified prospectivemethod.

 

In May 2005,FASB issued SFAS No. 154, “Accounting Changes and Error Corrections”, whichreplaces APB Opinion No. 20 and SFAS No. 3. SFAS No. 154 requires that a voluntarychange in accounting principle be applied retrospectively with all prior periodfinancial statements presented, unless it is impracticable to do so. The newstandard is effective for accounting changes and correction of errors made

 

33

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in fiscalyears beginning after December 15, 2005. The Company has not determined theeffect the adoption of SFAS No. 154 will have on its consolidated financialstatements.

 

In March 2006,FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets”, whichamends SFAS No. 140. SFAS No. 156 requires the recognition of all separatelyrecognized servicing assets and servicing liabilities to be initially measuredat fair value utilizing the amortization method or fair market value method.SFAS 156 is effective the beginning of the first fiscal year that begins afterSeptember 15, 2006. The Company has not determined the effect the adoption ofSFAS No. 156 will have on its financial statements.

 

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**Item 3. Quantitative and QualitativeDisclosures About Market Risk**

 

The Company’snet income is largely dependent on its net interest income. Net interest incomeis susceptible to interest rate risk to the degree that interest-bearingliabilities with short- and medium-term maturities mature or reprice morerapidly than its interest-earning assets. When interest-bearing liabilitiesmature or reprice more quickly than interest-earning assets in a given period,a significant increase in market rates of interest could adversely affect netinterest income. Similarly, when interest-earning assets mature or reprice morequickly than interest-bearing liabilities, falling interest rates could resultin a decrease in net income.

 

In an attempt to manage itsexposure to change in interest rates, management monitors the Company’sinterest rate risk. The Company’s Asset-Liability Committee meets periodicallyto review the Company’s interest rate risk position and profitability, and torecommend adjustments for consideration by executive management. Managementalso reviews the Bank’s securities portfolio, formulates investment strategies,and oversees the timing and implementation of transactions to assure attainmentof the Board’s objectives in the most effective manner. In managing market riskand the asset/liability mix, the Bank has placed its emphasis on developing aportfolio in which, to the extent practicable, assets and liabilities repricewithin similar periods. Notwithstanding the Company’s interest rate riskmanagement activities, the potential for changing interest rates is anuncertainty that can have an adverse effect on net income. The Company does notcurrently engage in trading activities or use derivative instruments to controlinterest rate risk although it may in the future, if necessary, to manageinterest rate risk.

 

In adjustingthe Company’s asset/liability position, management attempts to manage theCompany’s interest rate risk while enhancing net interest margins. At times,depending on the level of general interest rates, the relationship between longand short-term interest rates, market conditions and competitive factors,management may determine to increase the Company’s interest rate risk positionsomewhat in order to increase its net interest margin.

 

As set forthbelow, depending upon the volatility of the 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 conversesituation can also be expected. One approach used to quantify interest raterisk is the NPV analysis. In essence, this analysis calculates the difference betweenthe present value of the liabilities and the present value of expected cashflows from assets and off-balance sheet contracts. The following tables setforth, at December 31, 2005 (the most recent report available) and March 31,2005, an analysis of the Company’s interest rate risk as measured by theestimated changes in NPV resulting from instantaneous and sustained parallelshifts in the yield curve (+300 or —200 basis points, measured in 100 basispoint increments). Management does not believe that the Company has experiencedany material changes in its market risk position from that disclosed in theCompany’s Annual Report on Form 10-K for the fiscal year ended June 30, 2005 orthat the Company’s primary market risk exposures and how those exposures weremanaged during the nine months ended March 31, 2006 changed significantly whencompared to June 30, 2005.

 

The data in the followingtables is based on assumptions utilized by the OTS in assessing interest raterisk of thrift institutions and published in “Selected Asset and LiabilityPrice Tables as of December 31, 2005” and “Selected Asset and Liability PriceTables as of March 31, 2005”. 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.

 

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| ** **                    | ** ** | **December 31, 2005**      | ** ** | ** **             | ** ** |
|-------------------------------|------------|----------------------------|------------|------------------------|------------|
| **Change in  Interest Rates** | ** ** | **Estimated  NPV  Amount** | ** ** | **Estimated Increase** | ** ** |
| **(Decrease) in NPV**         |
| **Amount**                    | ** ** | **Percent**                |
| ** **                    | ** ** | ** **                 | ** ** | ** **             | ** ** | ** ** | ** ** |
| ** **                    | ** ** | **(Dollars in thousands)** | ** ** | ** **             | ** ** |
| Basis  Points                 |       |                       |       |                   |       |   |   |
| +300                          |       | $                          | 90,630     |                   | $          | (17,361 | ) | (16 | )% |
| +200                          |       | 97,846                     |       | (10,145                | )          | (9 | ) |
| +100                          |       | 103,269                    |       | (4,722                 | )          | (4 | ) |
|  —                  |       | 107,991                    |       | —                 |       | — |   |
| -100                          |       | 110,442                    |       | 2,451                  |       | 2 |   |
| -200                          |       | 107,618                    |       | (372                   | )          | — |   |
|                               |            |                            |            |                        |            |  |  |  |  |

 

| ** **                    | ** ** | **March 31, 2005**         | ** ** | ** **             | ** ** |
|-------------------------------|------------|----------------------------|------------|------------------------|------------|
| **Change in  Interest Rates** | ** ** | **Estimated  NPV  Amount** | ** ** | **Estimated Increase** | ** ** |
| **(Decrease) in NPV**         |
| **Amount**                    | ** ** | **Percent**                |
| ** **                    | ** ** | ** **                 | ** ** | ** **             | ** ** | ** ** | ** ** |
| ** **                    | ** ** | **(Dollars in thousands)** | ** ** | ** **             | ** ** |
| Basis  Points                 |       |                       |       |                   |       |   |   |
| +300                          |       | $                          | 95,398     |                   | $          | (9,866 | ) | (9 | )% |
| +200                          |       | 100,323                    |       | (4,941                 | )          | (5 | ) |
| +100                          |       | 103,605                    |       | (1,659                 | )          | (2 | ) |
|  —                  |       | 105,264                    |       | —                 |       | — |   |
| -100                          |       | 103,748                    |       | (1,516                 | )          | (1 | ) |
| -200                          |       | 97,604                     |       | (7,660                 | )          | (7 | ) |
|                               |            |                            |            |                        |            |  |  |  |  |

 

In managingmarket risk and the asset/liability mix, the Bank has placed its emphasis ondeveloping a portfolio in which, to the extent practicable, assets and liabilitiesreprice within similar periods. The effect of this policy will generally be toreduce the Bank’s sensitivity to interest rate changes. The goal of this policyis to provide a relatively consistent level of net interest income in varyinginterest rate cycles and to minimize the potential for significant fluctuationsfrom period to period.

 

**Item 4. Controls and Procedures**

 

The Company’smanagement has evaluated, under the supervision and with the participation ofthe Company’s Chairman, President and Chief Executive Officer and the Company’sExecutive Vice President, Chief Financial Officer and Treasurer, theeffectiveness of the design and operation of the Company’s disclosure controlsand procedures, as defined in Rule 13a-15(e), and have concluded that, as ofthe end of the period covered by this Quarterly Report, the Company’sdisclosure controls and procedures are effective for gathering, analyzing anddisclosing information the Company is required to disclose in its periodicreports filed under the Exchange Act. There were no significant changes in theCompany’s internal control over financial reporting identified in the abovereferenced evaluation that materially affected, or are reasonably likely tomaterially affect, the Company’s internal control over financial reporting.

 

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**PART II – OTHER INFORMATION**

 

**Item1.    Legal Proceedings**

 

The Company, the Bank and their subsidiaries are involved as plaintiffor defendant in various legal actions arising in the normal course of theirbusinesses. While the ultimate outcome of these proceedings cannot be predictedwith certainty, it is the opinion of management, after consultation withcounsel representing the Company and/or the Bank in the proceedings, that theresolution of these proceedings are not likely to have a material effect on theCompany’s consolidated financial condition or results of operations. TheCompany and its direct and indirect subsidiaries are not aware of any legalactions or proceedings outside of the normal course of business.

 

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

 

The following table sets forth the purchasesby the Company of its common stock during the quarterly period ended March 31,2006.

 
| **Period**             | ** ** | **Total  Number  of Shares  Purchased** | ** ** | **Average  Price Paid  per Share** | ** ** | **Total Number  of Shares Purchased  as Part of Publicly  Announced Programs** | ** ** | **Maximum Number of  Shares that May Yet  Be Purchased Under  the Current Program** | ** ** |
|------------------------|------------|-----------------------------------------|------------|------------------------------------|------------|--------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|
| January 1 -  31, 2006  |       | 0                                       |       | $                                  | 0.00       |                                                                           | 0          |                                                                                | 303,614    |   |
| February 1 -  28, 2006 |       | 0                                       |       | $                                  | 0.00       |                                                                           | 0          |                                                                                | 303,614    |   |
| March 1 -  31, 2006    |       | 0                                       |       | $                                  | 0.00       |                                                                           | 0          |                                                                                | 303,614    |   |
|                   |       |                                    |       |                               |       |                                                                           |       |                                                                                |       |
| 3rd Quarter Total      |       | 0                                       |       | $                                  | 0.00       |                                                                           | 0          |                                                                                |       |   |

 

The Company currently has in effect stockbuyback program, which was publicly announced on April 25, 2005 and pursuant towhich up to 10% of the common stock of the Company that was outstanding on May1, 2005, which equals 350,914 shares, may be acquired through April 30, 2006.As of March 31, 2006, a total of 47,300 shares of common stock have beenpurchased pursuant to the program, all of which were purchased in the openmarket during May and June 2005.

 

The Company approved a new stock buybackprogram effective as of May 1, 2006, which was publicly announced onApril 24, 2006, in which up to 10% of the common stock of the Companyoutstanding on May 1, 2006, which equals 394,035 shares, may be acquiredthrough April 30, 2007.

 

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**Item6.    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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**HF FINANCIAL CORP.**

 

**FORM10-Q**

**SIGNATURES**

 

Pursuant tothe requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
|   |         |   | HF Financial Corp.                             |                    |
|--------|--------------|--------|------------------------------------------------|-------------------------|
|   |         |   |                                           |                    |   |
|   |         |   | (Registrant)                                   |                    |
|   |         |   |                                           |
| Date:  | May 12, 2006 |   | By:                                            | /s/ Curtis  L. Hage     |   |
|   |         |   | Curtis L.  Hage, Chairman, President           |
|   |         |   | And Chief  Executive Officer                   |
|   |         |   | (Principal  Executive Officer)                 |
|   |         |   |                                           |
| Date:  | May 12, 2006 |   | 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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**Index to Exhibits**

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

 

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