**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON, D.C.  20549**

 

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**FORM 10-Q**

 

**ý****      QUARTERLY REPORT PURSUANT TO SECTION 13OR 15 (d) OF THE**

**SECURITIES EXCHANGE ACT OF 1934**

 

**For the Quarterly Period ended December 31,2005**

 

**Commission File Number: 0-19972**

 

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**HFFINANCIAL CORP.**

(Exact name of registrant as specified inits charter.)

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

 

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer 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 by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act.) YES  o   NO ý

 

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

 

As of February 9, 2006 there were 3,577,931issued and outstanding shares of the Registrant’s Common Stock, with $.01 parvalue 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 December 31, 2005 and June 30, 2005          |   |
|           |                                                                                                          |   |
|           | Consolidated Statements of  Income for the  Three Months and Six Months Ended December 31, 2005 and 2004 |   |
|           |                                                                                                          |   |
|           | Consolidated Statements of  Cash Flows for the  Six Months Ended December 31, 2005 and 2004              |   |
|           |                                                                                                          |   |
|           | 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 3.        | Defaults  upon Senior Securities                                                                              |   |
|           |                                                                                                          |   |
| Item 4.        | Submission  of Matters to a Vote of Security Holders                                                          |   |
|           |                                                                                                          |   |
| Item 5.        | Other Information                                                                                             |   |
|           |                                                                                                          |   |
| Item  6.       | Exhibits                                                                                                      |   |
|           |                                                                                                          |   |
| Form 10-Q | Signature  Page                                                                                               |   |

 

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**PART I- FINANCIAL INFORMATION**

 

**Item 1.             Financial Statements**

 

**HF FINANCIALCORP. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION**

**(Dollars inThousands)**

 
| ** **                                                                                                                                                         | ** ** | **December 31, 2005** | ** ** | **June 30, 2005** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|------------------------|------------|
| ** **                                                                                                                                                         | ** ** | **(Unaudited)**            | ** ** | **(Audited)**          | ** ** |
| **ASSETS**                                                                                                                                                         | ** ** | ** **                 | ** ** | ** **             | ** ** |
| Cash and cash equivalents                                                                                                                                          |       | $                          | 22,740     |                   | $          | 18,248 |   |
| Securities available for sale                                                                                                                                      |       | 148,564                    |       | 142,429                |       |
| Federal Home Loan Bank stock                                                                                                                                       |       | 6,645                      |       | 7,699                  |       |
| Loans held for sale                                                                                                                                                |       | 13,800                     |       | 10,238                 |       |
| Loans and leases receivable                                                                                                                                        |       | 695,433                    |       | 675,657                |       |
| Allowance for loan and lease losses                                                                                                                                |       | (5,174                     | )          | (5,076                 | )          |
| Net loans and  leases receivable                                                                                                                                   |       | 690,259                    |       | 670,581                |       |
|                                                                                                                                                               |       |                       |       |                   |       |
| Accrued interest receivable                                                                                                                                        |       | 6,675                      |       | 5,087                  |       |
| Office properties and equipment, net of accumulated  depreciation                                                                                                  |       | 13,741                     |       | 12,978                 |       |
| Foreclosed real estate and other properties                                                                                                                        |       | 141                        |       | 1,387                  |       |
| Cash value of life insurance                                                                                                                                       |       | 12,772                     |       | 12,530                 |       |
| Servicing rights                                                                                                                                                   |       | 5,595                      |       | 5,211                  |       |
| Goodwill, net                                                                                                                                                      |       | 4,951                      |       | 4,951                  |       |
| Other assets                                                                                                                                                       |       | 8,181                      |       | 6,535                  |       |
| Total assets                                                                                                                                                       |       | $                          | 934,064    |                   | $          | 897,874 |   |
|                                                                                                                                                               |       |                       |       |                   |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                      |       |                       |       |                   |       |
| **LIABILITIES**                                                                                                                                                    |       |                       |       |                   |       |
| Deposits                                                                                                                                                           |       | $                          | 725,711    |                   | $          | 681,216 |   |
| Advances from Federal Home Loan Bank and other  borrowings                                                                                                         |       | 107,480                    |       | 119,664                |       |
| Subordinated debentures payable to trusts                                                                                                                          |       | 27,837                     |       | 27,837                 |       |
| Advances by borrowers for taxes and insurance                                                                                                                      |       | 6,933                      |       | 6,446                  |       |
| Accrued expenses and other liabilities                                                                                                                             |       | 11,090                     |       | 9,076                  |       |
| Total  liabilities                                                                                                                                                 |       | 879,051                    |       | 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, 5,553,597 and 5,462,066 shares  issued at December 31, 2005 and June 30, 2005, respectively |       | 55                         |       | 55                     |       |
| Common stock subscribed for but not issued, 66,644  shares at June 30, 2005                                                                                   |       | —                     |       | 1,266                  |       |
| Additional paid-in capital                                                                                                                                         |       | 18,904                     |       | 19,190                 |       |
| Retained earnings, substantially restricted                                                                                                                        |       | 66,803                     |       | 65,267                 |       |
| Deferred compensation                                                                                                                                              |       | —                     |       | (2,140                 | )          |
| Accumulated other comprehensive income (loss), net of  related deferred tax effect                                                                                 |       | (1,582                     | )          | (836                   | )          |
| Less cost of  treasury stock, 1,977,836 and 1,977,836 shares at December 31, 2005 and  June 30, 2005, respectively                                       |       | (29,167                    | )          | (29,167                | )          |
| Total  stockholders’ equity                                                                                                                                   |       | 55,013                     |       | 53,635                 |       |
| Total  liabilities and stockholders’ equity                                                                                                                   |       | $                          | 934,064    |                   | $          | 897,874 |   |

 

*Seeaccompanying notes to unaudited consolidated financial statements.*

 

1

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**HF FINANCIALCORP. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF INCOME**

**(Dollars inThousands, Except Per Share Data)**

**(Unaudited)**

 
| ** **                                                              | ** ** | **Three Months Ended  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|-------------------------------------------------------------------------|------------|-------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                              | ** ** | **2005**                                  | ** ** | **2004**                                | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                    |       |                                      |       |                                    |       |   |   |   |   |
| Interest,  dividend and loan fee income:                                |       |                                      |       |                                    |       |   |   |   |   |
| Loans and leases  receivable                                            |       | $                                         | 11,593     |                                    | $          | 10,204 |   | $ | 22,714 |   | $ | 19,938 |   |
| Investment  securities and interest-earning deposits                    |       | 1,550                                     |       | 1,045                                   |       | 2,901 |   | 2,001 |   |
|                                                                    |       | 13,143                                    |       | 11,249                                  |       | 25,615 |   | 21,939 |   |
| Interest  expense:                                                      |       |                                      |       |                                    |       |   |   |   |   |
| Deposits                                                                |       | 4,793                                     |       | 2,941                                   |       | 9,089 |   | 5,712 |   |
| Advances from  Federal Home Loan Bank and other borrowings              |       | 1,957                                     |       | 1,504                                   |       | 3,798 |   | 2,883 |   |
|                                                                    |       | 6,750                                     |       | 4,445                                   |       | 12,887 |   | 8,595 |   |
| **Net  interest income**                                                |       | 6,393                                     |       | 6,804                                   |       | 12,728 |   | 13,344 |   |
| ** **                                                              |       |                                      |       |                                    |       |   |   |   |   |
| Provision for  losses on loans and leases                               |       | 3,630                                     |       | 196                                     |       | 4,092 |   | 375 |   |
|                                                                    |       |                                      |       |                                    |       |   |   |   |   |
| **Net interest  income after provision for losses on loans and leases** |       | 2,763                                     |       | 6,608                                   |       | 8,636 |   | 12,969 |   |
|                                                                    |       |                                      |       |                                    |       |   |   |   |   |
| Noninterest  income:                                                    |       |                                      |       |                                    |       |   |   |   |   |
| Gain on sale of  land, net                                              |       | 3,557                                     |       | —                                  |       | 3,557 |   | — |   |
| Fees on deposits                                                        |       | 1,170                                     |       | 1,127                                   |       | 2,346 |   | 2,247 |   |
| Loan servicing  income                                                  |       | 309                                       |       | 409                                     |       | 621 |   | 781 |   |
| Gain on sale of  loans, net                                             |       | 219                                       |       | 234                                     |       | 474 |   | 336 |   |
| Trust income                                                            |       | 200                                       |       | 172                                     |       | 395 |   | 331 |   |
| Gain on sale of  securities, net                                        |       | —                                    |       | —                                  |       | — |   | 13 |   |
| Other                                                                   |       | 534                                       |       | 397                                     |       | 981 |   | 829 |   |
|                                                                    |       | 5,989                                     |       | 2,339                                   |       | 8,374 |   | 4,537 |   |
| Noninterest  expense:                                                   |       |                                      |       |                                    |       |   |   |   |   |
| Compensation and  employee benefits                                     |       | 4,212                                     |       | 4,129                                   |       | 8,515 |   | 8,127 |   |
| Occupancy and  equipment                                                |       | 829                                       |       | 766                                     |       | 1,609 |   | 1,549 |   |
| Other                                                                   |       | 1,651                                     |       | 1,544                                   |       | 3,242 |   | 3,094 |   |
|                                                                    |       | 6,692                                     |       | 6,439                                   |       | 13,366 |   | 12,770 |   |
|                                                                    |       |                                      |       |                                    |       |   |   |   |   |
| **Income  before income taxes**                                         |       | 2,060                                     |       | 2,508                                   |       | 3,644 |   | 4,736 |   |
| ** **                                                              |       |                                      |       |                                    |       |   |   |   |   |
| Income tax  expense                                                     |       | 761                                       |       | 860                                     |       | 1,322 |   | 1,628 |   |
|                                                                    |       |                                      |       |                                    |       |   |   |   |   |
| **Net  income**                                                         |       | $                                         | 1,299      |                                    | $          | 1,648 |   | $ | 2,322 |   | $ | 3,108 |   |
| ** **                                                              |       |                                      |       |                                    |       |   |   |   |   |   |   |   |   |
| **Comprehensive  income**                                               |       | $                                         | 715        |                                    | $          | 1,401 |   | $ | 1,576 |   | $ | 3,826 |   |
| **Cash  dividends declared per share**                                  |       | $                                         | 0.1125     |                                    | $          | 0.1100 |   | $ | 0.2225 |   | $ | 0.2175 |   |
|                                                                    |       |                                      |       |                                    |       |   |   |   |   |
| **Earnings  per share:**                                                |       |                                      |       |                                    |       |   |   |   |   |
| Basic                                                                   |       | $                                         | 0.36       |                                    | $          | 0.46 |   | $ | 0.66 |   | $ | 0.88 |   |
| Diluted                                                                 |       | $                                         | 0.36       |                                    | $          | 0.45 |   | $ | 0.64 |   | $ | 0.86 |   |

 

*Seeaccompanying notes to unaudited consolidated financial statements.*

 

2

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**HF FINANCIALCORP. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Dollars inThousands)**

**(Unaudited)**

 
| ** **                                                                                     | ** ** | **Six Months Ended December 31,** | ** ** |
|------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                     | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| **Cash flows from operating activities**                                                       |       |                                   |       |   |   |
| Net income                                                                                     |       | $                                      | 2,322      |   | $ | 3,108 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities:             |       |                                   |       |   |   |
| Provision for  losses on loans and leases                                                      |       | 4,092                                  |       | 375 |   |
| Depreciation                                                                                   |       | 738                                    |       | 708 |   |
| Amortization of  discounts and premiums on securities and other                                |       | 1,030                                  |       | 757 |   |
| Stock based  compensation                                                                      |       | 292                                    |       | 216 |   |
| Deferred income  taxes (credits)                                                               |       | (985                                   | )          | 523 |   |
| Loans originated  for resale                                                                   |       | (55,716                                | )          | (42,923 | ) |
| Proceeds from  the sale of loans                                                               |       | 54,900                                 |       | 41,276 |   |
| (Gain) on sale of  loans, net                                                                  |       | (474                                   | )          | (336 | ) |
| Realized (gain)  on sale of securities, net                                                    |       | —                                 |       | (13 | ) |
| (Gain) on sale  of land                                                                        |       | (3,557                                 | )          | — |   |
| Losses and  provision for losses on sales of foreclosed real estate and other properties,  net |       | 21                                     |       | 21 |   |
| Loss on disposal  of office properties and equipment, net                                      |       | 20                                     |       | 7 |   |
| Change in other  assets and liabilities                                                        |       | (1,640                                 | )          | (1,333 | ) |
| Net cash  provided by operating activities                                                     |       | 1,043                                  |       | 2,386 |   |
|                                                                                           |       |                                   |       |   |   |
| **Cash flows from investing activities**                                                       |       |                                   |       |   |   |
| Loans and leases  purchased                                                                    |       | —                                 |       | (5,763 | ) |
| Loans and leases  originated and held                                                          |       | (200,612                               | )          | (123,471 | ) |
| Principal  collected on loans and leases                                                       |       | 175,857                                |       | 123,939 |   |
| Proceeds from  sale of land                                                                    |       | 4,863                                  |       | — |   |
| Securities  available for sale:                                                                |       |                                   |       |   |   |
| Sales and  maturities and repayments                                                           |       | 24,005                                 |       | 30,376 |   |
| Purchases                                                                                      |       | (31,955                                | )          | (21,791 | ) |
| Purchase of  Federal Home Loan Bank stock                                                      |       | (2,015                                 | )          | (2,539 | ) |
| Redemption of  Federal Home Loan Bank stock                                                    |       | 3,069                                  |       | 1,726 |   |
| Proceeds from  sale of office properties and equipment                                         |       | 2                                      |       | 1 |   |
| Purchase of  office properties and equipment                                                   |       | (1,523                                 | )          | (612 | ) |
| Purchase of  servicing rights                                                                  |       | (689                                   | )          | (585 | ) |
| Proceeds from  sale of foreclosed real estate and other properties, net                        |       | 139                                    |       | 361 |   |
| Net cash  provided by (used in) investing activities                                           |       | (28,859                                | )          | 1,642 |   |
|                                                                                                |            |                                        |            |  |  |  |  |

 

*Seeaccompanying notes to unaudited consolidated financial statements.*

 

3

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**HF FINANCIALCORP. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS (CONTINUED)**

**(Dollars inThousands)**

**(Unaudited)**

 
| ** **                                                             | ** ** | **Six Months Ended December 31,** | ** ** |
|------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                             | ** ** | **2005**                               | ** ** | **2004** | ** ** |
|                                                                   |       |                                   |       |   |   |
| **Cash flows from financing activities**                               |       |                                   |       |   |   |
| Net increase  (decrease) in deposit accounts                           |       | $                                      | 44,495     |   | $ | (9,373 | ) |
| Proceeds of  advances from Federal Home Loan Bank and other borrowings |       | 260,083                                |       | 327,713 |   |
| Payments on  advances from Federal Home Loan Bank and other borrowings |       | (272,267                               | )          | (320,210 | ) |
| Increase in  advances by borrowers                                     |       | 487                                    |       | 375 |   |
| Purchase of  treasury stock                                            |       | —                                 |       | (836 | ) |
| Proceeds from  issuance of common stock                                |       | 296                                    |       | 242 |   |
| Cash dividends  paid                                                   |       | (786                                   | )          | (772 | ) |
| Net cash  provided by (used in) financing activities                   |       | 32,308                                 |       | (2,861 | ) |
|                                                                   |       |                                   |       |   |   |
| Increase in cash  and cash equivalents                                 |       | 4,492                                  |       | 1,167 |   |
|                                                                   |       |                                   |       |   |   |
| Cash and cash equivalents                                              |       |                                   |       |   |   |
| Beginning                                                              |       | 18,248                                 |       | 20,474 |   |
| Ending                                                                 |       | $                                      | 22,740     |   | $ | 21,641 |   |
|                                                                   |       |                                   |       |   |   |
| Supplemental Disclosures of Cash Flows Information                     |       |                                   |       |   |   |
| Cash payments  for interest                                            |       | $                                      | 11,931     |   | $ | 8,591 |   |
| Cash payments  for income and franchise taxes, net                     |       | 1,772                                  |       | 1,218 |   |

 

*Seeaccompanying notes to unaudited consolidated financial statements.*

 

4

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**HF FINANCIAL CORP. AND SUBSIDIARIES**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

ForThe Three and Six Months Ended December 31, 2005 and 2004

(Unaudited)

 

**NOTE1.          SELECTED ACCOUNTING POLICIES**

 

*Basis ofpresentation:*

 

The consolidated financial information of HF FinancialCorp. (the “Company”) and its wholly-owned subsidiaries included in thisQuarterly Report on Form 10-Q is unaudited.  However, in the opinion of management,adjustments (consisting of normal recurring adjustments) necessary for a fairpresentation for the interim periods have been included.  Results for any interim period are notnecessarily indicative of results to be expected for the fiscal year.  Interim consolidated financial statements andthe notes thereto should be read in conjunction with the consolidated financialstatements and notes thereto included in the Company’s Annual Report on Form 10-Kfor the fiscal year ended June 30, 2005 (“Fiscal 2005”), filed with theSecurities and Exchange Commission.  Theaccounting and reporting policies of the Company and its subsidiaries conformto accounting principles generally accepted in the United States of America (“GAAP”)and to general practice within the industry.

 

The interim consolidated financial statements includethe accounts of the Company, its wholly-owned subsidiaries, Home Federal Bank(the “Bank”), HF Financial Group, Inc. (“HF Group”) and HomeFirst MortgageCorp. (the “Mortgage Corp.”), and the Bank’s wholly-owned subsidiaries, MidAmerica Capital Services, Inc. (“Mid America Capital”), Hometown Insurors, Inc.(“Hometown”), Home Federal Securitization Corp. (“HFSC”), Mid-America ServiceCorporation and PMD, Inc.  Theinterim consolidated financial statements reflect the deconsolidation of thesubsidiary trusts of the Company, HF Financial Capital Trust I (“Trust I”), HFFinancial Capital Trust II (“Trust II”), HF Financial Capital Trust III (“TrustIII”) and HF Financial Capital Trust IV (“Trust IV”).  All intercompany balances and transactionhave been eliminated in consolidation.

 

Stock-based compensation:  In December 2004, the FinancialAccounting Standards Board (“FASB”) issued Statement of Financial AccountingStandards (“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 SFAS No. 123, *“Accounting for Stock-Based Compensation,”*andsupersedes Accounting Principles Board (“APB”) Opinion No. 25, *“Accounting for Stock Issued to Employees”*.

 

The Company adopted SFAS No. 123R effective as ofJuly 1, 2005, using the Black-Scholes option-pricing model and themodified prospective method in which compensation cost is recognized for allawards granted subsequent to the Company’s adoption of this statement as wellas for the unvested portion of awards outstanding as of the Company’s adoptionof this statement.  Prior to July 1,2005, the Company accounted for stock-based compensation in accordance with APBNo. 25 and related interpretations. As such, no stock-based employeecompensation cost was recognized for grants under the Company’s stock optionand incentive plans, as all options granted under those plans had an exerciseprice equal to the market value of the underlying common stock on the date ofgrant.  These stock option and incentiveplans are described more fully in Part II, Item 8 “Financial Statementsand Supplementary Data” of the Company’s Annual Report on Form 10-K forFiscal 2005, under Note 17 of “Notes to Consolidated Financial Statements.”

 

5

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The following table illustrates the effect on netincome and earnings per share if the Company had applied the fair valuerecognition provisions of SFAS 123R to stock-based employee compensation forthe three and six months ended December 31, 2004.

 
| ** **                                                                                                                                        | ** ** | **Three Months Ended December 31,** | ** ** | **Six Months Ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                                                                        | ** ** | **2005**                                 | ** ** | **2004**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                                                                        | ** ** | ** **                               | ** ** | ** **                             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income, as reported (1)                                                                                                                       |       | $                                        | 1,299      |                                   | $          | 1,648 |   | $ | 2,322 |   | $ | 3,108 |   |
| Add: Total  stock-based employee compensation expense included in reported net income, net  of related tax effects                                |       |                                     |       | 66                                     |       |   |   | 97 |   |
| Deduct: Total  stock-based employee compensation expense determined under fair value based  method for all awards, net of related tax effects (2) |       |                                     |       | (129                                   | )          |   |   | (201 | ) |
| Pro forma net income                                                                                                                              |       | $                                        | 1,299      |                                   | $          | 1,585 |   | $ | 2,322 |   | $ | 3,004 |   |
|                                                                                                                                              |       |                                     |       |                                   |       |   |   |   |   |
| Basic earnings per share:                                                                                                                         |       |                                     |       |                                   |       |   |   |   |   |
| As reported                                                                                                                                       |       | $                                        | 0.36       |                                   | $          | 0.46 |   | $ | 0.66 |   | $ | 0.88 |   |
| Pro forma                                                                                                                                         |       |                                     |       | 0.45                                   |       |   |   | 0.85 |   |
|                                                                                                                                              |       |                                     |       |                                   |       |   |   |   |   |
| Diluted earnings per share:                                                                                                                       |       |                                     |       |                                   |       |   |   |   |   |
| As reported                                                                                                                                       |       | 0.36                                     |       | 0.45                                   |       | 0.64 |   | 0.86 |   |
| Pro forma                                                                                                                                         |       |                                     |       | 0.43                                   |       |   |   | 0.83 |   |

 

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(1)          Includes expense related to stock-based employee compensation for thethree and six months ended December 31, 2005 due to the adoption of SFAS No. 123R.

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

 

**NOTE2.          REGULATORY CAPITAL**

 

The following table sets forth the Bank’scompliance with its minimum capital requirements for a well-capitalizedinstitution at December 31, 2005:

 
|                                              |   | **Amount**                 | ** **   | **Percent** |   |
|---------------------------------------------------|--------|----------------------------|--------------|-------------|--------|
|                                              |   | **(Dollars in Thousands)** |         |
| Tier I (core) capital (to adjusted total assets): |   |                       |         |        |   |
| Required                                          |   | $                          |  46,423 |        | 5.00   | % |
| Actual                                            |   | 73,876                     |         | 7.96        |   |
| Excess over  required                             |   | 27,453                     |         | 2.96        |   |
|                                              |   |                       |         |        |   |
| Risk-based capital (to risk-weighted assets):     |   |                       |         |        |   |
| Required                                          |   | $                          |  74,146 |        | 10.00  | % |
| Actual                                            |   | 79,050                     |         | 10.66       |   |
| Excess over  required                             |   | 4,904                      |         | 0.66        |   |

 

6

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**NOTE3.          EARNINGS PER SHARE**

 

Basicearnings per share is computed by dividing income available to commonstockholders (the numerator) by the weighted-average number of common sharesoutstanding  (the denominator) during theperiod.  Shares issued during the periodand shares reacquired during the period are weighted for the portion of theperiod that they were outstanding. The weighted average number of basic commonshares outstanding for the three months ended December 31, 2005 and 2004was 3,574,272 and 3,553,354, respectively. The weighted average number of basic common shares outstanding for thesix months ended December 31, 2005 and 2004 was 3,535,780 and 3,543,600,respectively.

 

Dilutive earnings per share is similar to thecomputation of basic earnings per share except that the denominator isincreased to include the number of additional common shares that would havebeen outstanding if the dilutive options outstanding had been exercised. Theweighted average number of common and dilutive potential common shares outstandingfor the three months ended December 31, 2005 and 2004 was 3,650,287 and3,649,299, respectively.  The weightedaverage number of common and dilutive potential common shares outstanding forthe six months ended December 31, 2005 and 2004 was 3,615,537 and3,624,589, respectively.

 

 **NOTE 4.         CONSUMER AUTOMOBILE LOAN SECURITIZATION**

 

On January 31, 2003,the Bank securitized and sold motor vehicle installment loans with principalbalances totaling $50.0 million through HFSC and Home Federal Automobile SecuritizationTrust 2003-A (“Automobile Securitization Trust”).  As part of the sales transaction, the Bankretained servicing responsibilities.  Inaddition, the Bank retained the rights to cash flows remaining after investorsin the Automobile Securitization Trust have received their contractual paymentsand has pledged a $1.5 million reserve fund to the Automobile SecuritizationTrust.  These retained interests aresubordinated to investors’ interests. The investors and Automobile Securitization Trust have no recourse tothe Bank’s other assets for failure of debtors to pay when due.  The pass through rate to investors is 2.65%.

 

Thegain recognized on the sale of these loans was determined by allocating thecarrying amount of the loans between the loans sold and the interestsretained.  The Bank determined that 50basis points of the 100 basis points servicing contract represented was excessservicing and was capitalized as part of the transaction utilizing a market discountrate of 10.0%.  This asset is amortizedin proportion to, and over the period of, estimated net servicing income.

 

The Company had the option to execute a cleanup callwhen the total outstanding balance was at 10% or less of the original poolbalance, 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.          INVESTMENTS IN SECURITIES**

 

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

 
| ** **                 | ** ** | **December 31,  2005** | ** ** |
|----------------------------|------------|-----------------------------|------------|
| ** **                 | ** ** | **Amortized  Cost**         | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  (Losses)** | ** ** | **Fair  Value** | ** ** |
| ** **                 | ** ** | **(Dollars  in Thousands)** |       |
|                       |       |                        |       |   |   |   |   |   |   |
| Debt securities:           |       |                        |       |   |   |   |   |   |   |
| U.S. government  agencies  |       | $                           | 7,955      |   | $ | 2 |   | $ | (73 | ) | $ | 7,884 |   |
| Federal Home  Loan Bank    |       | 8,966                       |       | 6 |   | (83 | ) | 8,889 |   |
| Municipal bonds            |       | 2,287                       |       | — |   | (21 | ) | 2,266 |   |
| Preferred Term  Securities |       | 11,019                      |       | 68 |   | — |   | 11,087 |   |
|                       |       | 30,227                      |       | 76 |   | (177 | ) | 30,126 |   |
|                       |       |                        |       |   |   |   |   |   |   |
| Equity securities:         |       |                        |       |   |   |   |   |   |   |
| FNMA                       |       | 8                           |       | 11 |   | — |   | 19 |   |
| Federal Ag  Mortgage       |       | 7                           |       | 4 |   | — |   | 11 |   |
| Other  Investments         |       | 39                          |       | — |   | — |   | 39 |   |
|                       |       | 54                          |       | 15 |   | — |   | 69 |   |
|                       |       |                        |       |   |   |   |   |   |   |
| Mortgage-backed securities |       | 120,834                     |       | 6 |   | (2,471 | ) | 118,369 |   |
|                       |       | $                           | 151,115    |   | $ | 97 |   | $ | (2,648 | ) | $ | 148,564 |   |

 
| ** **                 | ** ** | **December 31,  2004** | ** ** |
|----------------------------|------------|-----------------------------|------------|
| ** **                 | ** ** | **Amortized  Cost**         | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  (Losses)** | ** ** | **Fair  Value** | ** ** |
| ** **                 | ** ** | **(Dollars  in Thousands)** |       |
|                       |       |                        |       |   |   |   |   |   |   |
| Debt securities:           |       |                        |       |   |   |   |   |   |   |
| U.S. government  agencies  |       | $                           | 3,000      |   | $ | 8 |   | $ | — |   | $ | 3,008 |   |
| Federal Home  Loan Bank    |       | 2,500                       |       | 4 |   | — |   | 2,504 |   |
| Municipal bonds            |       | 3,541                       |       | 3 |   | (10 | ) | 3,534 |   |
| Preferred Term  Securities |       | 9,000                       |       | 34 |   | — |   | 9,034 |   |
|                       |       | 18,041                      |       | 49 |   | (10 | ) | 18,080 |   |
|                       |       |                        |       |   |   |   |   |   |   |
| Equity securities:         |       |                        |       |   |   |   |   |   |   |
| FNMA                       |       | 8                           |       | 20 |   | — |   | 28 |   |
| Federal Ag  Mortgage       |       | 7                           |       | 2 |   | — |   | 9 |   |
| Other  Investments         |       | 25                          |       | — |   | — |   | 25 |   |
|                       |       | 40                          |       | 22 |   | — |   | 62 |   |
|                       |       |                        |       |   |   |   |   |   |   |
| Mortgage-backed securities |       | 97,759                      |       | 57 |   | (1,153 | ) | 96,663 |   |
|                       |       | $                           | 115,840    |   | $ | 128 |   | $ | (1,163 | ) | $ | 114,805 |   |

 

8

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The following table presentsthe fair value and age of gross unrealized losses by investment category at December 31,2005 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**       | ** ** |
|-----------------------------|------------|-----------------------------|------------|---------------------------------|------------|-----------------|------------|
| ** **                  | ** ** | **Fair  Value**             | ** ** | **Gross  Unrealized  (Losses)** | ** ** | **Fair  Value** | ** ** | **Gross  Unrealized  (Losses)** | ** ** | **Fair  Value** | ** ** | **Gross  Unrealized  (Losses)** | ** ** |
| ** **                  | ** ** | **(Dollars  in Thousands)** |       |
|                        |       |                        |       |                            |       |            |       |   |   |   |   |   |   |
| Debt securities:            |       |                        |       |                            |       |            |       |   |   |   |   |   |   |
| U.S. government  agencies   |       | $                           | 4,496      |                            | $          | (49             | )          | $ | 1,976 |   | $ | (24 | ) | $ | 6,472 |   | $ | (73 | ) |
| Federal Home  Loan Bank     |       | 7,442                       |       | (83                             | )          | —          |       | — |   | 7,442 |   | (83 | ) |
| Municipal bonds             |       | 1,333                       |       | (9                              | )          | 933             |       | (12 | ) | 2,266 |   | (21 | ) |
| Mortgage-backed  securities |       | 65,929                      |       | (1,245                          | )          | 50,409          |       | (1,226 | ) | 116,338 |   | (2,471 | ) |
|                        |       | $                           | 79,200     |                            | $          | (1,386          | )          | $ | 53,318 |   | $ | (1,262 | ) | $ | 132,518 |   | $ | (2,648 | ) |

 

Management does not believeany individual unrealized losses as of December 31, 2005 represent another-than-temporary impairment.  Theunrealized losses reported for mortgage-backed securities relate to securitiesissued by the Federal National Mortgage Association (“FNMA”), the GovernmentNational Mortgage Association and the Federal Home Loan Mortgage Corporation (“FHLMC”).  These unrealized losses are primarilyattributable to changes in interest rates and as a group were less than 2.0% ofits respective amortized cost basis at December 31, 2005.  The Company has the ability to hold thesecurities to maturity or for a time necessary to recover the amortized cost.

 

TheCompany invests in investment securities issued by FNMA and FHLMC.  FNMA and FHLMC are government-sponsoredenterprises (“GSEs”).  GSE, as defined inthe Omnibus Budget Reconciliation Act of 1990, refers to a private corporationthat operates under a charter granted by Congress.  The majority of the members of the board ofdirectors of a GSE must be elected by the private shareholders, though some portionmay be appointed by Congress or the President. The central function of a GSE is to serve as a financial intermediary,making loans or issuing loan guarantees to borrowers or sectors identified inthe enabling legislation.  A GSE mayraise funds in a variety of ways, but in no case are the liabilities of the GSEto be backed by the full faith and credit of the federal government.  The legislation specifically states that aGSE 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 that GSEs are generally perceived by thecredit markets to have an implicit federal government guarantee backing itsobligations.

 

Managementcannot predict the role of GSEs in the future or how Congress would respond toaccounting or credit issues that may affect GSEs.  Management presently expects to continue toinvest in investment securities issued by FNMA and FHLMC in the normal courseof business.  If Congress would evereliminate the implicit guarantee associated with securities issued by GSEs, theoutcome would most likely be adverse to the Company.

 

9

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**NOTE6.          SEGMENT REPORTING**

 

Operatingsegments are defined as components of an enterprise for which separatefinancial information is available that is evaluated regularly by the chiefoperating decision makers in deciding how to allocate resources and inassessing performance.  The Company’sreportable segments are “banking” (including leasing activities) and“other”.  The “banking” segment isconducted through the Bank and Mid America Capital and the “other” segment iscomposed of smaller nonreportable segments, the Company and inter-segmenteliminations.

 

Themanagement approach is used as the conceptual basis for identifying reportablesegments and is based on the way that management organizes the segments withinthe enterprise for making operating decisions, allocating resources andmonitoring performance, which is primarily based on products.

 
| **Three Months Ended December 31, 2005**                 | ** ** | **Banking**                | ** ** | **Other** | ** ** | **Total** | ** ** |
|---------------------------------------------------------------|------------|----------------------------|------------|-----------|------------|-----------|------------|
| ** **                                                    | ** ** | **(Dollars in Thousands)** | ** ** |
|                                                          |       |                       |       |      |       |      |       |
| Net interest  income                                          |       | $                          | 7,222      |      | $          | (829      | )          | $ | 6,393 |   |
| Intersegment  interest income                                 |       | (301                       | )          | 301       |       | —    |       |
| Provision for  losses on loans and leases                     |       | (3,630                     | )          | —    |       | (3,630    | )          |
| Noninterest  income                                           |       | 2,400                      |       | 3,589     |       | 5,989     |       |
| Intersegment  noninterest income                              |       | (50                        | )          | 50        |       | —    |       |
| Noninterest  expense                                          |       | (6,497                     | )          | (195      | )          | (6,692    | )          |
| Intersegment  noninterest expense                             |       | 8                          |       | (8        | )          | —    |       |
| Income (loss)  from continuing operations before income taxes |       | $                          | (848       | )         | $          | 2,908     |       | $ | 2,060 |   |
|                                                          |       |                       |       |      |       |      |       |
| Total assets at  Decmeber 31, 2005                            |       | $                          | 932,299    |      | $          | 1,765     |       | $ | 934,064 |   |

 
| **Three Months Ended December 31, 2004**                 | ** ** | **Banking**                | ** ** | **Other** | ** ** | **Total** | ** ** |
|---------------------------------------------------------------|------------|----------------------------|------------|-----------|------------|-----------|------------|
| ** **                                                    | ** ** | **(Dollars in Thousands)** | ** ** |
|                                                          |       | ** **                 |       |      |       |      |       |
| Net interest  income                                          |       | $                          | 7,487      |      | $          | (683      | )          | $ | 6,804 |   |
| Intersegment  interest income                                 |       | (288                       | )          | 288       |       | —    |       |
| Provision for  losses on loans and leases                     |       | (196                       | )          | —    |       | (196      | )          |
| Noninterest  income                                           |       | 2,375                      |       | (36       | )          | 2,339     |       |
| Intersegment  noninterest income                              |       | (80                        | )          | 80        |       | —    |       |
| Noninterest  expense                                          |       | (6,167                     | )          | (272      | )          | (6,439    | )          |
| Intersegment  noninterest expense                             |       | 1                          |       | (1        | )          | —    |       |
| Income (loss)  from continuing operations before income taxes |       | $                          | 3,132      |      | $          | (624      | )          | $ | 2,508 |   |
|                                                          |       |                       |       |      |       |      |       |
| Total assets at  December 31, 2004                       |       | $                          | 845,102    |      | $          | 3,754     |       | $ | 848,856 |   |

 

10

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| **Six Months Ended December 31, 2005** | ** ** | **Banking**                | ** ** | **Other** | ** ** | **Total** | ** ** |
|---------------------------------------------|------------|----------------------------|------------|-----------|------------|-----------|------------|
| ** **                                  | ** ** | **(Dollars in Thousands)** | ** ** |
|                                        |       |                       |       |      |       |      |       |
| Net interest  income                        |       | $                          | 14,364     |      | $          | (1,636    | )          | $ | 12,728 |   |
| Intersegment  interest income               |       | (599                       | )          | 599       |       | —    |       |
| Provision for  losses on loans and leases   |       | (4,092                     | )          | —    |       | (4,092    | )          |
| Noninterest  income                         |       | 4,836                      |       | 3,538     |       | 8,374     |       |
| Intersegment  noninterest income            |       | (102                       | )          | 102       |       | —    |       |
| Noninterest expense                         |       | (12,977                    | )          | (389      | )          | (13,366   | )          |
| Intersegment  noninterest expense           |       | 9                          |       | (9        | )          | —    |       |
| Income (loss)  before income taxes          |       | $                          | 1,439      |      | $          | 2,205     |       | $ | 3,644 |   |
|                                        |       |                       |       |      |       |      |       |
| Total assets at  December 31, 2005     |       | $                          | 932,299    |      | $          | 1,765     |       | $ | 934,064 |   |

 
| **Six Months Ended December 31, 2004** | ** ** | **Banking**                | ** ** | **Other** | ** ** | **Total** | ** ** |
|---------------------------------------------|------------|----------------------------|------------|-----------|------------|-----------|------------|
| ** **                                  | ** ** | **(Dollars in Thousands)** | ** ** |
|                                        |       |                       |       |      |       |      |       |
| Net interest income                         |       | $                          | 14,642     |      | $          | (1,298    | )          | $ | 13,344 |   |
| Intersegment interest income                |       | (534                       | )          | 534       |       | —    |       |
| Provision for losses on loans and leases    |       | (375                       | )          | —    |       | (375      | )          |
| Noninterest income                          |       | 4,599                      |       | (62       | )          | 4,537     |       |
| Intersegment noninterest income             |       | (172                       | )          | 172       |       | —    |       |
| Noninterest expense                         |       | (12,220                    | )          | (550      | )          | (12,770   | )          |
| Intersegment noninterest expense            |       | 2                          |       | (2        | )          | —    |       |
| Income (loss)  before income taxes          |       | $                          | 5,942      |      | $          | (1,206    | )          | $ | 4,736 |   |
|                                        |       |                       |       |      |       |      |       |
| Total assets at December 31, 2004      |       | $                          | 845,102    |      | $          | 3,754     |       | $ | 848,856 |   |

 

11

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**NOTE7.          DEFINED BENEFIT PLAN**

 

TheCompany has a noncontributory (cash balance) defined benefit pension plancovering all employees of the Company and its wholly-owned subsidiaries whohave attained the age of 21 and have completed 1,000 hours in a plan year.  The benefits are based on 6% of each eligibleparticipant’s annual compensation, plus income earned in the accounts at a ratedetermined annually based on 30-year treasury note rates.  The Company’s funding policy is to make theminimum annual required contribution plus such amounts as the Company maydetermine to be appropriate from time to time. One hundred percent vesting occurs after five years with a normalretirement age of 65.  Informationrelative to the components of net periodic benefit cost for the Company’sdefined benefit plan is presented below:

 
| ** **                         | ** ** | **Three Months Ended** | ** ** | **Six Months Ended**  | ** ** |
|------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                         | ** ** | **December 31,**  | ** ** | **December 31,** | ** ** |
| ** **                         | ** ** | **2005**               | ** ** | **2004**              | ** ** | **2005** | ** ** | **2004** | ** ** |
|                               |       |                   |       |                  |       |   |   |   |   |
| Service cost                       |       | $                      | 116,367    |                  | $          | 113,536 |   | $ | 232,734 |   | $ | 227,071 |   |
| Interest cost                      |       | 91,238                 |       | 91,584                |       | 182,476 |   | 183,169 |   |
| Expected return  on plan assets    |       | (93,185                | )          | (92,629               | )          | (186,370 | ) | (185,258 | ) |
| Amortization of  prior losses      |       | —                 |       | 8,297                 |       | — |   | 16,594 |   |
| Accretion of  prior service cost   |       | —                 |       | —                |       | — |   | — |   |
| Amortization of  transition asset  |       | 2,907                  |       | 2,907                 |       | 5,815 |   | 5,815 |   |
| Total costs  recognized in expense |       | $                      | 117,327    |                  | $          | 123,695 |   | $ | 234,655 |   | $ | 247,391 |   |

 

TheCompany previously disclosed in its consolidated financial statements forFiscal 2005, which are included in Part II, Item 8 “Financial Statementsand Supplementary Data” of the Company’s Annual Report on Form 10-K forFiscal 2005, that it contributed $662,000 to fund its qualified pensionplan.  During the first quarter endedSeptember 30, 2005, the Company made contributions of $610,000 to fund itsqualified pension plan.  The Companyanticipates no additional contributions for the fiscal year endingJune 30, 2006 (“Fiscal 2006”).

 

12

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**NOTE8.          SELF-INSURED HEALTHCARE PLAN**

 

The Company has had aself-insured health plan for its employees, subject to certain limits, sinceJanuary 1994.  The Bank is named theplan administrator for this plan and has retained the services of anindependent third party administrator to process claims and handle other dutiesfor this plan.  The third partyadministrator does not assume liability for benefits payable under this plan.

 

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

 

Total net healthcarecosts are inclusive of health claims expenses and administration fees offset bystop loss and employee reimbursement. Reported below is a summary of net healthcare costs by quarter for thefiscal 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     |       |                                 |       | 379 |   | 678 |   | 204 |   |
| Quarter ended June 30      |       |                                 |       | 282 |   | 244 |   | 780 |   |
| Net healthcare  costs           |       | $                                    | 828        |   | $ | 1,255 |   | $ | 1,789 |   | $ | 1,829 |   |

 

13

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**Item 2.  Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

**Forward-LookingStatements**

 

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, theCompany’s management may make forward-looking statements orally to the media,securities analysts, investors or others. These forward-looking statements might include one or more of thefollowing:

 

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

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

•      Forecasts of future economic performance.

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

 

Forward-looking statements can be identified by thefact 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 of similar meaning, or future or conditional verbs such as“will,” “would,” “should,” “could” or “may.”

 

Forward-lookingstatements about the Company’s expected financial results and other plans aresubject to certain risks, uncertainties and assumptions.  These include, but are not limited to thefollowing: possible legislative changes and adverse economic, business andcompetitive conditions and developments (such as shrinking interest margins andcontinued short-term rate environments); deposit outflows; reduced demand forfinancial services and loan products; changes in accounting policies orguidelines, or in monetary and fiscal policies of the federal government;changes in credit and other risks posed by the Company’s loan portfolios; theability or inability of the Company to manage interest rate and other risks;unexpected or continuing claims against the Company’s self-insured health plan;the Company’s use of trust preferred securities; the ability or inability ofthe Company to successfully enter into a definitive agreement for and closeanticipated transactions; technological, computer-related or operationaldifficulties; adverse changes in securities markets; results of litigation; orother significant uncertainties.

 

Forward-lookingstatements speak only as of the date they are made.  The Company does not undertake to updateforward-looking statements to reflect circumstances or events that occur afterthe date the forward-looking statements are made.

 

14

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**ExecutiveSummary**

 

The Company’s net incomefor the second quarter of Fiscal 2006 was $1.3 million, or $0.36 per dilutedshare, compared to $1.6 million, or $0.45 per diluted share, for the secondquarter of Fiscal 2005.  For the firstsix months of Fiscal 2006, net income was $2.3 million, or $0.64 per dilutedshare, compared to $3.1 million, or $0.86 per diluted share, for the first sixmonths of Fiscal 2005.  Return on averageequity was 8.59% at December 31, 2005 compared to 11.72% atDecember 31, 2004.

 

Aspreviously reported, the Company closed on a $4.9 million land sale transactionin December 2005.  The gain on salerecognized was $3.6 million, which increased diluted earnings per share by$0.65.

 

Aspreviously announced, the Company downgraded a $4.1 million participation loanas of June 30, 2005.  A provisionfor loan and lease losses charge of $2.0 million, including a $1.75 millionimpaired loan valuation allowance, was recorded as of June 30, 2005.  On November 7, 2005, the participants inthe loan, including the Bank, agreed to sell their interests in the loan to athird party.  Accordingly, the Companyrecorded a charge of approximately $1.47 million in its second quarter ofFiscal 2006.  Part of the loanrelationship related to customer receivables was reclassified as held for saleuntil the completion of the sale of the loan, which occurred onDecember 23, 2005.  Due to theintraquarter information being updated at the time of the sale, the Companytook the additional $418,000 as a provision and charge-off to the allowance forloan and lease losses.  The effect of theadditional provision was to lower diluted earnings per share by $0.25.

 

Theallowance for loan and lease losses is calculated based on loan and leaselevels, loan and lease loss history, credit quality of the loan and leaseportfolio, and environmental factors such as economic health of the region andmanagement experience.  This risk ratinganalysis is designed to give the Company a consistent and systematicmethodology to determine proper levels for the allowance at a given time.  The allowance for loan and lease lossesincreased to $5.2 million at December 31, 2005, compared to $3.5 millionat December 31, 2004, an increase of $1.7 million or 47.2%.  The ratio of allowance for loan and leaselosses to total loans and leases was 0.73% as of December 31, 2005compared to 0.53% at December 31, 2004. Total nonperforming assets at December 31, 2005 were $4.6 millionas compared to $3.5 million a year ago, an increase of $1.1 million or 31.4%.  The ratio of nonperforming assets to totalassets increased to 0.50% at December 31, 2005, compared to 0.41% atDecember 31, 2004.

 

Thenet interest margin for the three months ended December 31, 2005 was2.98%, compared to 3.41% for the same period a year ago.  For the first six months of Fiscal 2006, thenet interest margin was 3.00%, compared to 3.36% for the same period a yearago.  The flattening of the treasuryyield curve caused by increasing short-term rates and lagging long-term ratescontinued to affect the Company’s net interest margin ratio during the quarter.  Variability of the net interest margin ratiomay be affected by many aspects, including Federal Reserve policies forshort-term interest rates, competitive and global economic factors and customerpreferences for various products and services. From December 31, 2004 to December 31, 2005, the FederalReserve increased short-term interest rates eight times at 25 basis pointseach, for a total increase of 200 basis points.

 

Netinterest margin in dollars for the first six months of Fiscal 2006 was $12.7million, which decreased by $616,000, or 4.6%, over the same period a yearago.  Net interest margin in dollarsdecreased $411,000, or 6.0%, to $6.4 million for the three months endedDecember 31, 2005 from $6.8 million for same period in the prior fiscalyear.  The change in net interest marginin dollars for the three and six months ended December 31, 2005 ascompared to the same period a year ago was due in large part to the recentincreases in the national prime rate. The national prime rate has increased steadily in increments of 25 basispoints each, from 4.00% at June 30, 2004 to 7.25% at December 31,2005.  In addition, the Company’s averageinterest-earning assets in volume through the first six months of Fiscal 2006have increased 6.9% from the same period a year ago.  For the same time period, averageinterest-bearing liabilities increased in volume by 7.1%.

 

15

----

 

Totaldeposits at December 31, 2005 were $725.7 million, an increase of $76.4million, or 11.8%, from December 31, 2004. Interest expense on these deposits was $9.1 million for the six monthsended December 31, 2005, an increase of $3.4 million, or 59.1%, over thesame period a year ago.  In-marketdeposits increased from $629.9 million at December 31, 2004 to $685.9million at December 31, 2005, an increase of $56.0 million, or 8.9%.  For the same period, out-of-market depositsincreased from $19.5 million to $39.9 million, respectively.  The primary factor affecting interest expensehas been money market accounts.  Thevolume of money market accounts increased by $22.9 million, or 11.0%, fromDecember 31, 2004, to December 31, 2005.  Interest expense for these accounts, whichare primarily indexed to the 91-day Treasury bill, also increased by $1.6million, or 88.9%, compared to the same period in the prior fiscal year.  With the actions taken by the FederalReserve, the 91-day Treasury bill has risen significantly from 2.21% atDecember 31, 2004 to 4.11% at December 31, 2005, an increase of 190basis points.

 

InOctober 2005, the Company announced an increase in its quarterly cashdividend, from 11.0 cents per share to 11.25 cents per share, resulting in anannualized increase of 2.3%.

 

Thetotal risk-based capital ratio of 10.66% at December 31, 2005 is below the10.91% at December 31, 2004, a decrease of 25 basis points.  Despite the decrease, this ratio remains thesame from the end of Fiscal 2005 and the first quarter of Fiscal 2006.  This performance continues to place the Bankin the “well capitalized” category within OTS regulation at December 31,2005 and is consistent within the “well capitalized” OTS category in which theCompany 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.

 

TheCompany focuses on balancing operating costs with operating revenue levels inorder to provide better efficiency ratios over time and continues to review itsoperations for ways to reduce its cost structure while continuing to supportlong-term revenue enhancements. Noninterest expense was $6.7 million for the quarter endedDecember 31, 2005 compared to $6.4 million at December 31, 2004, anincrease of 3.9%.  Compensation andemployee benefits expense accounted for an increase of $83,000 due to increasesin employee compensation and net healthcare costs.  However, noninterest income was $6.0 millionfor the quarter ended December 31, 2005 compared to $2.3 million for thequarter ended December 31, 2004, an increase of 156.0%.  This increase was primarily attributable tothe one-time gain on sale of land of $3.6 million.

 

TheCompany adopted FAS 123R effective as of July 1, 2005.  As a result, the Company recognized $88,000in stock option expense for the six months ended December 31, 2005compared to no expense recognized for stock options granted under the Company’sstock option and incentive plans for the same period a year ago.  The Company also recognized $196,000 inrestricted stock expense for the six months ended December 31, 2005,compared to $95,000 for the same period a year ago.

 

Theoperating efficiency ratio at December 31, 2005 was 71.98%, compared to68.53% for the same time period a year ago, an increase of 345 basispoints.  The operating efficiency ratioexcludes the impact of net interest expense on the variable priced trustpreferred securities and the one-time gain on sale of land.  The Company has issued trust preferredsecurities primarily to provide funding for stock repurchases and to repayother borrowings.  Interest expense onthe $27.8 million of trust preferred securities outstanding increased to $1.1million for the six months ended December 31, 2005, compared to $775,000for the same period a year ago, an increase of $280,000 or 36.1%.  The total efficiency ratio was 63.34% atDecember 31, 2005.  Excluding thegain from sale of land, the total efficiency ratio at December 31, 2005was 76.18%, compared to 71.42% for the same period a year ago, an increase of476 basis points.  Factors contributingto this increase in the efficiency ratio from a year ago include a $616,000reduction in net interest income and an increase of $596,000 in noninterest expensesfor the six months ended December 31, 2005 compared to the same period inthe 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 income include credit risk, liquidityrisk, operational risk, regulatory compliance risk and reputation risk.  The Company’s net income is derived bymanaging net interest margin, the ability to collect fees from services provided,by controlling the costs of delivering services and the management of loan andlease losses.  The primary source ofrevenues comes from the net interest margin, which represents the differencebetween income on interest-earning assets (i.e. loans and investmentsecurities) and expense on interest-bearing liabilities (i.e. deposits andborrowed funding).  The net interestmargin is affected by regulatory, economic and competitive factors thatinfluence interest rates, loan demand and deposit flows.  Fees earned include charges for depositservices, trust services and loan services. Personnel costs are the primary expenses required to deliver theservices to customers.  Other costsinclude occupancy and equipment and general and administrative expenses.

 

**FinancialCondition Data**

 

AtDecember 31, 2005, the Company had total assets of $934.1 million, anincrease of $36.2 million from the level at June 30, 2005.  The increase in assets was due primarily toincreases in net loans and leases receivable of $19.7 million, securitiesavailable for sale of $6.1 million, cash and cash equivalents of $4.5 millionand loans held for sale of $3.6 million. The increase in liabilities of $34.8 million from June 30, 2005 toDecember 31, 2005 was primarily due to an increase in deposits of $44.5million offset by a decrease in advances from the Federal Home Loan Bank of DesMoines (“FHLB”) and other borrowings of $12.2 million.  In addition, stockholders’ equity increased$1.4 million to $55.0 million at December 31, 2005 from $53.6 million atJune 30, 2005, primarily due to net income of $2.3 million.

 

Theincrease in net loans and leases receivable of $19.7 million was due primarilyto an increase in purchases and originations over sales, amortization andrepayments of principal**. **In addition, net deferred (fees),costs and discounts decreased $201,000 from the levels at June 30, 2005 to$1.1 million at December 31, 2005. This decrease was primarily due to an increase of $40,000 in commercialdeferred loan fees and decrease of $171,000 in indirect automobile loan coststhat include prepaid dealer reserves.

 

Theincrease in securities available for sale of $6.1 million was primarily theresult of purchases of $32.0 million exceeding sales, maturities and repaymentsof $24.0 million.  The purchases of $32.0million included variable-rate, mortgage-backed securities of $12.1 million.

 

Theincrease in cash and cash equivalents of $4.5 was primarily due to an increasein deposits of $44.5 million offset by a decrease in advances from the FHLB andother borrowings of $12.2 million.  Theremainder of the increase was primarily due to the timing of items in clearing.

 

Theincrease in loans held for sale of $3.6 million was primarily due to mortgageloans held for sale increasing from $9.8 million at June 30, 2005 to $11.1million at December 31, 2005 and student loans held for sale increasingfrom $400,000 at June 30, 2005 to $2.1 million at December 31,2005.  In addition, commercial loans heldfor sale increased $659,000.

 

Advances from the FHLBand other borrowings decreased $12.2 million, which was primarily due topaydowns of FHLB borrowings of $348.1 million exceeding new borrowings of$240.1 million.  The overall decrease inFHLB borrowings was primarily the result of a $44.5 million increase indeposits.

 

The$44.5 million increase in deposits was due to increases in money marketaccounts of $22.1 million, in-market certificates of deposit of $22.0 million,out-of-market certificates of deposit of $3.6 million and interest-bearingchecking accounts of $2.4 million offset by decreases in savings accounts of$3.5 million and noninterest-bearing checking accounts of $2.1 million.

 

17

----

 

 

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

 
| ** **                                       | ** ** | **At December 31, 2005** | ** ** | **At June 30, 2005**               | ** ** |
|--------------------------------------------------|------------|-------------------------------|------------|-----------------------------------------|------------|
| ** **                                       | ** ** | **Amount**                    | ** ** | **Percent of  Loans in  Each Category** | ** ** | **Amount** | ** ** | **Percent of  Loans in  Each Category** | ** ** |
| ** **                                       | ** ** | **(Dollars in Thousands)**    | ** ** |
| One-to four-family (1)                           |       | $                             | 94,560     |                                    | 13.59      | % | $ | 96,496 |   | 14.28 | % |
| Commercial business and real estate (2) (3) |       | 237,534                       |       | 34.16                                   | %          | 223,638 |   | 33.10 | % |
| Multi-family real estate                         |       | 33,834                        |       | 4.87                                    | %          | 34,123 |   | 5.05 | % |
| Equipment finance leases                         |       | 33,801                        |       | 4.86                                    | %          | 33,170 |   | 4.91 | % |
| Consumer Direct (4) (5)                     |       | 113,771                       |       | 16.36                                   | %          | 111,210 |   | 16.46 | % |
| Consumer Indirect                                |       | 94,781                        |       | 13.63                                   | %          | 93,984 |   | 13.91 | % |
| Agricultural                                     |       | 76,320                        |       | 10.97                                   | %          | 74,010 |   | 10.95 | % |
| Construction and development                     |       | 10,832                        |       | 1.56                                    | %          | 9,026 |   | 1.34 | % |
| Total Loans and  Leases Receivable (6)           |       | $                             | 695,433    |                                    | 100.00     | % | $ | 675,657 |   | 100.00 | % |
|                                                  |            |                               |            |                                         |            |  |  |  |  |  |  |  |  |  |

 

----

(1) Excludes$11,084 and $9,838 loans held for sale at December 31, 2005 and June 30,2005, respectively.

(2) Includes $3,563 taxexempt leases at December 31, 2005.

(3) Excludes $659 commercial loans held for saleat December 31, 2005.

(4) Includes mobile homeloans.

(5) Excludes$2,057 and $400 student loans held for sale at December 31, 2005 and June 30,2005, respectively.

(6) Includes deferred loan fees and discountsand undisbursed portion of loans in process.

 
| ** **                             | ** ** | **At December 31, 2005** | ** ** | **At June 30, 2005**                  | ** ** |
|----------------------------------------|------------|-------------------------------|------------|--------------------------------------------|------------|
| ** **                             | ** ** | **Amount**                    | ** ** | **Percent of  Deposits in  Each Category** | ** ** | **Amount** | ** ** | **Percent of  Deposits in  Each Category** | ** ** |
| ** **                             | ** ** | **(Dollars in Thousands)**    | ** ** |
|                                   |       |                          |       |                                       |       |   |   |   |   |
| Noninterest  bearing checking accounts |       | $                             | 83,593     |                                       | 11.53      | % | $ | 85,705 |   | 12.58 | % |
| Interest bearing  accounts             |       | 52,522                        |       | 7.24                                       | %          | 50,120 |   | 7.36 | % |
| Money market  accounts                 |       | 231,226                       |       | 31.86                                      | %          | 209,116 |   | 30.70 | % |
| Savings accounts                       |       | 59,732                        |       | 8.23                                       | %          | 63,235 |   | 9.28 | % |
| Certificates of  deposit               |       | 298,638                       |       | 41.15                                      | %          | 273,040 |   | 40.08 | % |
| Total Deposits                         |       | $                             | 725,711    |                                       | 100.00     | % | $ | 681,216 |   | 100.00 | % |

 

18

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**Analysisof Net Interest Income**

 

Net interest income represents the difference between income oninterest-earning assets and expense on interest-bearing liabilities.  Net interest income depends upon the volumeof interest-earning assets and interest-bearing liabilities and the interestrates earned or paid on them.

 

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

 
| ** **                                     | ** ** | **THREE MONTHS ENDED DECEMBER 31,** | ** ** |
|------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                     | ** ** | **2005**                                 | ** ** | **2004** | ** ** |
| ** **                                     | ** ** | **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)      |       | $                                        | 692,818    |   | $ | 11,593 |   | 6.64 | % | $ | 671,387 |   | $ | 10,204 |   | 6.03 | % |
| Investment  securities (2) (3)            |       | 150,788                                  |       | 1,491 |   | 3.92 | % | 113,906 |   | 996 |   | 3.47 | % |
| FHLB stock                                     |       | 7,289                                    |       | 59 |   | 3.21 | % | 6,576 |   | 49 |   | 2.96 | % |
|                                           |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Total  interest-earning assets                 |       | 850,895                                  |       | $ | 13,143 |   | 6.13 | % | 791,869 |   | $ | 11,249 |   | 5.64 | % |
| Noninterest-earning  assets                    |       | 73,186                                   |       |   |   |   |   | 66,704 |   |   |   |   |   |
| Total assets                                   |       | $                                        | 924,081    |   |   |   |   |   | $ | 858,573 |   |   |   |   |   |
|                                           |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:                 |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Deposits:                                      |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Checking and  money market                     |       | $                                        | 272,261    |   | $ | 1,987 |   | 2.90 | % | $ | 264,507 |   | $ | 1,077 |   | 1.62 | % |
| Savings                                        |       | 48,872                                   |       | 257 |   | 2.09 | % | 45,053 |   | 111 |   | 0.98 | % |
| Certificates of  deposit                       |       | 292,653                                  |       | 2,549 |   | 3.46 | % | 259,927 |   | 1,753 |   | 2.68 | % |
| Total  interest-bearing deposits               |       | 613,786                                  |       | 4,793 |   | 3.10 | % | 569,487 |   | 2,941 |   | 2.05 | % |
| FHLB advances  and other borrowings            |       | 127,876                                  |       | 1,414 |   | 4.39 | % | 115,391 |   | 1,102 |   | 3.79 | % |
| Subordinated  debentures payable to trusts     |       | 27,837                                   |       | 543 |   | 7.74 | % | 27,837 |   | 402 |   | 5.73 | % |
|                                           |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Total  interest-bearing liabilities            |       | 769,499                                  |       | 6,750 |   | 3.48 | % | 712,715 |   | 4,445 |   | 2.47 | % |
| Noninterest-bearing  deposits                  |       | 80,529                                   |       |   |   |   |   | 75,948 |   |   |   |   |   |
| Other  liabilities                             |       | 19,705                                   |       |   |   |   |   | 16,156 |   |   |   |   |   |
| Total  liabilities                             |       | 869,733                                  |       |   |   |   |   | 804,819 |   |   |   |   |   |
| Equity                                         |       | 54,348                                   |       |   |   |   |   | 53,754 |   |   |   |   |   |
| Total  liabilities and equity                  |       | $                                        | 924,081    |   |   |   |   |   | $ | 858,573 |   |   |   |   |   |
|                                           |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Net interest  income; interest rate spread (4) |       |                                     |       | $ | 6,393 |   | 2.65 | % |   |   | $ | 6,804 |   | 3.17 | % |
|                                           |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Net interest  margin (4) (5)              |       |                                     |       |   |   | 2.98 | % |   |   |   |   | 3.41 | % |
|                                           |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Net interest  margin, TE (6)                   |       |                                     |       |   |   | 3.02 | % |   |   |   |   | 3.43 | % |

 

----

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

(2) Includesfederal funds sold.

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

(4) Percentages for the three months ended December 31,2005 and December 31, 2004 have been annualized.

(5) Net interest marginis net interest income divided by average interest-earning assets.

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

 

19

----

 
| ** **                                     | ** ** | **SIX MONTHS ENDED DECEMBER 31,** | ** ** |
|------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                     | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| ** **                                     | ** ** | **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)      |       | $                                      | 688,398    |   | $ | 22,714 |   | 6.55 | % | $ | 667,444 |   | $ | 19,938 |   | 5.93 | % |
| Investment  securities (2) (3)            |       | 147,326                                |       | 2,834 |   | 3.82 | % | 115,068 |   | 1,917 |   | 3.30 | % |
| FHLB stock                                     |       | 7,133                                  |       | 67 |   | 1.86 | % | 6,228 |   | 84 |   | 2.68 | % |
|                                           |       |                                   |       |   |   |   |   |   |   |   |   |   |   |
| Total  interest-earning assets                 |       | 842,857                                |       | $ | 25,615 |   | 6.03 | % | 788,740 |   | $ | 21,939 |   | 5.52 | % |
| Noninterest-earning  assets                    |       | 70,140                                 |       |   |   |   |   | 66,326 |   |   |   |   |   |
| Total assets                                   |       | $                                      | 912,997    |   |   |   |   |   | $ | 855,066 |   |   |   |   |   |
|                                           |       |                                   |       |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:                 |       |                                   |       |   |   |   |   |   |   |   |   |   |   |
| Deposits:                                      |       |                                   |       |   |   |   |   |   |   |   |   |   |   |
| Checking and  money market                     |       | $                                      | 270,476    |   | $ | 3,774 |   | 2.77 | % | $ | 262,359 |   | $ | 1,972 |   | 1.49 | % |
| Savings                                        |       | 50,078                                 |       | 497 |   | 1.97 | % | 47,982 |   | 217 |   | 0.90 | % |
| Certificates of  deposit                       |       | 287,060                                |       | 4,818 |   | 3.33 | % | 261,680 |   | 3,523 |   | 2.67 | % |
| Total  interest-bearing deposits               |       | 607,614                                |       | 9,089 |   | 2.97 | % | 572,021 |   | 5,712 |   | 1.98 | % |
| FHLB advances  and other borrowings            |       | 126,090                                |       | 2,743 |   | 4.32 | % | 110,879 |   | 2,108 |   | 3.77 | % |
| Subordinated  debentures payable to trusts     |       | 27,837                                 |       | 1,055 |   | 7.52 | % | 27,837 |   | 775 |   | 5.52 | % |
| Total  interest-bearing liabilities            |       | 761,541                                |       | 12,887 |   | 3.36 | % | 710,737 |   | 8,595 |   | 2.40 | % |
| Noninterest-bearing  deposits                  |       | 78,016                                 |       |   |   |   |   | 73,288 |   |   |   |   |   |
| Other  liabilities                             |       | 19,360                                 |       |   |   |   |   | 18,020 |   |   |   |   |   |
| Total  liabilities                             |       | 858,917                                |       |   |   |   |   | 802,045 |   |   |   |   |   |
| Equity                                         |       | 54,080                                 |       |   |   |   |   | 53,021 |   |   |   |   |   |
| Total  liabilities and equity                  |       | $                                      | 912,997    |   |   |   |   |   | $ | 855,066 |   |   |   |   |   |
|                                           |       |                                   |       |   |   |   |   |   |   |   |   |   |   |
| Net interest  income; interest rate spread (4) |       |                                   |       | $ | 12,728 |   | 2.67 | % |   |   | $ | 13,344 |   | 3.12 | % |
|                                           |       |                                   |       |   |   |   |   |   |   |   |   |   |   |
| Net interest  margin (4) (5)              |       |                                   |       |   |   | 3.00 | % |   |   |   |   | 3.36 | % |
|                                           |       |                                   |       |   |   |   |   |   |   |   |   |   |   |
| Net interest  margin, TE (6)                   |       |                                   |       |   |   | 3.03 | % |   |   |   |   | 3.38 | % |

 

----

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

(2) Includesfederal funds sold.

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

(4) Percentages for the six months ended December 31,2005 and December 31, 2004 have been annualized.

(5) Net interest marginis net interest income divided by average interest-earning assets.

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

 

20

----

 

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

 

Thefollowing schedule presents the dollar amount of changes in interestincome and interest expense for major components of interest-earning assets andinterest-bearing liabilities.  Itdistinguishes between the increases and decreases due to fluctuating outstandingbalances that are due to the levels and volatility of interest rates.  For each category of interest-earning assetsand interest-bearing liabilities, information is provided on changesattributable to (i) changes in volume (i.e., changes in volume multipliedby old rate) and (ii) changes in rate (i.e., changes in rate multiplied byold volume).  For purposes of this table,changes attributable to both rate and volume, which cannot be segregated, havebeen allocated proportionately to the change due to volume and the change dueto rate.

 
| ** **                                 | ** ** | **Three Months Ended December 31,** | ** ** | **Six Months Ended December 31,** | ** ** |
|--------------------------------------------|------------|------------------------------------------|------------|----------------------------------------|------------|
| ** **                                 | ** ** | **2005 vs 2004**                         | ** ** | **2005 vs 2004**                       | ** ** |
| ** **                                 | ** ** | **Increase  Due to  Volume**             | ** ** | **Increase  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)           |       | $                                        | 326        |                                   | $          | 1,063 |   | $ | 1,389 |   | $ | 626 |   | $ | 2,150 |   | $ | 2,776 |   |
| Investment  securities (2)                 |       | 322                                      |       | 173                                    |       | 495 |   | 537 |   | 380 |   | 917 |   |
| FHLB stock                                 |       | 5                                        |       | 5                                      |       | 10 |   | 12 |   | (29 | ) | (17 | ) |
|                                       |       |                                     |       |                                   |       |   |   |   |   |   |   |   |   |
| Total  interest-earning assets             |       | $                                        | 653        |                                   | $          | 1,241 |   | $ | 1,894 |   | $ | 1,175 |   | $ | 2,501 |   | $ | 3,676 |   |
|                                       |       |                                     |       |                                   |       |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:             |       |                                     |       |                                   |       |   |   |   |   |   |   |   |   |
| Deposits:                                  |       |                                     |       |                                   |       |   |   |   |   |   |   |   |   |
| Checking and  money market                 |       | $                                        | 32         |                                   | $          | 878 |   | $ | 910 |   | $ | 61 |   | $ | 1,741 |   | $ | 1,802 |   |
| Savings                                    |       | 9                                        |       | 137                                    |       | 146 |   | 9 |   | 271 |   | 280 |   |
| Certificates of  deposit                   |       | 221                                      |       | 575                                    |       | 796 |   | 342 |   | 953 |   | 1,295 |   |
| Total  interest-bearing deposits           |       | 262                                      |       | 1,590                                  |       | 1,852 |   | 412 |   | 2,965 |   | 3,377 |   |
| FHLB advances  and other borrowings        |       | 119                                      |       | 193                                    |       | 312 |   | 289 |   | 346 |   | 635 |   |
| Subordinated  debentures payable to trusts |       | —                                   |       | 141                                    |       | 141 |   | — |   | 280 |   | 280 |   |
|                                       |       |                                     |       |                                   |       |   |   |   |   |   |   |   |   |
| Total  interest-bearing liabilities        |       | $                                        | 381        |                                   | $          | 1,924 |   | $ | 2,305 |   | $ | 701 |   | $ | 3,591 |   | $ | 4,292 |   |
|                                       |       |                                     |       |                                   |       |   |   |   |   |   |   |   |   |
| Net interest  income (decrease)            |       |                                     |       |                                   |       | $ | (411 | ) |   |   |   |   | $ | (616 | ) |

 

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

(2) Includesfederal funds sold.

 

21

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**Applicationof Critical Accounting Policies**

 

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

 

*Allowance for Loan and Lease Losses*– GAAP requires the Company to set aside reserves or maintain an allowanceagainst probable loan and lease losses in the loan and lease portfolio.  Management must develop a consistent andsystematic approach to estimate the appropriate balances that will cover theprobable losses.  Due to the uncertaintyof future events, the approach includes a process that may differ significantlyfrom other methodologies and still produce an estimate that is in accordancewith GAAP.

 

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

 

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

 

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

 

Due to the substantialdecline in interest rates over the last several fiscal years, the Company hasincluded MSRs as a critical accounting policy because the use of estimates fordetermining fair value using present value concepts may produce results whichmay significantly differ from other fair value analysis perhaps even to thepoint of recording impairment.  The riskto earnings is when the underlying mortgages payoff significantly faster thanthe assumptions used in the previously recorded amortization.  Estimating future cash flows on theunderlying mortgages is a difficult analysis and requires judgment based on thebest information available.  The Companylooks at alternative assumptions and projections when preparing a reasonableand supportable analysis.  Based on theCompany’s quarterly analysis of MSRs, there was no impairment to the MSRs at December 31,2005.

 

22

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*Retained Interest fromSecuritization* – The Company recorded an asset as aresult of the automobile securitization. See Note 4 of the “Notes to Unaudited Consolidated Financial Statements”which is included in Part I, Item I “Financial Statements” of thisQuarterly Report on Form 10-Q.  Thisasset was recorded based on present value concepts of future expected cashflows.  The assumptions used to calculatethe initial retained interest value and subsequent assumptions were based onthe best information available.  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.

 

*Self-Insurance*-The Company has a self-insured health plan for its employees up to certainlimits.  To mitigate a portion of theserisks, the Company has a stop-loss insurance policy through a commercialinsurance carrier for coverage in excess of $60,000 per individual occurrencewith a maximum aggregate limitation of $1.0 million.  The estimate of self-insurance liability isbased upon known claims and an estimate of incurred, but not reported (“IBNR”)claims.  IBNR claims are estimated usinghistorical claims lag information received by a third party claimsadministrator.  Due to the uncertainty ofhealth claims, the approach includes a process that may differ significantlyfrom other methodologies and still produce an estimate that is in accordance withGAAP.  Although management believes thatit uses the best information available to determine the accrual, unforeseenhealth claims could result in adjustments to the accrual.  These adjustments could significantly affectnet earnings if circumstances differ substantially from the assumptions used inestimating the accrual.

 

**AssetQuality and Potential Problem Loans and Leases**

 

Nonperforming assets(nonaccrual loans and leases, accruing loans and leases delinquent more than 90days and foreclosed assets) decreased to $4.6 million at December 31, 2005from $7.0 million at June 30, 2005, a decrease of $2.4 million, or34.1%.  Nonaccruing loans and leasesdecreased $3.2 million to $2.1 million at December 31, 2005 from $5.3million at June 30, 2005.  Inaddition, the ratio of nonperforming assets to total assets, which is oneindicator of credit risk exposure, decreased to 0.50% at December 31, 2005from 0.78% at June 30, 2005.

 

Nonaccruing loans andleases decreased 60.8%, or $3.2 million, to $2.1 million at December 31,2005 compared to $5.3 million at June 30, 2005.  Included in nonaccruing loans and leases at December 31,2005 were seven loans totaling $507,000 secured by one- to four-family realestate, nine loans totaling $871,000 secured by commercial business, one leasetotaling $119,000, 35 consumer loans totaling $422,000 and one agriculture loantotaling $167,000.

 

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

 

As of December 31,2005, the Company had $142,000 of foreclosed assets.  The balance of foreclosed assets at December 31,2005 consisted of $1,000 of single-family collateral owned and $141,000 ofconsumer collateral owned.

 

At December 31,2005, the Company had designated $7.6 million of its assets as special mentionand classified $6.0 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 December 31, 2005 the Company had $18.5 million in multi-family,commercial business, commercial real estate and agricultural participationloans purchased, of which $679,000 were classified as of December 31,2005.  These loans and leases wereconsidered in determining the adequacy of the allowance for loan and leaselosses.  The allowance for loan and leaselosses is established based on management’s evaluation of the risks probable inthe loan and lease portfolio and changes in the nature and volume of loan andlease activity.  Such evaluation, whichincludes a review of all loans and leases for which full collectibility may notbe reasonably assured, considers the estimated fair market value of theunderlying collateral, present value of expected principal and interestpayments, economic conditions, historical loss experience and other factorsthat warrant recognition in providing for an adequate loan and lease lossallowance.

 

23

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Althoughthe Company’s management believes that the December 31, 2005 recordedallowance for loan and lease losses was adequate to provide for probable losseson the related loans and leases, there can be no assurance that the allowanceexisting at December 31, 2005 will be adequate in the future.

 

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

 
| ** **                                                                      | ** ** | **Nonperforming Assets As Of** | ** ** |
|---------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                      | ** ** | **December 31,  2005**    | ** ** | **June 30,  2005** | ** ** |
| ** **                                                                      | ** ** | **(Dollars  in Thousands)**    | ** ** |
| Nonaccruing loans and leases:                                                   |       |                           |       |   |   |
| One - to  four-family                                                           |       | $                              | 507        |   | $ | 263 |   |
| Commercial real  estate                                                         |       | —                         |       | 70 |   |
| Commercial  business                                                            |       | 871                            |       | 4,518 |   |
| Equipment  finance leases                                                       |       | 119                            |       | 130 |   |
| Consumer (1)                                                                    |       | 422                            |       | 341 |   |
| Agricultural                                                                    |       | 167                            |       | — |   |
| Total                                                                           |       | 2,086                          |       | 5,322 |   |
|                                                                            |       |                           |       |   |   |
| Accruing loans and leases delinquent more than 90  days:                        |       |                           |       |   |   |
| One - to  four-family                                                           |       | 369                            |       | 98 |   |
| Commercial real  estate                                                         |       | 403                            |       | 292 |   |
| Commercial  business                                                            |       | 1,200                          |       | 1,052 |   |
| Equipment  finance leases                                                       |       | 44                             |       | 71 |   |
| Consumer (1)                                                                    |       | 1                              |       | — |   |
| Agricultural                                                                    |       | 381                            |       | 96 |   |
| Total                                                                           |       | 2,398                          |       | 1,609 |   |
|                                                                            |       |                           |       |   |   |
| Foreclosed assets: (2)                                                          |       |                           |       |   |   |
| One - to  four-family                                                           |       | 1                              |       | 39 |   |
| Equipment  finance leases                                                       |       | —                         |       | — |   |
| Consumer (1)                                                                    |       | 141                            |       | 50 |   |
| Total                                                                           |       | 142                            |       | 89 |   |
|                                                                            |       |                           |       |   |   |
| Total nonperforming assets                                                      |       | $                              | 4,626      |   | $ | 7,020 |   |
|                                                                            |       |                           |       |   |   |
| Ratio of nonperforming assets to total assets                                   |       | 0.50                           | %          | 0.78 | % |
|                                                                            |       |                           |       |   |   |
| Ratio of nonperforming loans and leases to total  loans and leases (3) (4) |       | 0.63                           | %          | 1.01 | % |

 

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(1)   Includes mobile home loans.

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

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

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

 

24

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

 
| ** **                                                                                               | ** ** | **Six Months Ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                               | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| ** **                                                                                               | ** ** | **(Dollars in Thousands)**             | ** ** |
|                                                                                                     |       |                                   |       |   |   |
| Balance at  beginning of period                                                                          |       | $                                      | 5,076      |   | $ | 3,605 |   |
| Charge-offs:                                                                                             |       |                                   |       |   |   |
| One - to  four-family                                                                                    |       | (1                                     | )          |  — |   |
| Commercial  business                                                                                     |       | (3,242                                 | )          | (126 | ) |
| Equipment  finance leases                                                                                |       | (17                                    | )          | (11 | ) |
| Consumer (1)                                                                                             |       | (542                                   | )          | (540 | ) |
| Agriculture                                                                                              |       | (350                                   | )          | (14 | ) |
| Total  charge-offs                                                                                       |       | (4,152                                 | )          | (691 | ) |
|                                                                                                     |       |                                   |       |   |   |
| Recoveries:                                                                                              |       |                                   |       |   |   |
| One - to  four-family                                                                                    |       | 1                                      |       | 8 |   |
| Commercial real  estate                                                                                  |       |  —                           |       |  — |   |
| Commercial  business                                                                                     |       |  —                           |       | 25 |   |
| Equipment  finance leases                                                                                |       | 39                                     |       | 1 |   |
| Consumer (1)                                                                                             |       | 118                                    |       | 119 |   |
| Agriculture                                                                                              |       |  —                           |       | 72 |   |
| Total recoveries                                                                                         |       | 158                                    |       | 225 |   |
|                                                                                                     |       |                                   |       |   |   |
| Net  (charge-offs)                                                                                       |       | (3,994                                 | )          | (466 | ) |
|                                                                                                     |       |                                   |       |   |   |
| Additions  charged to operations                                                                         |       | 4,092                                  |       | 375 |   |
|                                                                                                     |       |                                   |       |   |   |
| Balance at end  of period                                                                                |       | $                                      | 5,174      |   | $ | 3,514 |   |
|                                                                                                     |       |                                   |       |   |   |
| Ratio of net  (charge-offs) during the period to average loans and leases outstanding  during the period |       | (0.58                                  | )%         | (0.07 | )% |
|                                                                                                     |       |                                   |       |   |   |
| Ratio of  allowance for loan and lease losses to total loans and leases at end of  period (2)            |       | 0.73                                   | %          | 0.53 | % |
|                                                                                                     |       |                                   |       |   |   |
| Ratio of  allowance for loan and lease losses to nonperforming loans and leases at end  of period (3)    |       | 115.39                                 | %          | 110.68 | % |

 

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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 and leases delinquent more than 90 days. |

 

25

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

** **
| ** **                | ** ** | **FASB 5**                     | ** ** | **FASB 114**               | ** ** | **FASB 5**        | ** ** | **FASB 114**       | ** ** |
|---------------------------|------------|--------------------------------|------------|----------------------------|------------|-------------------|------------|--------------------|------------|
| ** **                | ** ** | **Allowance**                  | ** ** | **Impaired  Loan**         | ** ** | **Allowance**     | ** ** | **Impaired  Loan** | ** ** |
| ** **                | ** ** | **for Loan  and**              | ** ** | **Valuation**              | ** ** | **for Loan  and** | ** ** | **Valuation**      | ** ** |
| ** **                | ** ** | **Lease  Losses**              | ** ** | **Allowance**              | ** ** | **Lease  Losses** | ** ** | **Allowance**      | ** ** |
| **Loan Type**             | ** ** | **At  December 31, 2005** | ** ** | **At  June 30, 2005** | ** ** |
| ** **                | ** ** | **(Dollars  in Thousands)**    | ** ** |
| One- to  four-family      |       | $                              | 182        |                       | $          | —            |       | $                  | 186        |   | $ | — |   |
| Commercial real  estate   |       | 283                            |       | —                     |       | 200               |       | —             |       |
| Multi-family  real estate |       | 72                             |       | —                     |       | 61                |       | —             |       |
| Commercial business       |       | 2,150                          |       | —                     |       | 844               |       | 1,750              |       |
| Equipment  finance leases |       | 649                            |       | —                     |       | 359               |       | —             |       |
| Consumer (1)              |       | 1,434                          |       | —                     |       | 1,343             |       | —             |       |
| Agricultural              |       | 404                            |       | —                     |       | 333               |       | —             |       |
| Total                     |       | $                              | 5,174      |                       | $          | —            |       | $                  | 3,326      |   | $ | 1,750 |   |

 

----

(1)   Includes mobile home loans.

 

**FASB 114 Impaired Loan Summary**

** **
| ** **          | ** ** | ** **                     | ** ** | ** **                 | ** ** | **Impaired**  | ** ** | ** **    | ** ** | ** **  | ** ** | **Impaired**  | ** ** |
|---------------------|------------|--------------------------------|------------|----------------------------|------------|---------------|------------|---------------|------------|-------------|------------|---------------|------------|
| ** **          | ** ** | **Number**                     | ** ** | ** **                 | ** ** | **Loan**      | ** ** | **Number**    | ** ** | ** **  | ** ** | **Loan**      | ** ** |
| ** **          | ** ** | **of Loan**                    | ** ** | **Loan**                   | ** ** | **Valuation** | ** ** | **of Loan**   | ** ** | **Loan**    | ** ** | **Valuation** | ** ** |
| ** **          | ** ** | **Customers**                  | ** ** | **Balance**                | ** ** | **Allowance** | ** ** | **Customers** | ** ** | **Balance** | ** ** | **Allowance** | ** ** |
| **Loan Type**       | ** ** | **At  December 31, 2005** | ** ** | **At  June 30, 2005** | ** ** |
| ** **          | ** ** | **(Dollars in Thousands)**     | ** ** | **(Dollars in Thousands)** | ** ** |
| Commercial business |       | 4                              |       | $                          | 831        |          | $          |  —  |       | 4           |       | $             | 4,152      |   | $ | 1,750 |   |
| Total               |       | 4                              |       | $                          | 831        |          | $          |  —  |       | 4           |       | $             | 4,152      |   | 1,750 |   |
|                     |            |                                |            |                            |            |               |            |               |            |             |            |               |            |  |  |  |  |

 

26

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The allowance for loanand lease losses was $5.2 million at December 31, 2005 as compared to $3.5million at December 31, 2004.  Theratio of the allowance for loan and lease losses to total loans and leases was0.73% at December 31, 2005 compared to 0.53% at December 31,2004.  The Company’s management hasconsidered nonperforming loans and leases and potential problem loans andleases in establishing the allowance for loan and lease losses.  The Company continues to monitor itsallowance for probable loan and lease losses and make future additions orreductions in light of the level of loans and leases in its portfolio and aseconomic conditions dictate.  Thecurrent level of the allowance for loan and lease losses is a result ofmanagement’s assessment of the risks within the portfolio based on the informationrevealed in credit reporting processes. The Company utilizes a risk-ratingsystem on all commercial business, agricultural, construction and multi-familyand commercial real estate loans, including purchased loans.  A periodic credit review is performed on alltypes of loans and leases to establish the necessary reserve based on theestimated risk within the portfolio. This assessment of risk takes into accountthe composition of the loan and lease portfolio, historical loss experience foreach loan and lease category, previous loan and lease experience,concentrations of credit, current economic conditions and other factors that inmanagement’s judgment deserve recognition.

 

Realestate properties acquired through foreclosure are recorded at thelower of cost or fair value (less a deduction for disposition costs).  Valuations are periodically updated bymanagement and a specific provision for losses on such properties isestablished by a charge to operations if the carrying values of the propertiesexceed their estimated net realizable values.

 

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

 

27

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** **

**Comparison of the Three MonthsEnded December 31, 2005 and December 31, 2004**

 

*General*.  The Company’s net income was $1.3 million, or$0.36 for both basic and diluted earnings per share for the three months ended December 31,2005, a $349,000 decrease in earnings compared to $1.6 million, or $0.46 forbasic and $0.45 for diluted earnings per share for the same period in the priorfiscal year.  For the three months ended December 31,2005, the return on average equity was 9.56%, a 22.0% decrease compared to12.26% for the same period in the prior fiscal year.  For the three months ended December 31,2005, the return on average assets was 0.56%, a 27.3% decrease compared to0.77% for the same 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 $411,000 and increases in provision for losses on loans andleases of $3.4 million and noninterest expense of $253,000 offset by anincrease in noninterest income of $3.7 million and a decrease in income taxexpense of $99,000.

 

*Interest, Dividend and Loan FeeIncome.*  Interest, dividendand loan fee income was $13.1 million for the three months ended December 31,2005 as compared to $11.2 million for the same period in the prior fiscal year,an increase of $1.9 million or 16.8%.  A$1.1 million increase in interest, dividend and loan fee income was the resultof an increase in the average yield on loans and leases receivable from 6.03%for the three months ended December 31, 2004 to 6.64% for the three monthsended December 31, 2005 and a $326,000 increase in interest, dividend andloan fee income was due to a 3.2% increase in the average volume of loans andleases receivable. The average yield on total interest-earning assets was 6.13%for the three months ended December 31, 2005 as compared to 5.64% for thesame period in the prior fiscal year.

 

*InterestExpense.*  Interestexpense was $6.8 million for the three months ended December 31, 2005 ascompared to $4.4 million for the same period in the prior fiscal year, anincrease of $2.3 million or 51.9%.  A$1.6 million increase in interest expense was the result of an increase inaverage rate paid on interest-bearing deposits from 2.05% for the three monthsended December 31, 2004 to 3.10% for the three months ended December 31,2005.  A $193,000 increase in interestexpense was a result of the average rate paid on FHLB advances and otherborrowings increasing from 3.79% for the three months ended December 31,2004 to 4.39% for the three months ended December 31, 2005 and a $119,000increase in interest expense was the result of a 10.8% increase in the averagebalance of FHLB advances and other borrowings. An increase of $1.9 million in interest expense was the result of anincrease in the average rate paid on total interest-bearing liabilities from2.47% for the three months ended December 31, 2004 to 3.48% for the threemonths ended December 31, 2005.

 

*NetInterest Income.* The Company’s net interest income for thethree months ended December 31, 2005 decreased $411,000, or 6.0%, to $6.4million compared to $6.8 million for the same period in the prior fiscalyear.  The decrease in net interestincome was due primarily to an increase in the average rate paid oninterest-bearing liabilities for the three months ended December 31, 2005compared to the same period in the prior fiscal year offset by an increase inthe average yield on interest earning assets for the three months ended December 31,2005 compared to the same period in the prior fiscal year.  The Company’s net interest margin was 2.98%for the second quarter of Fiscal 2006 as compared to 3.41% for the same periodin the prior fiscal year.

 

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

 

During the three monthsended December 31, 2005, the Company recorded a provision for losses onloans and leases of $3.6 million compared to $196,000 for the three monthsended December 31, 2004, an increase of $3.4 million.  See “Asset Quality” for further discussion.

 

28

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*Noninterest Income.*  Noninterest income was $6.0 million for thethree months ended December 31, 2005 as compared to $2.3 million for thesame period in the prior fiscal year, an increase of $3.7 million, or156.1%.  The increase in noninterestincome was due primarily to a one-time gain on sale of land of $3.6million.  In addition, there wereincreases in fees on deposits of $43,000 and trust income of $28,000 offset bya decrease in loan servicing income of $100,000.

 

Net gain on sale of land was $3.6 million for the three months ended December 31,2005 due to the completion of a land sale transaction during the second quarterof Fiscal 2006.

 

Fees on depositsincreased $43,000 primarily due to an increase in fees collected on point-of-salepurchases by customers.  The remainingincrease in fees on deposits is comprised of various other deposit fee income.

 

Trust income increased$28,000 primarily due to assets under management increasing from $92.9 millionat December 31, 2004 to $106.5 million at December 31, 2005.

 

Loan servicing income decreased $100,000 from $409,000 for the threemonths ended December 31, 2004 to $309,000 for the three months ended December 31,2005 primarily due to a decrease in the number of loans serviced by the Bank.

 

*Noninterest Expense.*  Noninterest expense was $6.7 million for thethree months ended December 31, 2005 as compared to $6.4 million for thethree months ended December 31, 2004. The increase in noninterest expense was primarily due to increases incompensation and employee benefits of $83,000, occupancy and equipment of$63,000 and other noninterest expense of $107,000.

 

Compensation andemployee benefits increased $83,000, or 2.0%, to $4.2 million for the threemonths ended December 31, 2005 as compared to $4.1 million for the threemonths ended December 31, 2004.  Nethealthcare costs, inclusive of health claims and administration fees offset bystop loss and employee reimbursement under the Company’s self-insured healthplan were $409,000 for the three months ended December 31, 2005, anincrease of $196,000, or 92.0% compared to the same period in the prior fiscalyear.  In addition, compensation andemployee benefits decreased $110,000 for employee bonus expense.

 

Occupancy and equipment expense increased $63,000 for the three monthsended December 31, 2005 compared to the same period in the prior fiscalyear primarily due to increases in depreciation expense of $27,000 andmaintenance expenses of $10,000.

 

Other noninterest expense increased $107,000 for the three months endedDecember 31, 2005 compared to the same period in the prior fiscal yearprimarily due to increases in advertising of $61,000, advantage expense of$37,000, legal expense of $35,000, computer service expense of $21,000, andfreight and courier expense of $21,000 and offset by a decrease incontributions of $81,000.

 

*Income tax expense.*  The Company’s income tax expense for thethree months ended December 31, 2005 decreased $99,000 or 11.5% to$761,000 compared to $860,000 for the same period in the prior fiscalyear.  The effective tax rate was 36.9%and 34.3% for the three months ended December 31, 2005 and December 31,2004, respectively.  The increase in theeffective tax rate for the quarter was the result of an increase in theexpected effective tax rate for Fiscal 2006 due to permanent tax differences.

 

29

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** **

**Comparison of the Six MonthsEnded December 31, 2005 and December 31, 2004**

 

*General*.  The Company’s net income was $2.3 million, or$0.66 for basic and $0.64 for diluted earnings per share for the six monthsended December 31, 2005, a $786,000 decrease in earnings compared to $3.1million, or $0.88 for basic and $0.86 for diluted earnings per share for thesame period in the prior fiscal year. For the six months ended December 31, 2005, the return on averageequity was 8.59%, a 26.7% decrease compared to 11.72% for the same period inthe prior fiscal year.  For the sixmonths ended December 31, 2005, the return on average assets was 0.51%, a30.1% decrease compared to 0.73% for the same period in the prior fiscalyear.  As discussed in more detail below,the decreases were due to a variety of key factors, including a decrease in netinterest income of $616,000 and increases in provision for losses on loans andleases of $3.7 million and noninterest expense of $596,000 offset by anincrease in noninterest income of $3.8 million and a decrease in income taxexpense of $306,000.

 

*Interest, Dividend and Loan FeeIncome.*  Interest, dividendand loan fee income was $25.6 million for the six months ended December 31,2005 as compared to $21.9 million for the same period in the prior fiscal year,an increase of $3.7 million or 16.8%.  A$2.2 million increase in interest, dividend and loan fee income was the resultof an increase in the average yield on loans and leases receivable from 5.93%for the six months ended December 31, 2004 to 6.55% for the six monthsended December 31, 2005 and a $626,000 increase in interest, dividend andloan fee income was due to a 3.1% increase in the average volume of loans andleases receivable. The average yield on total interest-earning assets was 6.03%for the six months ended December 31, 2005 as compared to 5.52% for thesame period in the prior fiscal year.

 

*InterestExpense.*  Interestexpense was $12.9 million for the six months ended December 31, 2005 ascompared to $8.6 million for the same period in the prior fiscal year, anincrease of $4.3 million or 49.9%.  A$3.0 million increase in interest expense was the result of an increase inaverage rate paid on interest-bearing deposits from 1.98% for the six monthsended December 31, 2004 to 2.97% for the six months ended December 31,2005.  A $346,000 increase in interestexpense was a result of the average rate paid on FHLB advances and otherborrowings increasing from 3.77% for the six months ended December 31,2004 to 4.32% for the six months ended December 31, 2005 and a $289,000increase in interest expense was the result of a 13.7% increase in the averagebalance of FHLB advances and other borrowings and.  An increase of $3.6 million in interestexpense was the result of an increase in the average rate paid on totalinterest-bearing liabilities from 2.40% for the six months ended December 31,2004 to 3.36% for the six months ended December 31, 2005.

 

*NetInterest Income.* The Company’s net interest income for thesix months ended December 31, 2005 decreased $616,000, or 4.6%, to $12.7million compared to $13.3 million for the same period in the prior fiscalyear.  The decrease in net interestincome was due primarily to an increase in the average rate paid oninterest-bearing liabilities for the six months ended December 31, 2005compared to the same period in the prior fiscal year offset by an increase inthe average yield on interest earning assets for the six months ended December 31,2005 compared to the same period in the prior fiscal year.  The Company’s net interest margin was 3.00%for the first half of Fiscal 2006 as compared to 3.36% for the same period inthe prior fiscal year.

 

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

 

During the six monthsended December 31, 2005, the Company recorded a provision for losses onloans and leases of $4.1 million compared to $375,000 for the six months ended December 31,2004, an increase of $3.7 million.  See “AssetQuality” for further discussion.

 

30

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*NoninterestIncome.*  Noninterestincome was $8.4 million for the six months ended December 31, 2005 ascompared to $4.5 million for the same period in the prior fiscal year, anincrease of $3.8 million or 84.6%.  Theincrease in noninterest income was due primarily to a gain on sale of land of$3.6 million along with increases in gain on sale of loans of $138,000, fees ondeposits of $99,000 and trust income of $64,000 offset by a decrease in loanservicing income of $160,000.

 

Net gain on sale of landwas $3.6 million due to the completion of a land sale transaction in the secondquarter of Fiscal 2006.

 

Net gain on sale of loanswas $474,000 for the six months ended December 31, 2005 as compared to$336,000 for the same period in the prior fiscal year, an increase of $138,000or 41.1%.  The increase was primarily dueto an increase in residential mortgage loan production of 21.6% in dollarvolume for the six months ended December 31, 2005 as compared to the sameperiod in the prior fiscal year.

 

Feeson deposits increased $99,000 primarily due to an increase in fees collected onpoint-of-sale purchases by customers. The remaining increase in fees on deposits is comprised of various otherdeposit fee income.

 

Trustincome increased $64,000 primarily due to assets under management increasingfrom $92.9 million at December 31, 2004 to $106.5 million at December 31,2005.

 

Loan servicing incomedecreased $160,000 from $781,000 for the six months ended December 31,2004 to $621,000 for the six months ended December 31, 2005 primarily dueto a decrease in the number of loans serviced by the Bank.

 

*NoninterestExpense.*  Noninterestexpense was $13.4 million for the six months ended December 31, 2005 ascompared to $12.8 million for the six months ended December 31, 2004.  The increase in noninterest expense wasprimarily due to increases in compensation and employee benefits $388,000 andother noninterest expense of $148,000.

 

Compensation and employee benefits increased $388,000,or 4.8%, to $8.5 million for the six months ended December 31, 2005 ascompared to $8.1 million for the six months ended December 31, 2004.  Net healthcare costs, inclusive of healthclaims and administration fees offset by stop loss and employee reimbursementunder the Company’s self-insured health plan were $828,000 for the six monthsended December 31, 2005, an increase of $234,000, or 39.4% compared to thesame period in the prior fiscal year.  Inaddition, compensation and employee benefits increased $60,000 for training andtuition expenses with the remainder of the increase being primarily due tomerit increases, bonuses and additional staffing over the prior year.

 

Other noninterest expenseincreased $148,000 for the six months ended December 31, 2005 compared tothe same period in the prior fiscal year primarily due to increases in computerservice expense of $55,000, advantage expense of $52,000, freight and courierexpense of $41,000 and advertising of $37,000 offset by a decrease incontributions of $71,000.

 

*Income tax expense.*  The Company’s income tax expense for the sixmonths ended December 31, 2005 decreased $306,000 or 18.8% to $1.3 millioncompared to $1.6 million for the same period in the prior fiscal year.  The effective tax rate was 36.3% and 34.4%for the six months ended December 31, 2005 and December 31, 2004,respectively.  The increase in theeffective tax rate was the result of an increase in the expected effective taxrate for Fiscal 2006 due to permanent tax differences.

 

31

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** **

**Liquidityand Capital Resources**

 

The Bank’s primarysources of funds are earnings, in-market deposits, FHLB advances and otherborrowings, 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 loanpayments and maturing securities are relatively predictable, deposit flows andloan and security prepayments are more influenced by interest rates, generaleconomic conditions and competition. The Bank attempts to price its deposits tomeet its asset/liability objectives consistent with local marketconditions.  Excess balances are investedin overnight funds.

 

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

 

The Bank anticipates thatit will have sufficient funds available to meet current loan commitments.  At December 31, 2005, the Bank hadoutstanding commitments to originate residential mortgage loans of $19.2million, commercial real estate loans of $8.1 million and commercial businessloans of $5.7 million.  In addition, theBank had outstanding commitments to sell residential mortgage loans of $14.5million, commercial business loans of $659,000 and consumer student loans of$2.1 million.  Commitments by the Bank tooriginate loans are not necessarily executed by the customer.  The Bank monitors the ratio of commitments tofunding for use in liquidity management. At December 31, 2005, the Bank had no commitments to purchase orsell securities available for sale.

 

Althoughin-market deposits are the Bank’s primary source of funds, the Bank’s policyhas been to utilize borrowings where the funds can be invested in either loansor securities at a positive rate of return or to use the funds for short-termliquidity purposes.  The Bank currentlyhas two unsecured lines of federal funds totaling $25.0 million withcorrespondent banks.  There were no fundsdrawn on either line of credit at December 31, 2005.  Additionally, as of December 31, 2005,the Bank had $39.1 million in out-of-market certificates of deposit and$708,000 in out-of-market money market accounts.  The Bank may also seek other sources ofcontingent liquidity including additional federal funds purchased lines withcorrespondent banks and lines of credit with the Federal Reserve Bank.

 

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

 

TheCompany currently has in effect a stock buyback program in which up to 10% ofthe common stock of the Company outstanding on May 1, 2005 may be acquiredthrough April 30, 2006.  As of December 31,2005, a total of 47,300 shares of common stock have been purchased pursuant tothe current program, all of which were purchased during May and June 2005.  See Part II, Item 2 “Unregistered Salesof Equity Securities and Use of Proceeds” of this Form 10-Q.

 

Savingsinstitutions insured by the Federal Deposit Insurance Corporation are requiredby the Financial Institutions Reform, Recovery and Enforcement Act of 1989 tomeet three regulatory capital requirements. If a requirement is not met, regulatory authorities may take legal oradministrative actions, including restrictions on growth or operations or, inextreme cases, seizure.  Institutions notin compliance may apply for an exemption from the requirements and submit arecapitalization plan.  Under thesecapital requirements, at December 31, 2005, the Bank met all currentcapital requirements.

 

The minimum OTS Tier 1(core) capital requirement for well-capitalized institutions is 5.00% of totaladjusted assets for thrifts.  The Bankhad Tier 1 (core) capital of 7.96% at December 31, 2005.  The minimum OTS total risk-based capitalrequirement for well-capitalized institutions is 10.00% of risk-weightedassets.  The Bank had total risk-basedcapital of 10.66% at December 31, 2005.

 

32

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**Off-BalanceSheet Financing Arrangements**

 

During the fiscalyear ended June 30, 2003, the Bank securitized and sold consumerautomobile loans in the amount of $50.0 million through HFSC and AutomobileSecuritization Trust.  As part of thesales transaction, the Bank retained servicing responsibilities and a retainedinterest in the receivables, which is subordinated to third party investors’interests.  The receivables were soldwithout legal recourse.  The saleprovided the Bank with an additional source of liquidity at interest rates morefavorable than it could receive through other forms of financing.  It also assisted in reducing capitalrequirements and credit risk to the Bank, in addition to giving the Bank accessto the national capital markets.  TheCompany had the option to execute a cleanup call when the total outstandingbalance was at 10% or less of the original pool balance, or $5.0 million.  On November 9, 2005, the Bank exercisedits option to execute a cleanup call by purchasing the outstanding principalbalances of the securitized motor vehicle installment loans.  See Note 4 of the “Notes to ConsolidatedFinancial Statements” which is included in Part I, Item 1 “FinancialStatements” of this Form 10-Q for further detail.

 

**Impact ofInflation and Changing Prices**

 

Theunaudited consolidated financial statements and notes thereto presented in thisQuarterly Report on Form 10-Q have been prepared in accordance with GAAP,which require the measurement of financial position and operating results interms of historical dollars without considering the change in the relativepurchasing power of money over time due to inflation.  The impact of inflation is reflected in theincreased cost of the Bank’s operations. Unlike most industrial companies,nearly all the assets and liabilities of the Bank are monetary in nature.  As a result, interest rates have a greater impacton the Bank’s performance than do the effects of general levels ofinflation.  Interest rates do notnecessarily move in the same direction or to the same extent as the prices ofgoods and services.

 

**RecentAccounting Pronouncements**

 

In December 2004, FASB issued SFAS No. 123R, “Share-BasedPayment”, which requires all companies to measure compensation costs for allshare-based payments (including stock options) at fair value.  The Company adopted SFAS No. 123Reffective as of July 1, 2005.

 

SFAS No. 123R provides two alternatives for adoption: (1) a“modified prospective” method in which compensation costs is recognized for allawards granted subsequent to the effective date of this statement as well asfor the unvested portion of awards outstanding as of the effective date, and (2) a“modified retrospective” method which follows the approach in the “modifiedprospective” method, but also permits entities to restate prior periods toreflect compensation cost calculated under SFAS No. 123 for pro forma amountsdisclosure.  The Company adopted theBlack-Scholes option-pricing model and the modified prospective method.

 

In May 2005,FASB issued SFAS No. 154, “Accounting Changes and Error Corrections”,which requires that a voluntary change in accounting principle be appliedretrospectively with all prior period financial statements presented, unless itis impracticable to do so.  The newstandard is effective for accounting changes and correction of errors made infiscal years beginning after December 15, 2005.  The Company has not determined the effect theadoption of SFAS No. 154 will have on its consolidated financialstatements.

 

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** **

**Item 3.  Quantitative and Qualitative DisclosuresAbout Market Risk**

 

The Company’s net incomeis largely dependent on its net interest income.  Net interest income is susceptible tointerest rate risk to the degree that interest-bearing liabilities with short-and medium-term maturities mature or reprice more rapidly than its interest-earningassets.  When interest-bearingliabilities mature or reprice more quickly than interest-earning assets in agiven period, a significant increase in market rates of interest couldadversely affect net interest income. Similarly, when interest-earning assets mature or reprice more quicklythan interest-bearing liabilities, falling interest rates could result in adecrease in net income.

 

Inan attempt to manage its exposure to change in interest rates, managementmonitors the Company’s interest rate risk. The Company’s Asset-Liability Committee meets periodically to review theCompany’s interest rate risk position and profitability, and to recommendadjustments for consideration by executive management. Management also reviewsthe Bank’s securities portfolio, formulates investment strategies, and overseesthe timing and implementation of transactions to assure attainment of the Board’sobjectives in the most effective manner. In managing market risk and the asset/liability mix, the Bank has placedits emphasis on developing a portfolio in which, to the extent practicable,assets and liabilities reprice within similar periods.  Notwithstanding the Company’s interest raterisk management activities, the potential for changing interest rates is an uncertaintythat can have an adverse effect on net income. The Company does not currently engage in trading activities or usederivative instruments to control interest rate risk although it may in thefuture, if necessary, to manage interest rate risk.

 

In adjusting the Company’sasset/liability position, management attempts to manage the Company’s interestrate risk while enhancing net interest margins. At times, depending on the level of general interest rates, therelationship between long and short-term interest rates, market conditions andcompetitive factors, management may determine to increase the Company’sinterest rate risk position somewhat in order to increase its net interestmargin.

 

Asset forth below, depending upon the volatility of the rate change, the changein asset or liability mix of the Company or other factors may produce adecrease in net interest margin in an upward moving rate environment even asthe net portfolio value (“NPV”) estimate indicates an increase in netvalue.  The converse situation can alsobe expected.  One approach used toquantify interest rate risk is the NPV analysis.  In essence, this analysis calculates thedifference between the present value of the liabilities and the present valueof expected cash flows from assets and off-balance sheet contracts.  The following tables set forth, at September 30,2005 (the most recent report available) and December 31, 2004, an analysisof the Company’s interest rate risk as measured by the estimated changes in NPVresulting from instantaneous and sustained parallel shifts in the yield curve(+300 or –200 basis points, measured in 100 basis point increments).  Due to the abnormally low prevailing interestrate environment, -200 NPV was not estimated by the OTS for December 31,2004.  Management does not believe thatthe Company has experienced any material changes in its market risk positionfrom that disclosed in the Company’s Annual Report on Form 10-K for thefiscal year ended June 30, 2005 or that the Company’s primary market riskexposures and how those exposures were managed during the six months ended December 31,2005 changed significantly when compared to June 30, 2005.

 

Thedata in the following tables is based on assumptions utilized by the OTS inassessing interest rate risk of thrift institutions and published in “SelectedAsset and Liability Price Tables as of September 30, 2005” and “SelectedAsset and Liability Price Tables as of December 31, 2004”.  Even if interest rates change in thedesignated amounts, there can be no assurance that the Company’s assets andliabilities would perform as set forth below.

 

34

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September 30, 2005

 

| ** **          | ** ** | **Estimated**              | ** ** | **Estimated Increase** | ** ** |
|---------------------|------------|----------------------------|------------|------------------------|------------|
| **Change  in**      | ** ** | **NPV**                    | ** ** | **(Decrease) in NPV**  | ** ** |
| **Interest  Rates** | ** ** | **Amount**                 | ** ** | **Amount**             | ** ** | **Percent** | ** ** |
| ** **          | ** ** | **(Dollars in thousands)** | ** ** | ** **             | ** ** |
| Basis Points        |       |                       |       |
|                |       |                       |       |                   |       |   |   |
| +300                |       |                       | $          | 92,463                 |       | $ | (12,479 | ) | (12 | )% |
| +200                |       |                       | 98,449     |                   | (6,493     | ) | (6 | ) |
| +100                |       |                       | 102,549    |                   | (2,393     | ) | (2 | ) |
| —              |       |                       | 104,942    |                   | —     |   | — |   |
| -100                |       |                       | 104,695    |                   | (247       | ) | (0 | ) |
| -200                |       |                       | 99,463     |                   | (5,479     | ) | (5 | ) |
|                     |            |                            |            |                        |            |  |  |  |  |  |

 

December 31, 2004

 

| ** **          | ** ** | **Estimated**              | ** ** | **Estimated Increase** | ** ** |
|---------------------|------------|----------------------------|------------|------------------------|------------|
| **Change  in**      | ** ** | **NPV**                    | ** ** | **(Decrease) in NPV**  | ** ** |
| **Interest  Rates** | ** ** | **Amount**                 | ** ** | **Amount**             | ** ** | **Percent** | ** ** |
| ** **          | ** ** | **(Dollars in thousands)** | ** ** | ** **             | ** ** |
| Basis Points        |       |                       |       |                   |       |   |   |
|                |       |                       |       |                   |       |   |   |
| +300                |       |                       | $          | 93,913                 |       | $ | (5,598 | ) | (6 | )% |
| +200                |       |                       | 97,324     |                   | (2,087     | ) | (2 | ) |
| +100                |       |                       | 99,508     |                   | 97         |   | — |   |
| —              |       |                       | 99,411     |                   | —     |   | — |   |
| -100                |       |                       | 95,778     |                   | (3,632     | ) | (4 | ) |
|                     |            |                            |            |                        |            |  |  |  |  |  |

 

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. The effect of this policy will generally be to reducethe Bank’s sensitivity to interest rate changes.  The goal of this policy is to provide arelatively consistent level of net interest income in varying interest ratecycles and to minimize the potential for significant fluctuations from periodto period.

 

**Item4.  Controls and Procedures**

 

TheCompany’s management has evaluated, under the supervision and with theparticipation of the Company’s Chairman, President and Chief Executive Officerand the Company’s Executive Vice President, Chief Financial Officer andTreasurer, the effectiveness of the design and operation of the Company’sdisclosure controls and procedures, as defined in Rule 13a-15(e), and haveconcluded that, as of the end of the period covered by this Quarterly Report,the Company’s disclosure controls and procedures are effective for gathering,analyzing and disclosing information the Company is required to disclose in itsperiodic reports filed under the Exchange Act. There were no significant changes in the Company’s internal control overfinancial reporting identified in the above referenced evaluation thatmaterially affected, or are reasonably likely to materially affect, the Company’sinternal control over financial reporting.

 

35

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**PART II  - OTHER INFORMATION**

 

**Item 1.          Legal Proceedings**

 

TheCompany, the Bank and their subsidiaries are involved as plaintiff or defendantin various legal actions arising in the normal course of their businesses.  While the ultimate outcome of theseproceedings cannot be predicted with certainty, it is the opinion ofmanagement, after consultation with counsel representing the Company and/or theBank in the proceedings, that the resolution of these proceedings are notlikely to have a material effect on the Company’s consolidated financialposition 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.          Unregistered Sales of EquitySecurities and Use of Proceeds**

 

The following table sets forth the purchases by theCompany of its common stock during the quarterly period ended December 31,2005.

 
| ** **                 | ** ** | **Total**     | ** ** | ** **     | ** ** | **Total Number**             | ** ** | **Maximum Number of**        | ** ** |
|----------------------------|------------|---------------|------------|----------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                 | ** ** | **Number**    | ** ** | **Average**    | ** ** | **of Shares Purchased**      | ** ** | **Shares that May Yet** | ** ** |
| ** **                 | ** ** | **of Shares** | ** ** | **Price Paid** | ** ** | **as Part of Publicly** | ** ** | **Be Purchased Under**       | ** ** |
| **Period**                 | ** ** | **Purchased** | ** ** | **per Share**  | ** ** | **Announced Programs**       | ** ** | **the Current Program**      | ** ** |
| October 1 - 31, 2005  |       | 0             |       | $              | 0.00       |                         | 0          |                         | 303,614    |   |
| November 1 - 30, 2005 |       | 0             |       | $              | 0.00       |                         | 0          |                         | 303,614    |   |
| December 1 - 31, 2005 |       | 0             |       | $              | 0.00       |                         | 0          |                         | 303,614    |   |
|                       |       |          |       |           |       |                         |       |                         |       |
| 2nd Quarter  Total         |       | 0             |       | $              | 0.00       |                         | 0          |                         |       |   |

 

The Company currently has in effect stock buybackprogram, 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 May 1,2005, which equals 350,914 shares, may be acquired through April 30,2006.  As of December 31, 2005, atotal of 47,300 shares of common stock have been purchased pursuant to theprogram, all of which were purchased in the open market during May and June 2005.

 

**Item 3.          Defaults upon Senior Securities**

 

None

 

36

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

 

At the Company’s Annual Meeting of Stockholders heldon November 16, 2005 (the “Annual Meeting”), the stockholders elected thethree individuals nominated to serve as Class III directors until 2008 oruntil their respective successors are elected and qualified, as set forth inProposal 1 in the Company’s Proxy Statement relating to the AnnualMeeting.  The three individuals elected,and the number of votes cast for, or withheld, with respect to each of them, isas follows:

 
| Curtis L. Hage        |   | For: | 3,213,400 |   | Vote Withheld: | 157,289 |   |
|-----------------------|--------|------|-----------|--------|----------------|---------|--------|
| Christine E. Hamilton |   | For: | 3,256,943 |   | Vote Withheld: | 113,746 |   |
| Thomas L. Van Wyhe    |   | For: | 3,260,335 |   | Vote Withheld: | 110,354 |   |

 

Additionally, the following directors continue to serve on the Board ofDirectors following the Annual Meeting: Curtis J. Bernard, Robert L. Hanson, Wm. G. Pederson and Steven R.Sershen .

 

**Item 5.          Other Information**

 

None

 

**Item 6.          Exhibits**

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

 

37

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**HF FINANCIAL CORP.**

 

**FORM 10-Q**

**SIGNATURES**

 

Pursuantto the 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:  |   February 10,  2006 |   |                                           |               | By:    |     /s/  Curtis L. Hage |   |
|   |                                |   | Curtis  L. Hage, Chairman, President           |
|   |                                |   | And  Chief Executive Officer                   |
|   |                                |   | (Principal  Executive Officer)                 |
|   |                                |   |                                           |
| Date:  |   February 10,  2006 |   |                                           |               | By:    |     /s/  Darrel L. Posegate |   |
|   |                                |   | Darrel  L. Posegate, Executive Vice President, |
|   |                                |   | Chief  Financial Officer and Treasurer         |
|   |                                |   | (Principal  Financial and Accounting Officer)  |
|        |                                     |        |                                                |                    |        |  |  |  |

 

38

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**Index toExhibits**

 
| **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 |

 

-Index-

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