Table of Contents

 

 

** **

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

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**FORM 10-Q**

 

| **x**      | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
|------------|------------|---------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                              |
| ** ** | ** ** | **For  the Quarterly Period Ended September 30, 2008**                                             |

 

**OR**

 

| **o** | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
|-------|------------|----------------------------------------------------------------------------------------------------------|

 

**Forthe transition period from             to            **

 

**Commission filenumber 0-19972**

 

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**HF FINANCIAL CORP.**

(Exact name of registrant as specified in its charter)

 

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

 

(**605) 333-7556**

(Registrant’stelephone number, including area code)

 

Indicate by check markwhether the Registrant (1) has filed all reports required to be filed by Section 13or Section 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the Registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

 

Yes  x    No  o

 

Indicate by check mark whether the Registrant is alarge accelerated filer, an accelerated filer, a non-accelerated filer, or asmaller reporting company.  See thedefinitions of “large accelerated filer,” “accelerated filer” and “smallerreporting company” in Rule 12b-2 of the Exchange Act.  

 
| Large accelerated filer  o | Accelerated filer o | Non-accelerated filer o | Smaller reporting  company x |
|----------------------------|--------------------------|-------------------------|-----------------------------------|

 

Indicate by check markwhether the Registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).

 

Yes o     No x

 

As of November 7,2008, there were 4,021,367 shares of the Registrant’s common stock outstanding.

 

 

 

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Table of Contents

 

**Quarterly Report on Form 10-Q**

**Table of Contents**

 
| ** **     | ** **                                                                                            | **Page Number** |
|----------------|-------------------------------------------------------------------------------------------------------|----------------------|
|           |                                                                                                  |                 |
|           | **PART I –  FINANCIAL INFORMATION**                                                         |                 |
|           |                                                                                                  |                 |
| Item 1.        | Financial Statements (Unaudited):                                                                     |                 |
|           |                                                                                                  |                 |
|           | Consolidated  Statements of Financial Condition As of September 30, 2008 and  June 30, 2008 | 1                    |
|           |                                                                                                  |                 |
|           | Consolidated Statements of Income for the Three Months  Ended September 30, 2008 and 2007        | 2                    |
|           |                                                                                                  |                 |
|           | Consolidated Statements of Cash Flows for the Three  Months Ended September 30, 2008 and 2007    | 3                    |
|           |                                                                                                  |                 |
|           | Notes to Consolidated Financial Statements                                                            | 4                    |
|           |                                                                                                  |                 |
| Item 2.        | Management’s  Discussion and Analysis of Financial Condition and Results of Operations           | 15                   |
|           |                                                                                                  |                 |
| Item 3.        | Quantitative  and Qualitative Disclosures about Market Risk                                           | 31                   |
|           |                                                                                                  |                 |
| Item 4.        | Controls and  Procedures                                                                              | 32                   |
|           |                                                                                                  |                 |
|           | **PART II  – OTHER INFORMATION**                                                            |                 |
|           |                                                                                                  |                 |
| Item 1.        | Legal Proceedings                                                                                     | 33                   |
|           |                                                                                                  |                 |
| Item 1A.       | Risk Factors                                                                                          | 33                   |
|           |                                                                                                  |                 |
| Item 2.        | Unregistered  Sales of Equity Securities and Use of Proceeds                                          | 33                   |
|           |                                                                                                  |                 |
| Item 6.        | Exhibits                                                                                              | 34                   |
|           |                                                                                                  |                 |
| Form 10-Q | Signature  Page                                                                                       | 35                   |

 

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Table of Contents

 

**PART I- FINANCIAL INFORMATION**

 

**Item1.                    Financial Statements**

 

**HF FINANCIAL CORP.**

**CONSOLIDATED STATEMENTS OF FINANCIALCONDITION**

**(Dollars in Thousands)**

 
| ** **                                                                                                                                                          | ** ** | **September 30, 2008** | ** ** | **June 30, 2008** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                          | ** ** | **(Unaudited)**                  | ** ** | **(Audited)**               | ** ** |
| **ASSETS**                                                                                                                                                          | ** ** | ** **                       | ** ** | ** **                  | ** ** |
| Cash and cash  equivalents                                                                                                                                          |       | $                                | 18,819     |                        | $          | 21,170 |   |
| Securities  available for sale                                                                                                                                      |       | 225,695                          |       | 225,004                     |       |
| Federal Home  Loan Bank stock                                                                                                                                       |       | 12,098                           |       | 11,245                      |       |
| Loans held for  sale                                                                                                                                                |       | 13,371                           |       | 8,796                       |       |
| Loans and leases  receivable                                                                                                                                        |       | 802,088                          |       | 783,710                     |       |
| Allowance for  loan and lease losses                                                                                                                                |       | (6,183                           | )          | (5,933                      | )          |
| Net loans and  leases receivable                                                                                                                                    |       | 795,905                          |       | 777,777                     |       |
|                                                                                                                                                                |       |                             |       |                        |       |
| Accrued interest  receivable                                                                                                                                        |       | 8,816                            |       | 7,540                       |       |
| Office  properties and equipment, net of accumulated depreciation                                                                                                   |       | 15,008                           |       | 14,849                      |       |
| Foreclosed real  estate and other properties                                                                                                                        |       | 599                              |       | 643                         |       |
| Cash value of  life insurance                                                                                                                                       |       | 14,188                           |       | 14,050                      |       |
| Servicing rights                                                                                                                                                    |       | 11,426                           |       | 11,189                      |       |
| Goodwill, net                                                                                                                                                       |       | 4,951                            |       | 4,951                       |       |
| Other assets                                                                                                                                                        |       | 7,208                            |       | 6,280                       |       |
| Total assets                                                                                                                                                        |       | $                                | 1,128,084  |                        | $          | 1,103,494 |   |
|                                                                                                                                                                |       |                             |       |                        |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                      |       |                             |       |                        |       |
|                                                                                                                                                                |       |                             |       |                        |       |
| **LIABILITIES**                                                                                                                                                     |       |                             |       |                        |       |
| Deposits                                                                                                                                                            |       | $                                | 765,022    |                        | $          | 784,237 |   |
| Advances from  Federal Home Loan Bank and other borrowings                                                                                                          |       | 237,267                          |       | 198,454                     |       |
| Subordinated  debentures payable to trusts                                                                                                                          |       | 27,837                           |       | 27,837                      |       |
| Advances by  borrowers for taxes and insurance                                                                                                                      |       | 16,742                           |       | 10,795                      |       |
| Accrued expenses  and other liabilities                                                                                                                             |       | 15,403                           |       | 17,968                      |       |
| Total  liabilities                                                                                                                                                  |       | 1,062,271                        |       | 1,039,291                   |       |
|                                                                                                                                                                |       |                             |       |                        |       |
| **STOCKHOLDERS’  EQUITY**                                                                                                                                      |       |                             |       |                        |       |
| Preferred stock,  $.01 par value, 500,000 shares authorized, none outstanding                                                                                       |       | —                           |       | —                      |       |
| Series A  Junior Participating Preferred Stock, $1.00 stated value, 50,000 shares  authorized, none outstanding                                                |       | —                           |       | —                      |       |
| Common stock,  $.01 par value, 10,000,000 shares authorized, 6,069,120 and 6,035,447 shares  issued at September 30, 2008 and June 30, 2008, respectively |       | 61                               |       | 60                          |       |
| Common stock  subscribed for but not issued                                                                                                                         |       | —                           |       | 95                          |       |
| Additional  paid-in capital                                                                                                                                         |       | 22,513                           |       | 21,905                      |       |
| Retained  earnings, substantially restricted                                                                                                                        |       | 77,569                           |       | 76,041                      |       |
| Accumulated  other comprehensive (loss), net of related deferred tax effect                                                                                         |       | (3,433                           | )          | (3,001                      | )          |
| Less cost of  treasury stock, 2,083,455 and 2,083,455 shares at September 30, 2008 and  June 30, 2008, respectively                                       |       | (30,897                          | )          | (30,897                     | )          |
| Total  stockholders’ equity                                                                                                                                    |       | 65,813                           |       | 64,203                      |       |
| Total  liabilities and stockholders’ equity                                                                                                                    |       | $                                | 1,128,084  |                        | $          | 1,103,494 |   |

 

*See accompanying notes to unaudited consolidated financialstatements.*

 

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**HF FINANCIAL CORP.**

**CONSOLIDATEDSTATEMENTS OF INCOME**

**(Dollars in Thousands, except sharedata)**

**(Unaudited)**

 
| ** **                                                              | ** ** | **Three Months Ended  September 30,** | ** ** |
|-------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                              | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
|                                                                    |       |                                                 |       |   |   |
| Interest, dividend and loan fee income:                                 |       |                                                 |       |   |   |
| Loans and leases  receivable                                            |       | $                                                    | 13,018     |   | $ | 14,120 |   |
| Investment  securities and interest-earning deposits                    |       | 2,813                                                |       | 1,865 |   |
|                                                                    |       | 15,831                                               |       | 15,985 |   |
| Interest expense:                                                       |       |                                                 |       |   |   |
| Deposits                                                                |       | 4,577                                                |       | 7,498 |   |
| Advances from  Federal Home Loan Bank and other borrowings              |       | 2,565                                                |       | 1,819 |   |
|                                                                    |       | 7,142                                                |       | 9,317 |   |
| **Net  interest income**                                                |       | 8,689                                                |       | 6,668 |   |
|                                                                    |       |                                                 |       |   |   |
| Provision for losses on loans and leases                                |       | 387                                                  |       | 325 |   |
|                                                                    |       |                                                 |       |   |   |
| **Net  interest income after provision for losses on loans and leases** |       | 8,302                                                |       | 6,343 |   |
|                                                                    |       |                                                 |       |   |   |
| Noninterest income:                                                     |       |                                                 |       |   |   |
| Fees on deposits                                                        |       | 1,551                                                |       | 1,413 |   |
| Loan servicing  income                                                  |       | 557                                                  |       | 505 |   |
| Gain on sale of  loans, net                                             |       | 251                                                  |       | 259 |   |
| Trust income                                                            |       | 222                                                  |       | 249 |   |
| Gain on sale of  securities, net                                        |       | 80                                                   |       | — |   |
| Other                                                                   |       | 388                                                  |       | 389 |   |
|                                                                    |       | 3,049                                                |       | 2,815 |   |
| Noninterest expense:                                                    |       |                                                 |       |   |   |
| Compensation and  employee benefits                                     |       | 5,121                                                |       | 4,443 |   |
| Occupancy and  equipment                                                |       | 977                                                  |       | 937 |   |
| Check and data  processing expense                                      |       | 622                                                  |       | 613 |   |
| Marketing                                                               |       | 338                                                  |       | 263 |   |
| Foreclosed real  estate and other properties, net                       |       | 117                                                  |       | 43 |   |
| Other                                                                   |       | 1,228                                                |       | 845 |   |
|                                                                    |       | 8,403                                                |       | 7,144 |   |
|                                                                    |       |                                                 |       |   |   |
| **Income  before income taxes**                                         |       | 2,948                                                |       | 2,014 |   |
|                                                                    |       |                                                 |       |   |   |
| Income tax expense                                                      |       | 973                                                  |       | 667 |   |
| **Net income**                                                          |       | $                                                    | 1,975      |   | $ | 1,347 |   |
|                                                                    |       |                                                 |       |   |   |
| **Comprehensive income**                                                |       | $                                                    | 1,543      |   | $ | 2,064 |   |
| **Cash dividends declared per share**                                   |       | $                                                    | 0.1125     |   | $ | 0.1075 |   |
|                                                                    |       |                                                 |       |   |   |
| **Earnings per share:**                                                 |       |                                                 |       |   |   |
| Basic                                                                   |       | $                                                    | 0.50       |   | $ | 0.34 |   |
| Diluted                                                                 |       | $                                                    | 0.49       |   | $ | 0.33 |   |

 

*Seeaccompanying notes to unaudited consolidated financial statements.*

 

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**HF FINANCIAL CORP.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Dollars in Thousands)**

**(Unaudited)**

 
| ** **                                                                                                                             | ** ** | **Three Months Ended September 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                                                                                             | ** ** | **2008**                                                 | ** ** | **2007** | ** ** |
| **Cash flows from operating activities**                                                                                               |       |                                                     |       |   |   |
| Net income                                                                                                                             |       | $                                                        | 1,975      |   | $ | 1,347 |   |
| Adjustments to  reconcile net income to net cash provided by (used in) operating activities: Provision  for losses on loans and leases |       | 387                                                      |       | 325 |   |
| Depreciation                                                                                                                           |       | 392                                                      |       | 415 |   |
| Amortization of  discounts and premiums on securities and other                                                                        |       | 284                                                      |       | 505 |   |
| Stock based  compensation                                                                                                              |       | 125                                                      |       | 108 |   |
| Net change in  loans held for resale                                                                                                   |       | (4,324                                                   | )          | 1,163 |   |
| (Gain) on sale of  loans, net                                                                                                          |       | (251                                                     | )          | (259 | ) |
| Realized (gain)  on sale of securities, net                                                                                            |       | (80                                                      | )          | — |   |
| Losses and  provision for losses on sales of foreclosed real estate and other properties,  net                                         |       | 2                                                        |       | 2 |   |
| Change in other  assets and liabilities                                                                                                |       | (4,763                                                   | )          | (1,025 | ) |
| Net cash provided  by (used in) operating activities                                                                                   |       | (6,253                                                   | )          | 2,581 |   |
|                                                                                                                                   |       |                                                     |       |   |   |
| **Cash flows from investing activities**                                                                                               |       |                                                     |       |   |   |
| Loan  participations purchased                                                                                                         |       | (804                                                     | )          | (500 | ) |
| Net change in  loans outstanding                                                                                                       |       | (17,812                                                  | )          | (5,361 | ) |
| Securities  available for sale:                                                                                                        |       |                                                     |       |   |   |
| Sales and  maturities and repayments                                                                                                   |       | 21,095                                                   |       | 9,451 |   |
| Purchases                                                                                                                              |       | (22,304                                                  | )          | (20,770 | ) |
| Purchase of  Federal Home Loan Bank stock                                                                                              |       | (2,352                                                   | )          | (2,220 | ) |
| Redemption of  Federal Home Loan Bank stock                                                                                            |       | 1,499                                                    |       | 402 |   |
| Purchase of  office properties and equipment                                                                                           |       | (551                                                     | )          | (543 | ) |
| Purchase of  servicing rights                                                                                                          |       | (466                                                     | )          | (550 | ) |
| Proceeds from  sale of foreclosed real estate and other properties, net                                                                |       | 15                                                       |       | 132 |   |
| Net cash (used  in) investing activities                                                                                               |       | (21,680                                                  | )          | (19,959 | ) |
|                                                                                                                                   |       |                                                     |       |   |   |
| **Cash flows from financing activities**                                                                                               |       |                                                     |       |   |   |
| Net (decrease)  in deposit accounts                                                                                                    |       | (19,215                                                  | )          | (43,504 | ) |
| Proceeds of  advances from Federal Home Loan Bank and other borrowings                                                                 |       | 698,178                                                  |       | 311,767 |   |
| Payments on  advances from Federal Home Loan Bank and other borrowings                                                                 |       | (659,365                                                 | )          | (259,147 | ) |
| Proceeds from  issuance of subordinated debentures                                                                                     |       | —                                                   |       | 5,000 |   |
| Redemption of  subordinated debentures                                                                                                 |       | —                                                   |       | (5,000 | ) |
| Increase in  advances by borrowers                                                                                                     |       | 5,947                                                    |       | 4,085 |   |
| Purchase of  treasury stock                                                                                                            |       | —                                                   |       | (1,148 | ) |
| Proceeds from  issuance of common stock                                                                                                |       | 484                                                      |       | 353 |   |
| Cash dividends  paid                                                                                                                   |       | (447                                                     | )          | (422 | ) |
| Net cash  provided by financing activities                                                                                             |       | 25,582                                                   |       | 11,984 |   |
|                                                                                                                                   |       |                                                     |       |   |   |
| (Decrease) in  cash and cash equivalents                                                                                               |       | (2,351                                                   | )          | (5,394 | ) |
|                                                                                                                                   |       |                                                     |       |   |   |
| Cash and cash equivalents                                                                                                              |       |                                                     |       |   |   |
| Beginning                                                                                                                              |       | 21,170                                                   |       | 22,476 |   |
| Ending                                                                                                                                 |       | $                                                        | 18,819     |   | $ | 17,082 |   |
|                                                                                                                                   |       |                                                     |       |   |   |
| Supplemental Disclosures of Cash Flows Information                                                                                     |       |                                                     |       |   |   |
| Cash payments  for interest                                                                                                            |       | $                                                        | 8,063      |   | $ | 9,282 |   |
| Cash payments  for income and franchise taxes, net                                                                                     |       | 152                                                      |       | 364 |   |

 

*Seeaccompanying notes to unaudited consolidated financial statements.*

 

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**HF FINANCIAL CORP.**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

For The Three MonthsEnded September 30, 2008 and 2007

(Unaudited)

 

**NOTE 1.****                                                 SELECTEDACCOUNTING POLICIES**

 

*Basis of presentation:*

 

The consolidatedfinancial information of HF Financial Corp. (the “Company”) and itswholly-owned subsidiaries included in this Quarterly Report on Form 10-Qis unaudited.  However, in the opinion ofmanagement, adjustments (consisting of normal recurring adjustments) necessaryfor a fair presentation for the interim periods have been included.  Results for any interim period are notnecessarily indicative of results to be expected for the fiscal year.  Interim consolidated financial statements andthe notes thereto should be read in conjunction with the consolidated financialstatements and notes thereto included in the Company’s Annual Report on Form 10-Kfor the fiscal year ended June 30, 2008 (“Fiscal 2008”), filed with the Securitiesand Exchange Commission.  The accountingand reporting policies of the Company and its subsidiaries conform toaccounting principles generally accepted in the United States of America (“GAAP”)and to general practice within the industry.

 

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

 

**NOTE 2.****                                                 REGULATORYCAPITAL**

 

The following table setsforth the Bank’s compliance with its minimum capital requirements for awell-capitalized institution at September 30, 2008:

 
| ** **                                        | ** ** | **Amount**                           | ** ** | **Percent** | ** ** |
|---------------------------------------------------|------------|--------------------------------------|------------|-------------|------------|
| ** **                                        | ** ** | **(Dollars in Thousands)** | ** ** |
| Tier I (core) capital (to adjusted total assets): |       |                                 |       |        |       |
| Required                                          |       | $                                    | 56,275     |        | 5.00       | % |
| Actual                                            |       | 87,335                               |       | 7.76        |       |
| Excess over  required                             |       | 31,060                               |       | 2.76        |       |
|                                              |       |                                 |       |        |       |
| Risk-based capital (to risk-weighted assets):     |       |                                 |       |        |       |
| Required                                          |       | $                                    | 86,919     |        | 10.00      | % |
| Actual                                            |       | 93,265                               |       | 10.76       |       |
| Excess over  required                             |       | 6,595                                |       | 0.76        |       |

 

**NOTE 3.****                                                 EARNINGSPER SHARE**

 

Basic earnings per shareis computed by dividing income available to common stockholders (the numerator)by the weighted-average number of common shares outstanding (the denominator)during the period.  Shares issued duringthe period and shares reacquired during the period are weighted for the portionof the period they were outstanding. The weighted average number of basiccommon shares outstanding for the three months ended September 30, 2008and 2007 was 3,972,055 and 4,002,458, respectively.

 

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Dilutive earnings pershare is similar to the computation of basic earnings per share except thedenominator is increased to include the number of additional common shares thatwould have been outstanding if the dilutive options outstanding had beenexercised. The weighted average number of common and dilutive potential commonshares outstanding for the three months ended September 30, 2008 and 2007was 4,004,126 and 4,067,075, respectively.

 

**NOTE 4.****                                                 INVESTMENTSIN SECURITIES**

 

Theamortized cost and fair values of investments in securities, all of which areclassified as available for sale according to management’s intent, are asfollows:

 
| ** **                  | ** ** | **September 30, 2008** | ** ** |
|-----------------------------|------------|----------------------------------|------------|
| ** **                  | ** ** | ** **                       | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                  | ** ** | **Amortized**                    | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **                  | ** ** | **Cost**                         | ** ** | **Gains** | ** ** | **(Losses)** | ** ** | **Value** | ** ** |
| ** **                  | ** ** | **(Dollars  in Thousands)**      | ** ** |
|                        |       |                             |       |   |   |   |   |   |   |
| Debt securities:            |       |                             |       |   |   |   |   |   |   |
| U.S. government  agencies   |       | $                                | 6,402      |   | $ | 202 |   | $ | — |   | $ | 6,604 |   |
| Federal Home  Loan Bank     |       | 3,947                            |       | 67 |   | — |   | 4,014 |   |
| Municipal bonds             |       | 12,932                           |       | 44 |   | (399 | ) | 12,577 |   |
| Trust preferred  securities |       | 12,373                           |       | — |   | (2,874 | ) | 9,499 |   |
|                        |       | 35,654                           |       | 313 |   | (3,273 | ) | 32,694 |   |
|                        |       |                             |       |   |   |   |   |   |   |
| Equity  securities:         |       |                             |       |   |   |   |   |   |   |
| FNMA-common                 |       | 8                                |       | — |   | (8 | ) | — |   |
| Farmer  Mac-common          |       | 7                                |       | — |   | (5 | ) | 2 |   |
| Other  investments          |       | 253                              |       | — |   | — |   | 253 |   |
|                        |       | 268                              |       | — |   | (13 | ) | 255 |   |
|                        |       |                             |       |   |   |   |   |   |   |
| Mortgage-backed securities  |       | 193,773                          |       | 605 |   | (1,632 | ) | 192,746 |   |
|                        |       | $                                | 229,695    |   | $ | 918 |   | $ | (4,918 | ) | $ | 225,695 |   |

 

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| ** **                  | ** ** | **September 30, 2007**     | ** ** |
|-----------------------------|------------|--------------------------------------|------------|
| ** **                  | ** ** | ** **                           | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                  | ** ** | **Amortized**                        | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **                  | ** ** | **Cost**                             | ** ** | **Gains** | ** ** | **(Losses)** | ** ** | **Value** | ** ** |
| ** **                  | ** ** | **(Dollars in Thousands)** | ** ** |
| Debt securities:            |       |                                 |       |   |   |   |   |   |   |
| U.S. government  agencies   |       | $                                    | 12,103     |   | $ | 75 |   | $ | (1 | ) | $ | 12,177 |   |
| Federal Home  Loan Bank     |       | 17,450                               |       | 147 |   | — |   | 17,597 |   |
| Municipal bonds             |       | 8,019                                |       | 14 |   | (123 | ) | 7,910 |   |
| Trust preferred  securities |       | 10,302                               |       | — |   | (126 | ) | 10,176 |   |
|                        |       | 47,874                               |       | 236 |   | (250 | ) | 47,860 |   |
|                        |       |                                 |       |   |   |   |   |   |   |
| Equity  securities:         |       |                                 |       |   |   |   |   |   |   |
| FNMA-common                 |       | 8                                    |       | 16 |   | — |   | 24 |   |
| Farmer  Mac-common          |       | 7                                    |       | 4 |   | — |   | 11 |   |
| Other  investments          |       | 199                                  |       | — |   | — |   | 199 |   |
|                        |       | 214                                  |       | 20 |   | — |   | 234 |   |
|                        |       |                                 |       |   |   |   |   |   |   |
| Mortgage-backed securities  |       | 107,665                              |       | 248 |   | (1,307 | ) | 106,606 |   |
|                        |       | $                                    | 155,753    |   | $ | 504 |   | $ | (1,557 | ) | $ | 154,700 |   |

 

The following table presents the fair value and age of gross unrealizedlosses by investment category at September 30, 2008, in accordance withFASB Staff Position (“FSP”) No. FAS 115-1, *The Meaning of Other-Than-Temporary Impairment and Its Application toCertain Investments:*

 
| ** **                  | ** ** | **Less than 12 Months** | ** ** | **12 Months or More** | ** ** | **Total**  | ** ** |
|-----------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|------------|------------|
| ** **                  | ** ** | ** **                             | ** ** | **Gross**                            | ** ** | ** ** | ** ** | **Gross** | ** ** | ** ** | ** ** | **Gross** | ** ** |
| ** **                  | ** ** | **Fair**                               | ** ** | **Unrealized**                       | ** ** | **Fair**   | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| ** **                  | ** ** | **Value**                              | ** ** | **(Losses)**                         | ** ** | **Value**  | ** ** | **(Losses)** | ** ** | **Value** | ** ** | **(Losses)** | ** ** |
| ** **                  | ** ** | **(Dollars  in Thousands)**            | ** ** |
| Debt securities:            |       |                                   |       |                                 |       |       |       |   |   |   |   |   |   |
| Municipal bonds             |       | $                                      | 6,507      |                                 | $          | (286       | )          | $ | 1,102 |   | $ | (113 | ) | $ | 7,609 |   | $ | (399 | ) |
| Trust preferred  securities |       | 7,943                                  |       | (2,412                               | )          | 1,556      |       | (462 | ) | 9,499 |   | (2,874 | ) |
|                        |       | 14,450                                 |       | (2,698                               | )          | 2,658      |       | (575 | ) | 17,108 |   | (3,273 | ) |
| Equity securities:          |       |                                   |       |                                 |       |       |       |   |   |   |   |   |   |
| FNMA-common                 |       | —                                 |       | (8                                   | )          | —     |       | — |   | — |   | (8 | ) |
| Farmer  Mac-common          |       | 2                                      |       | (5                                   | )          | —     |       | — |   | 2 |   | (5 | ) |
|                        |       | 2                                      |       | (13                                  | )          | —     |       | — |   | 2 |   | (13 | ) |
| Mortgage-backed securities  |       | 108,659                                |       | (945                                 | )          | 29,512     |       | (687 | ) | 138,171 |   | (1,632 | ) |
|                        |       | $                                      | 123,111    |                                 | $          | (3,656     | )          | $ | 32,170 |   | $ | (1,262 | ) | $ | 155,281 |   | $ | (4,918 | ) |

 

Managementdoes not believe any individual unrealized losses as of September 30,2008, represent an other-than-temporary impairment.  The Company has the ability and intent to holdthose investments until a recovery of fair value.

 

The unrealized lossesreported for municipal bonds relate to 44 municipal general obligation orrevenue bonds.  The unrealized losses areprimarily caused by market interest rate increases since the securities wereoriginally acquired, rather than due to credit or other causes.

 

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Theunrealized losses reported for mortgage-backed securities relate to 92securities issued by the Federal National Mortgage Association (“FNMA”), theGovernment National Mortgage Association (“GNMA”), or the Federal Home LoanMortgage Corporation (“FHLMC”).  Theseunrealized losses in total are primarily attributable to changes in interestrates and the contractual cashflows of those investments which are guaranteedby an agency of the U.S. government. Mortgage-backed securities also include one “private-label”collateralized mortgage obligation which has maintained its AAA rating as of September 30,2008.

 

Theunrealized losses reported for trust preferred securities are attributable tosix rated pooled securities.  There hasbeen one rating downgrade change regarding these investments during the currentfiscal year.  The investment gradesecurities have an amortized cost of $5.7 million rated AA, $2.7 million ratedA and $4.0 million rated BBB.  The marketfor these securities is currently inactive. Based upon information available at financial statement date, managementbelieves that it is probable that all amounts due according to contractualterms will be collected.  Within thissegment, five securities with amortized cost of $10.4 million are quarterlyvariable-rate securities tied to 3-month LIBOR.

 

**NOTE 5.****                                                 SEGMENTREPORTING**

 

Operating segments aredefined as components of an enterprise for which separate financial informationis available that is evaluated regularly by the chief operating decision makersin deciding how to allocate resources and in assessing performance.  The Company’s reportable segments are “banking”(including leasing activities) and “other.” The “banking” segment is conducted through the Bank and Mid AmericaCapital and the “other” segment is composed of smaller nonreportable segments,the Company and inter-segment eliminations.

 

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

 
| **Three Months Ended September 30, 2008** | ** ** | **Banking**                          | ** ** | **Other** | ** ** | **Total** | ** ** |
|--------------------------------------------------------------------|------------|--------------------------------------|------------|-----------|------------|-----------|------------|
| ** **                                                         | ** ** | **(Dollars in Thousands)** | ** ** |
|                                                               |       |                                 |       |      |       |      |       |
| Net interest income                                                |       | $                                    | 9,118      |      | $          | (429      | )          | $ | 8,689 |   |
| Provision for losses on loans and leases                           |       | (387                                 | )          | —    |       | (387      | )          |
| Noninterest income                                                 |       | 2,931                                |       | 118       |       | 3,049     |       |
| Intersegment noninterest income                                    |       | (38                                  | )          | (22       | )          | (60       | )          |
| Noninterest expense                                                |       | (8,050                               | )          | (353      | )          | (8,403    | )          |
| Intersegment noninterest expense                                   |       | —                               |       | 60        |       | 60        |       |
| Income (loss)  before income taxes                                 |       | $                                    | 3,574      |      | $          | (626      | )          | $ | 2,948 |   |
|                                                               |       |                                 |       |      |       |      |       |
| Total assets at September 30, 2008                            |       | $                                    | 1,122,049  |      | $          | 6,035     |       | $ | 1,128,084 |   |

 
| **Three Months Ended September 30, 2007** | ** ** | **Banking**                 | ** ** | **Other** | ** ** | **Total** | ** ** |
|--------------------------------------------------------------------|------------|-----------------------------|------------|-----------|------------|-----------|------------|
| ** **                                                         | ** ** | **(Dollars  in Thousands)** | ** ** |
|                                                               |       |                        |       |      |       |      |       |
| Net interest income                                                |       | $                           | 7,294      |      | $          | (626      | )          | $ | 6,668 |   |
| Provision for losses on loans and leases                           |       | (325                        | )          | –    |       | (325      | )          |
| Noninterest income                                                 |       | 2,769                       |       | 46        |       | 2,815     |       |
| Intersegment noninterest income                                    |       | (32                         | )          | (12       | )          | (44       | )          |
| Noninterest expense                                                |       | (6,905                      | )          | (239      | )          | (7,144    | )          |
| Intersegment noninterest expense                                   |       | —                      |       | 44        |       | 44        |       |
| Income (loss)  before income taxes                                 |       | $                           | 2,801      |      | $          | (787      | )          | $ | 2,014 |   |
|                                                               |       |                        |       |      |       |      |       |
| Total assets at September 30, 2007                            |       | $                           | 1,013,252  |      | $          | 2,524     |       | $ | 1,015,776 |   |

 

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**NOTE 6.****                                                 FAIRVALUE MEASUREMENT**

 

Effective July 1,2008, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 157,*Fair Value Measurements*. In accordancewith the FASB Staff Position 157-2, *Effective Date of SFAS No. 157*,the Company has not applied the provisions of this statement to non-financialassets and liabilities such as real estate owned, repossessed assets andequipment held for sale.  SFAS 157 defines fair value and establishes aconsistent framework for measuring fair value under GAAP and expands disclosurerequirements for fair value measurements.  Fair values represent theestimated price that would be received from selling an asset or paid totransfer a liability in an orderly transaction between market participants atthe measurement date.  The standarddescribes three levels of inputs that may be used to measure fair value:

 

Level 1: Quotedprices (unadjusted) for identical assets or liabilities in active markets thatthe entity has the ability to access as of the measurement date.

 

Level 2:Significant other observable inputs other than Level 1 prices such as quotedprices for similar assets or liabilities; quoted prices in markets that are notactive; or other inputs that are observable or can be corroborated byobservable market data.

 

Level 3:Significant unobservable inputs that reflect a company’s own assumptions aboutthe assumptions that market participants would use in pricing an asset orliability.  Level 3 assets and liabilities include financialinstruments whose value is determined using pricing models, discounted cashflow methodologies, or similar techniques, as well as instruments for which thedetermination of fair value requires significant management judgment orestimation.

 

The table belowpresents the Company’s balances of financial instruments measured at fair valueon a recurring basis by level within the hierarchy at September 30, 2008.

 
| ** **                    | ** ** | **September 30, 2008** | ** ** |
|-------------------------------|------------|----------------------------------|------------|
| ** **                    | ** ** | **Quoted Prices**           | ** ** | **Significant Other** | ** ** | **Significant** | ** ** | ** ** | ** ** |
| ** **                    | ** ** | **In Active**               | ** ** | **Observable** | ** ** | **Unobservable** | ** ** | ** ** | ** ** |
| ** **                    | ** ** | **Markets**                      | ** ** | **Inputs** | ** ** | **Inputs** | ** ** | ** ** | ** ** |
| ** **                    | ** ** | **(Level 1)**               | ** ** | **(Level 2)** | ** ** | **(Level 3)** | ** ** | **Total** | ** ** |
| ** **                    | ** ** | **(Dollars  in Thousands)**      | ** ** |
|                          |       |                             |       |   |   |   |   |   |   |
| Securities available for sale |       | $                                | 2          |   | $ | 216,194 |   | $ | 9,499 |   | $ | 225,695 |   |
| Interest rate swaps           |       | —                           |       | (153 | ) | — |   | (153 | ) |
|                               |            |                                  |            |  |  |  |  |  |  |  |  |  |  |

 

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

 

Securitiesavailable for sale: The fair values of securities available for sale aredetermined by obtaining quoted prices on nationally recognized securitiesexchanges (Level 1 inputs), or matrix pricing, which is a mathematicaltechnique widely used in the industry to value debt securities without relyingexclusively on quoted prices for the specific securities, but rather by relyingon the securities’ relationship to other benchmark quoted securities (Level 2inputs).  The Company outsourcesvaluation primarily to a third party provider which utilizes several sourcesfor valuing fixed-income securities.  Theprimary source for valuation is the Interactive Data Corporation (“IDC”). IDC’sevaluations are based on market data. IDC utilizes evaluated pricing models that vary based by asset class andinclude available trade, bid, and other market information. Generally,methodology includes broker quotes, proprietary modes, vast descriptive termsand conditions databases, as well as extensive quality control programs.  As further valuation sources, the third partyprovider uses a proprietary valuation Matrices model and capital marketstrading staff.  The Matrices model isused for valuing municipals. The model includes a separate curve structure forBank-Qualified municipals. The grouping of municipals is further broken downaccording to insurer, credit support, state of issuance, and rating toincorporate additional spreads and municipal curves.  The securities shown in Level 3 relate totrust preferred securities which are currently part of an inactive market,whereby management utilized discounted cash flow methodologies and benchmarkindices to determine fair values.

 

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

 

The followingtable reconciles the beginning and ending balances of the assets or liabilitiesof the Company that are measured at fair value on a recurring basis usingsignificant unobservable inputs.

 
| ** **                                   | ** ** | **September 30, 2008**                                                                                | ** ** |
|----------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------|------------|
| ** **                                   | ** ** | **Fair Value Measurements Using Significant  Unobservable Inputs (Level 3)** | ** ** |
| ** **                                   | ** ** | **(Dollars in Thousands)**                                                                            | ** ** |
| ** **                                   | ** ** | **Securities**                                                                                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                   | ** ** | **Available**                                                                                                   | ** ** | **Interest  Rate** | ** ** | ** ** | ** ** |
| ** **                                   | ** ** | **for Sale**                                                                                                    | ** ** | **Swaps** | ** ** | ** ** | ** ** |
|                                         |       |                                                                                                            |       |   |   |   |   |
| Beginning balance, June 30, 2008        |       | $                                                                                                               | —     |   | $ | — |   |   |   |
| Total realized/unrealized gains (losses)     |       |                                                                                                            |       |   |   |   |   |
| Included in  earnings                        |       | —                                                                                                          |       | — |   |   |   |
| Included in  other comprehensive loss        |       | —                                                                                                          |       | — |   |   |   |
| Purchases, issuances, (paydowns) and (sales) |       | 1                                                                                                               |       | — |   |   |   |
| Transfers into or (out) of Level 3           |       | 9,498                                                                                                           |       | — |   |   |   |
| Ending balance                               |       | $                                                                                                               | 9,499      |   | $ | — |   |   |   |

 

The table belowpresents the Company’s balances of financial instruments measured at fair valueon a nonrecurring basis by level within the hierarchy at September 30,2008.

 
| ** **     | ** ** | **September 30, 2008**     | ** ** |
|----------------|------------|--------------------------------------|------------|
| ** **     | ** ** | **Quoted Prices**               | ** ** | **Significant Other** | ** ** | **Significant** | ** ** | ** ** | ** ** |
| ** **     | ** ** | **In Active**                   | ** ** | **Observable** | ** ** | **Unobservable** | ** ** | ** ** | ** ** |
| ** **     | ** ** | **Markets**                          | ** ** | **Inputs** | ** ** | **Inputs** | ** ** | ** ** | ** ** |
| ** **     | ** ** | **(Level 1)**                   | ** ** | **(Level 2)** | ** ** | **(Level 3)** | ** ** | **Total** | ** ** |
| ** **     | ** ** | **(Dollars in Thousands)** | ** ** |
|           |       |                                 |       |   |   |   |   |   |   |
| Impaired loans |       | $                                    | —     |   | $ | 427 |   | $ | — |   | $ | 427 |   |
|                |            |                                      |            |  |  |  |  |  |  |  |  |  |  |

 

Impaired loans areevaluated and valued at the time the loan is identified as impaired, at thelower of cost or market value. Market value is measured based on the valueof the collateral securing these loans.  Collateral is primarily realestate and its fair value is generally determined based on real estateappraisals or other evaluations by qualified professionals. Impaired loans arereviewed and evaluated on at least a quarterly basis for additional impairmentand adjusted accordingly, based on the same factors identified above. Impairedloans that are collateral dependent are written down to their fair value, lesscosts to sell, through the establishment of specific reserves or by recordingcharge-offs when the carrying value exceeds the fair value. Valuationtechniques consistent with the market approach, income approach, and/or costapproach were used to measure fair value and primarily included observableinputs for the individual nonaccrual loans being evaluated such as recent salesof similar assets or observable market data for operational or carrying costs.

 

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**NOTE 7.****                                                 DEFINEDBENEFIT PLAN**

 

The Company has anoncontributory (cash balance) defined benefit pension plan covering allemployees of the Company and its wholly-owned subsidiaries who have attainedthe age of 21 and have completed 1,000 hours of service in a plan year.  The benefits are based on 6% of each eligibleparticipant’s annual compensation, plus income earned in the accounts at a ratedetermined annually based on 30-year Treasury note rates.  The Company’s funding policy is to make theminimum annual required contribution plus such amounts as the Company maydetermine to be appropriate from time to time. The Company has adopted all plan provisions required by the PensionProtection Act of 2006.  These provisionsare effective with the plan year beginning July 1, 2008.  Information relative to the components of netperiodic benefit cost for the Company’s defined benefit plan is presentedbelow:

 
| ** **                         | ** ** | **Three Months Ended** | ** ** |
|------------------------------------|------------|----------------------------------|------------|
| ** **                         | ** ** | **September 30,**           | ** ** |
| ** **                         | ** ** | **2008**                         | ** ** | **2007** | ** ** |
|                               |       |                             |       |   |   |
| Service  cost                      |       | $                                | 118,602    |   | $ | 111,830 |   |
| Interest  cost                     |       | 119,983                          |       | 109,260 |   |
| Amortization  of prior losses      |       | 15,499                           |       | — |   |
| Expected  return on plan assets    |       | (114,027                         | )          | (121,791 | ) |
| Total  costs recognized in expense |       | $                                | 140,057    |   | $ | 99,299 |   |

 

The Companypreviously disclosed in its consolidated financial statements for Fiscal 2008,which are included in Part II, Item 8 “Financial Statements andSupplementary Data” of the Company’s Annual Report on Form 10-K for Fiscal2008, that it contributed $532,000 to fund its qualified pension plan.  During the first quarter of the fiscal yearending June 30, 2009 (“Fiscal 2009”), the Company did not make acontribution to fund its qualified pension plan, but anticipates a contributionwill be made in the second quarter of Fiscal 2009.

 

**NOTE 8.****                                                 SELF-INSUREDHEALTHCARE PLAN**

 

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

 

The Company assumes the responsibility for funding theplan benefits out of general assets; however, employees cover some of the costsof covered benefits through contributions, deductibles, co-pays andparticipation amounts.  An employee iseligible for coverage upon completion of 30 calendar days of regularemployment.  The plan, which is on acalendar year basis, is intended to comply with, and be governed by, theEmployee Retirement Income Security Act of 1974, as amended.

 

The accrual estimate for pending and incurred but notreported health claims is based upon a pending claims lag report provided by athird party provider.  Althoughmanagement believes that it uses the best information available to determinethe accrual, unforeseen health claims could result in adjustments and netearnings being significantly affected if circumstances differ substantiallyfrom the assumptions used in estimating the accrual.  Net healthcare costs are inclusive of healthclaims expenses and administration fees offset by stop loss and employeereimbursement.

 

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Reported below isa summary of net healthcare costs by quarter during Fiscal 2009 and Fiscal2008:

 
| ** **                       | ** ** | **Fiscal Years Ended June 30,** | ** ** |
|----------------------------------|------------|-----------------------------------------------------|------------|
| ** **                       | ** ** | **2009**                                            | ** ** | **2008** | ** ** |
| ** **                       | ** ** | **(Dollars in Thousands)**                | ** ** |
|                             |       |                                                |       |   |   |
| Quarter  ended September 30 |       | $                                                   | 358        |   | $ | 221 |   |
| Quarter  ended December 31  |       | —                                              |       | 409 |   |
| Quarter  ended March 31     |       | —                                              |       | 328 |   |
| Quarter  ended June 30      |       | —                                              |       | 524 |   |
| Net  healthcare costs            |       | $                                                   | 358        |   | $ | 1,482 |   |

 

**NOTE 9.****                                                 STOCK-BASEDCOMPENSATION PLANS**

 

The fair value of eachincentive stock option and each stock appreciation right grant is estimated atthe grant date using the Black-Scholes option-pricing model.  The following assumptions were used forgrants in the three months ended September 30, 2008 and 2007:

 
| ** **                | ** ** | **For the Three Months Ended** | ** ** |
|---------------------------|------------|----------------------------------------------------|------------|
| ** **                | ** ** | **September 30,**                             | ** ** |
| ** **                | ** ** | **2008**                                           | ** ** | **2007** | ** ** |
|                      |       |                                               |       |   |   |
| Expected  volatility      |       | 19.00                                              | %          | 22.00 | % |
| Expected  dividend yield  |       | 3.06                                               | %          | 2.61 | % |
| Risk-free  interest rate  |       | 2.87                                               | %          | 4.10 | % |
| Expected  term (in years) |       | 5                                                  |       | 4 |   |

 

Stock optionactivity for the three months ended September 30, are as follows:

 
| ** **                      | ** ** | **2008**   | ** ** |
|---------------------------------|------------|------------|------------|
| ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** |
| ** **                      | ** ** | ** ** | ** ** | **Weighted** | ** ** | **Average** | ** ** | ** ** | ** ** |
| ** **                      | ** ** | ** ** | ** ** | **Average** | ** ** | **Remaining** | ** ** | **Aggregate** | ** ** |
| ** **                      | ** ** | ** ** | ** ** | **Exercise** | ** ** | **Contractual** | ** ** | **Intrinsic** | ** ** |
| ** **                      | ** ** | **Shares** | ** ** | **Price** | ** ** | **Term** | ** ** | **Value** | ** ** |
|                            |       |       |       |   |   |   |   |   |   |
| Beginning  balance, July 1 |       | 203,554    |       | $ | 12.48 |   |   |   |   |   |
| Granted                         |       | —     |       | — |   |   |   |   |   |
| Forfeited                       |       | (4,232     | )          | 16.86 |   |   |   |   |   |
| Exercised                       |       | (25,887    | )          | 13.00 |   |   |   |   |   |
|                            |       |       |       |   |   |   |   |   |   |
| Ending  balance                 |       | 173,435    |       | $ | 12.30 |   | 4.44 |   | $ | 401 |   |
|                            |       |       |       |   |   |   |   |   |   |
| Vested  and exercisable         |       | 173,435    |       | $ | 12.30 |   | 4.44 |   | $ | 401 |   |

 

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Stock appreciationrights activity for the three months ended September 30, are as follows:

 
| ** **                      | ** ** | **2008**   | ** ** |
|---------------------------------|------------|------------|------------|
| ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** |
| ** **                      | ** ** | ** ** | ** ** | **Weighted** | ** ** | **Average** | ** ** | ** ** | ** ** |
| ** **                      | ** ** | ** ** | ** ** | **Average** | ** ** | **Remaining** | ** ** | **Aggregate** | ** ** |
| ** **                      | ** ** | ** ** | ** ** | **Exercise** | ** ** | **Contractual** | ** ** | **Intrinsic** | ** ** |
| ** **                      | ** ** | **SARs**   | ** ** | **Price** | ** ** | **Term** | ** ** | **Value** | ** ** |
|                            |       |       |       |   |   |   |   |   |   |
| Beginning  balance, July 1 |       | 44,622     |       | $ | 16.06 |   |   |   |   |   |
| Granted                         |       | 47,051     |       | 14.71 |   |   |   |   |   |
| Forfeited                       |       | (1,985     | )          | 16.06 |   |   |   |   |   |
| Exercised                       |       | —     |       | — |   |   |   |   |   |
|                            |       |       |       |   |   |   |   |   |   |
| Ending  balance                 |       | 89,688     |       | $ | 15.35 |   | 9.29 |   | $ | — |   |
|                            |       |       |       |   |   |   |   |   |   |
| Vested  and exercisable         |       | 14,932     |       | $ | 16.04 |   | 8.39 |   | $ | — |   |

 

The totalintrinsic value of options exercised during the three months ended September 30,2008 and 2007 was $41,000 and $18,000, respectively.  Cash received from the exercise of optionsfor the three months ended September 30, 2008, and 2007 was $337,000 and$108,000, respectively.  The tax benefitrealized for the tax deductions from cashless option exercises totaled $1,000and $3,000 for the three months ended September 30, 2008, and 2007,respectively.  The weighted-average grantdate fair value of stock appreciation rights (SARs) granted during the threemonths ended September 30, 2008, and 2007 was $2.06 and $2.84,respectively.  The total unrecognizedcompensation cost related to nonvested SARs awards at September 30, 2008,and 2007 was $191,000 and $129,000, respectively.  The cost is expected to be recognized over aweighted-average period of 37 months.

 

Nonvested shareactivity for the three months ended September 30 follows:

 
| ** **                    | ** ** | **2008**   | ** ** | **2007**            | ** ** |
|-------------------------------|------------|------------|------------|---------------------|------------|
| ** **                    | ** ** | ** ** | ** ** | **Weighted**        | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                    | ** ** | ** ** | ** ** | **Average**         | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                    | ** ** | ** ** | ** ** | **Grant Date** | ** ** | ** ** | ** ** | **Grant Date** | ** ** |
| ** **                    | ** ** | **Shares** | ** ** | **Fair Value** | ** ** | **Shares** | ** ** | **Fair Value** | ** ** |
|                          |       |       |       |                |       |   |   |   |   |
| Nonvested  Balance, beginning |       | 121,746    |       | $                   | 16.57      |   | 144,711 |   | $ | 16.10 |   |
| Granted                       |       | 9,091      |       | 14.71               |       | 13,304 |   | 16.98 |   |
| Vested                        |       | (48,455    | )          | 16.44               |       | (29,501 | ) | 14.72 |   |
| Forfeited                     |       | (1,305     | )          | 16.95               |       | — |   | — |   |
| ** **                    | ** ** | ** ** | ** ** | ** **          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Nonvested  Balance, ending    |       | 81,077     |       | $                   | 16.43      |   | 128,514 |   | $ | 16.51 |   |

 

Pretaxcompensation expense recognized for nonvested shares for the three months endedSeptember 30, 2008, and 2007 was $115,000 and $111,000, respectively.  The tax benefit for the three months ended September 30,2008, and 2007 was $39,000 and $35,000, respectively.  As of September 30, 2008, there was$885,000 of total unrecognized compensation cost related to nonvested shares grantedunder the Company’s 2002 Stock Option and Incentive Plan, as amended (“the Plan”).  The cost is expected to be recognized over aweighted-average period of 25 months. The total fair value of shares vested during the three months ended September 30,2008, and 2007 was $797,000 and $329,000, respectively.

 

In associationwith the 2002 Option Plan, awards of nonvested shares of the Company’s commonstock are made to outside directors of the Company.  Each outside director is entitled to allvoting, dividend and distribution rights during the vesting period.  During the first quarter of Fiscal 2009, noshares of nonvested stock were awarded.

 

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Nonvested shares vest onthe first anniversary of the date of grant. For the three months ended September 30, 2008 and 2007,amortization expense was recorded in the amounts of $51,000 and $35,000,respectively.

 

These stock optionand incentive plans are described more fully in Part II, Item 8 “FinancialStatements and Supplementary Data” of the Company’s Annual Report on Form 10-Kfor Fiscal 2008, under Note 16 of “Notes to Consolidated Financial Statements.”

 

**NOTE 10.****                                          SUBORDINATEDDEBENTURES PAYABLE TO TRUSTS**

 

On July 5,2007, the Company issued 5,000 shares totaling $5.0 million of CompanyObligated Mandatorily Redeemable Preferred Securities of Trust VI.  Trust VI was established and exists for thesole purpose of issuing trust preferred securities and investing the proceedsin subordinated debentures of the Company. These subordinated debentures constitute the sole asset of TrustVI.  The securities provide forcumulative cash distributions calculated at a rate based on three-month LIBORplus 1.65%, adjusted quarterly.  Refer toNote 10 in regards to the interest rate swap agreement, which converted thevariable-rate Trust Preferred VI security into a fixed-rate security for a termof five years.  The Company may, at oneor more times, defer interest payments on the capital securities for up to 20consecutive quarterly periods, but not beyond October 1, 2037.  At the end of the deferral period, allaccumulated and unpaid distributions must be paid.  The capital securities must be redeemed on October 1,2037; however, the Company has the option to shorten the maturity date to adate not earlier than October 1, 2012. Holders of the capital securities have no voting rights, are unsecured,and rank junior in priority of the payment to all of the Company’s indebtednessand senior to the Company’s capital stock.

 

On July 7,2007, the Company exercised its option to redeem $5.0 million of CompanyObligated Mandatorily Redeemable Preferred Securities of Trust II.

 

**NOTE 11.****                                          INTERESTRATE CONTRACTS**

 

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

 

During the firstquarter of fiscal 2008, the Company entered into an interest rate swap agreementwith a $5.0 million notional amount to convert the variable-rate TrustPreferred VI security into a fixed-rate instrument for a term of five years ata fixed rate of 6.69%. This rate swap is designated as a cash flow hedge. Thefair value of the derivative was a $250,000 loss at September 30, 2008.

 

During the fourthquarter of fiscal 2008, the Company entered into an interest rate swapagreement with a $7.0 million notional amount to convert the variable-rateTrust Preferred IV security into a fixed-rate instrument for a term of threeyears at a fixed rate of 6.19%. This rate swap is designated as a cash flowhedge. The fair value of the derivative was a $48,000 gain at September 30,2008.

 

During the firstquarter of fiscal 2009, the Company entered into an interest rate swapagreement with a $3.0 million notional amount to convert a portion of thevariable-rate Trust Preferred III security into a fixed-rate instrument for aterm of three years at a fixed rate of 6.70%. The Company also entered into an interest rate swap agreement with a $2.0million notional amount to convert the remaining portion of variable rate TrustPreferred III security into a fixed rate instrument for a term of four years ata fixed rate of 6.91%.  These rate swapsare designated as cash flow hedges.  Thefair value of the $3.0 million notional amount derivative was a $26,000 gain,while the fair value of the $2.0 million notional amount derivative was a $23,000gain at September 30, 2008.

 

No gain or losswas recognized in earnings for the three months ended September 30, 2008,and 2007 related to interest rate swaps. No deferred net losses on interest rate swaps in other comprehensiveloss as of September 30, 2008, are expected to be reclassified intoearnings during the fiscal year.

 

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**NOTE 12.****                                          OTHERCOMPREHENSIVE INCOME**

 

Comprehensiveincome consists of two components, net income and other comprehensiveincome.  Other comprehensive incomerefers to revenues, expenses and gains and losses under accounting principlesgenerally accepted in the United States of America (“GAAP”) which are recordedas an element of shareholders’ equity but are excluded from net income.  The components of total comprehensive incomefollow:

 
|                                                                |   | **Three Months Ended**     |   |
|---------------------------------------------------------------------|--------|--------------------------------------|--------|
|                                                                |   | **September 30,**               |   |
|                                                                |   | **2008**                             |   | **2007** |   |
|                                                                |   | **(Dollars in Thousands)** |   |
|                                                                |   |                                 |   |   |   |
| Net  income                                                         |   | $                                    | 1,975  |   | $ | 1,347 |   |
| Other  comprehensive income (loss), net of tax:                     |   |                                 |   |   |   |
| Securities  available for sale:                                     |   |                                 |   |   |   |
| Net  unrealized gains (losses)                                      |   | (664                                 | )      | 785 |   |
| Income  tax benefit (expense)                                       |   | 253                                  |   | (34 | ) |
|                                                                |   |                                 |   |   |   |
| Other  comprehensive income (loss) on securities available for sale |   | (411                                 | )      | 751 |   |
|                                                                |   |                                 |   |   |   |
| Defined  benefit plan:                                              |   |                                 |   |   |   |
| Net  unrealized (loss)                                              |   | —                               |   | — |   |
| Income  tax benefit                                                 |   | —                               |   | — |   |
|                                                                |   |                                 |   |   |   |
| Other  comprehensive (loss) on defined benefit plan                 |   | —                               |   | — |   |
|                                                                |   |                                 |   |   |   |
| Derivatives  and hedging activities:                                |   |                                 |   |   |   |
| Net  unrealized (losses)                                            |   | (32                                  | )      | (60 | ) |
| Income  tax benefit                                                 |   | 11                                   |   | 26 |   |
|                                                                |   |                                 |   |   |   |
| Other  comprehensive (loss) on derivatives and hedging activities   |   | (21                                  | )      | (34 | ) |
|                                                                |   |                                 |   |   |   |
| Total  other comprehensive income (loss)                            |   | (432                                 | )      | 717 |   |
|                                                                |   |                                 |   |   |   |
| Other  comprehensive income                                         |   | $                                    | 1,543  |   | $ | 2,064 |   |

 
|                                                                                               | ** ** | **September 30,**               | ** ** |
|----------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
|                                                                                               | ** ** | **2008**                             | ** ** | **2007** | ** ** |
|                                                                                               | ** ** | **(Dollars in Thousands)** | ** ** |
| Cumulative other comprehensive (loss) balances were:                      | ** ** | ** **                           | ** ** | ** ** | ** ** |
|                                                                                               | ** ** | ** **                           | ** ** | ** ** | ** ** |
| Unrealized  loss on securities available for sale,   net of related tax effect of $1,521 and $826  | ** ** | $                                    | (2,479     | ) | $ | (653 | ) |
| Unrealized  loss on defined benefit plan, net of related tax effect of $523 and $60                |       | (853                                 | )          | (98 | ) |
| Unrealized  loss on derivatives and hedging activities,   net of related tax effect of $52 and $26 |       | (101                                 | )          | (34 | ) |
|                                                                                               |       |                                 |       |   |   |
|                                                                                               |       | $                                    | (3,433     | ) | $ | (785 | ) |

 

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

 

**Forward-Looking Statements**

 

This Quarterly Report on Form 10-Qand other reports issued by the Company, including reports filed with theSecurities and Exchange Commission, contain “forward-looking statements” thatdeal with future results, expectations, plans and performance.  In addition, the Company’s management maymake forward-looking statements orally to the media, securities analysts,investors or others.  Theseforward-looking statements might include one or more of the following:

 

·                  Projections ofincome, loss, revenues, earnings or losses per share, dividends, capitalexpenditures, capital structure, tax benefit or other financial items.

·                  Descriptions ofplans or objectives of management for future operations, products or services,transactions, investments and use of subordinated debentures payable to trusts.

·                  Forecastsof future economic performance.

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

 

Forward-lookingstatements can be identified by the fact they do not relate strictly tohistorical or current facts.  They ofteninclude words such as “optimism,” “look-forward,” “bright,” “pleased,” “believe,”“expect,” “anticipate,” “intend,” “plan,” “estimate” or words of similarmeaning, 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, therisks discussed in Part I, Item 1A “Risk Factors” in the Company’s AnnualReport on Form 10-K for Fiscal 2008 and the following: possiblelegislative changes and adverse economic, business and competitive conditionsand developments (such as shrinking interest margins and continued short-termrate environments); deposit outflows; reduced demand for financial services andloan products; changes in accounting policies or guidelines, or in monetary andfiscal policies of the federal government; changes in credit and other risksposed by the Company’s loan and lease portfolios; the ability or inability ofthe Company to manage interest rate and other risks; unexpected, continuing orexcessive claims against the Company’s self-insured health plan; the Company’suse of trust preferred securities; the ability or inability of the Company tosuccessfully enter into a definitive agreement for and close anticipatedtransactions; technological, computer-related or operational difficulties;adverse changes in securities markets; results of litigation; or othersignificant uncertainties.

 

Forward-looking statements speakonly as of the date they are made.  TheCompany does not undertake to update forward-looking statements to reflectcircumstances or events that occur after the date the forward-lookingstatements are made.  Although theCompany believes its expectations are reasonable, it can give no assurance thatsuch expectations will prove to be correct. Based upon changing conditions, should any one or more of these risks oruncertainties materialize, or should any underlying assumptions proveincorrect, actual results may vary materially from those described in anyforward-looking statements.

 

**ExecutiveSummary**

 

The Company’s netincome for the first quarter of Fiscal 2009 was $2.0 million, or $0.49 indiluted earnings per share, compared to $1.3 million, or $0.33 in dilutedearnings per share, for the first quarter of Fiscal 2008.  Return on average equity was 12.12% at September 30,2008 compared to 8.61% at September 30, 2007.

 

The net interestmargin on a fully taxable equivalent basis for the three months ended September 30,2008 was 3.35%, compared to 2.92% for the same period a year ago, an increaseof 43 basis points.  The increase overthe same period last year is primarily attributable to lower costs onliabilities and a higher volume of earning assets.  During the first quarter of Fiscal 2008,there was $125,000 expense of unamortized debt issue costs related to the earlyredemption of the Trust II Trust Preferred Securities, causing a decrease offour basis points to the net interest margin.

 

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Net interest income forthe first three months of Fiscal 2009 was $8.7 million, an increase of $2.0million, or 30.3%, over the same period a year ago.  For the three months ended September 30,2008, average interest-earning assets and average interest-bearing liabilitiesincreased 13.0% and 14.2%, respectively, compared to the same period a yearago.  Yields on earning assets decreasedto 5.99% in the first three months of Fiscal 2009, compared to 6.86% a yearago, a decrease of 87 basis points.  Forthe same period, cost of funds decreased to 3.01%, compared to 4.49%, adecrease of 148 basis points.

 

Net interest margin ratiomay vary due to many factors, including Federal Reserve policies for short-terminterest rates, competitive and economic factors and customer preferences forvarious products and services.  On September 18,2007 the Federal Reserve decreased the Fed Funds Target Rate by 50 basispoints, the first decrease in short-term interest rates since June 25,2003.  This action was followed byfurther Fed Funds rate cuts of 275 basis points through the remainder of Fiscal2008.

 

The Company hadpreviously issued trust preferred securities primarily to provide funding forstock repurchases and to repay other borrowings.  Interest expense on the $27.8 million oftrust preferred securities outstanding decreased to $421,000 for the threemonths ended September 30, 2008, compared to $665,000 for the same perioda year ago, a decrease of $244,000 or 36.7%. This decrease is due in part to the expense of $125,000 unamortized debtissue costs related to the early redemption of the Trust II Trust PreferredSecurities in the first quarter of Fiscal 2008. The average rate paid on these securities decreased 300 basis points,from 9.50% at September 30, 2007 to 6.50% at September 30, 2008.

 

The allowance for loanand lease losses increased to $6.2 million at September 30, 2008, comparedto $5.5 million at September 30, 2007, an increase of $690,000 or12.6%.  The ratio of allowance for loanand lease losses to total loans and leases was 0.76% as of September 30,2008 compared to 0.70% at September 30, 2007.  Total nonperforming assets at September 30,2008 were $3.6 million as compared to $3.6 million a year ago, a decrease of$14,000 or 0.4%.  The ratio ofnonperforming assets to total assets decreased to 0.32% at September 30,2008, compared to 0.36% at September 30, 2007.  The allowance for loan and lease losses iscalculated based on loan and lease levels, loan and lease loss history, creditquality of the loan and lease portfolio, and environmental factors such aseconomic health of the region and management experience.  This risk rating analysis is designed to givethe Company a consistent and systematic methodology to determine proper levelsfor the allowance at a given time.

 

The Company made astrategic decision during the first quarter of Fiscal 2008 to stop originatingindirect automobile loans, and to continue to service the existingportfolio.  As of September 30,2008, the Consumer Indirect loan portfolio balance was $37.4 million, adecrease of $6.9 million from June 30, 2008.  The Company entered this line of business inthe 1990’s as part of an interest rate risk reduction strategy, as well as forfurther diversification of the balance sheet.

 

As of September 30,2008, the Company continued to record a receivable in the amount of $223,000from the sale of certain loan participation interests in December 2005.  The balance of this receivable represents theremaining amount the Company expects to be paid on the receivable and theCompany has requested such payment from the lead bank.   In addition, on June 26, 2006, theCompany filed a $3.8 million lawsuit against this lead bank for their role inthis participation loan, alleging fraud, breach of fiduciary duty, conspiracy,and negligent misrepresentation.  See Part 1,Item 3 “Legal Proceedings” of the Fiscal 2008 Form 10-K.  Subsequent to the end of the quarter ended September 30,2008 and referenced in the 8K filed October 27, 2008, the lawsuit wassettled for $2.75 million inclusive of the remaining amount of receivables fromcertain loan participation interests in the amount of $223,000.  The settlement amount, less attorney fees of$292,000, will be recorded as other non-interest income for the second quarterof Fiscal 2009.  See Part II, Item 1“Legal Proceedings” of this Form 10-Q for more details.

 

Total deposits at September 30,2008 were $765.0 million, a decrease of $19.2 million, or 2.5%, from June 30,2008.  In-market deposits decreased from$757.0 million at June 30, 2008 to $729.9 million at September 30,2008, a decrease of $27.1 million, or 3.6%. For the same period, out-of-market deposits increased from $27.3 millionto $35.1 million, or 28.6%.  Public fundshave decreased, from $156.3 million at June 30, 2008 to $126.6 million at September 30,2008.  This decline of $29.7 million isdue to typical seasonal fluctuations with the expectation that the secondquarter of Fiscal 2009 balance will increase from the first quarter.  Interest expense on deposits was $4.6 millionfor the three months ended September 30, 2008, a decrease of $2.9 million,or 39.0%, over the same period a year ago. The primary factors affecting interest expense on deposits was thedecrease in the average rates

 

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paid from the three month period ended September 30, 2007 comparedto the three month period ended September 30, 2008.  Checking and money market deposits decreasedfrom 3.59% to 1.38%, savings deposits decreased from 2.98% to 1.47%, andcertificates of deposits decreased from 4.93% to 3.76% during this timeframe.

 

On July 28, 2008,the Company announced an increase in its quarterly cash dividend, from 10.75cents per share to 11.25 cents per share, resulting in an annualized increaseof 4.7%.  On October 27, 2008, theCompany declared a quarterly cash dividend payable of 11.25 cents per share on November 13,2008 for shareholders of record November 6, 2008.

 

The total risk-basedcapital ratio of 10.76% at September 30, 2008 is slightly below the 10.83%at June 30, 2008, with a decrease of seven basis points.  This continues to place the Bank in the “wellcapitalized” category within OTS regulation at September 30, 2008 and isconsistent with the “well capitalized” OTS category in which the Company plansto operate.  The Company historically hasbeen able to manage the size of its assets through secondary market loan salesof single-family mortgages and student loans.

 

On September 30,2008, the Company had in effect a stock buyback program in which up to 10% ofthe common stock of the Company outstanding on May 1, 2008 could beacquired through April 30, 2009. The Company did not utilized its stock buyback program during the firstquarter of Fiscal 2009, but is authorized to repurchase an additional 388,794shares of common stock through April 30, 2009.  See Part II, Item 2 “Unregistered Salesof Equity Securities and Use of Proceeds” of this Form 10-Q for moredetails.

 

Non-interest income was$3.0 million for the quarter ended September 30, 2008 compared to $2.8million at September 30, 2007, an increase of $234,000 or 8.3%.  The primary factors affecting non-interestincome were increases of $52,000 in loan servicing income, $138,000 in fees ondeposits and $80,000 in gain on sale of securities, net.

 

Non-interest expense was$8.4 million for the quarter ended September 30, 2008 compared to $7.1million at September 30, 2007, an increase of $1.3 million or 17.6%.  Compensation and employee benefit expenseincreased $678,000 primarily due to increases in regular employee compensationof $244,000, variable pay relating to employee incentives of $270,000, nethealthcare costs of $137,000, and recruiting expense of $41,000.  Marketing increased $75,000, primarily due toincreased promotional activity. Foreclosed real estate and other properties, net, increased $74,000 dueto the increased activity in repossessed equipment.  Other expense increased $385,000 primarilydue to increases in federal deposit insurance premiums, audit and regulatoryexams, and legal expenses of $118,000, $62,000, and $150,000,respectively.  Previously, the Companyhad credits to offset federal deposit insurance premiums.  In the first quarter of Fiscal 2009, thesecredits expired causing the expense to increase.  No future credits exist to offset this costin the future.  Audit and regulatoryexams expenses increased due to increased requirements and procedures.  Legal costs increased due in part to alawsuit, which was settled subsequent to September 30, 2008.  See Part II, Item 1 “Legal Proceedings”of this Form 10-Q.

 

**General**

 

The Company is a financial services provider and, assuch, has inherent risks that must be managed in order to achieve netincome.  Primary risks that affect netincome include credit risk, liquidity risk, operational risk, regulatory compliancerisk and reputation risk.  The Company’snet income is derived by managing net interest margin, the ability to collectfees from services provided, by controlling the costs of delivering servicesand the management of loan and lease losses. The primary source of revenues comes from the net interest margin, whichrepresents the difference between income on interest-earning assets (i.e. loansand investment securities) and expense on interest-bearing liabilities (i.e.deposits and borrowed funding).  The netinterest margin is affected by regulatory, economic and competitive factorsthat influence 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.

 

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**Financial Condition Data**

 

At September 30, 2008, the Company had totalassets of $1.1 billion, an increase of $24.2 million from the level at June 30,2008.  The increase in assets was dueprimarily to increases in net loans and leases receivable of $18.1 million andloans held for sale of $4.6 million. These increases were partially offset by a decrease in cash and cashequivalents of $2.4 million.  Theincrease in liabilities of $23.0 million from June 30, 2008 to September 30,2008 was primarily due to increases in advances from the FHLB and otherborrowings of $38.8 million, non-public funds deposits of $10.5 million, andadvances by borrowers for taxes and insurance of $5.9 million.  These increases were somewhat offset by adecrease in public funds deposits of $29.7 million and a decrease in accruedexpenses and other liabilities of $2.6 million. In addition, stockholders’ equity increased $1.6 million to $65.8million at September 30, 2008 from $64.2 million at June 30, 2008,primarily due to net income of $2.0 million and partially offset by an increasein unrealized losses on securities available for sale, net of income taxbenefit of $411,000.

 

The increase in net loans and leases receivable of$18.1 million at September 30, 2008 as compared to June 30, 2008, wasprimarily the result of increases in agricultural loans of $15.8 million to$176.0 million, increases in commercial business and real estate of $4.1million to $307.6 million, increases of consumer direct loans of $3.8 millionto $109.6 million and an increase in construction and development loans of $3.6million to $9.4 million.  These increaseswere partially offset by decreases in one-to four-family loans of $2.3 millionto $97.7 million and decreases in consumer indirect loans of $6.9 million to$37.4 million at September 30, 2008 as compared to June 30,2008.  Loans held for sale increased by$4.6 million at September 30, 2008, as compared to June 30, 2008, dueprimarily to seasonal fluctuation of single family and student loan activity.

 

Cash and cash equivalents decreased $2.4 million at September 30,2008 as compared to June 30, 2008. See the Consolidated Statement of Cash Flows for an in-depth analysis inthe change in cash and cash equivalents for the three months ended September 30,2008.

 

Advances from the FHLBand other borrowings increased $38.8 million to $237.3 million. The overallincrease in FHLB borrowings was primarily the result of an increase in loansand leases receivable, the increase in loans held for sale, and the decrease inpublic fund deposits.  These outflowswere somewhat offset by the increase in non-public funds.

 

The $19.2 million decrease in deposits was due todecreases in public funds of $29.7 million which are categorized in multipletypes of deposits.  The reduction ofpublic funds in the first quarter of Fiscal 2009 is a seasonal trend that isaffected primarily by the collection of property taxes and payment to theschool systems’ general funds.  Duringthe second quarter Fiscal 2009, the Company expects to see an increase in thesepublic funds deposits with the disbursement of property taxes expected in November 2008.  Conversely, non-public funds increased $10.5million to somewhat offset these reduced deposits in the first quarter.  Certificates of deposit increased by $25.3million to $378.6 million at September 30, 2008.  In-market certificates of deposit accountedfor $17.5 million of the increase while out-of-market certificates of depositincreased $7.8 million at September 30, 2008 as compared to June 30,2008.

 

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

 

**Loan and Lease Portfolio Composition**

 
| ** **                                        | ** ** | **At September 30, 2008** | ** ** | **At June 30, 2008** | ** ** |
|---------------------------------------------------|------------|------------------------------------------|------------|-------------------------------------|------------|
| ** **                                        | ** ** | **Amount**                               | ** ** | **Percent**                         | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| ** **                                        | ** ** | **(Dollars in Thousands)**     | ** ** |
|                                              |       |                                     |       |                                |       |   |   |   |   |
| One-to  four-family (1)                           |       | $                                        | 97,713     |                                | 12.18      | % | $ | 99,989 |   | 12.76 | % |
| Commercial  business and real estate (2) (3) |       | 307,553                                  |       | 38.34                               | %          | 303,415 |   | 38.72 | % |
| Multi-family  real estate                         |       | 44,854                                   |       | 5.59                                | %          | 45,093 |   | 5.75 | % |
| Equipment  finance leases                         |       | 19,592                                   |       | 2.44                                | %          | 19,288 |   | 2.46 | % |
| Consumer direct  (4)                              |       | 109,556                                  |       | 13.66                               | %          | 105,719 |   | 13.49 | % |
| Consumer  indirect (5)                            |       | 37,418                                   |       | 4.67                                | %          | 44,294 |   | 5.65 | % |
| Agricultural                                      |       | 176,042                                  |       | 21.95                               | %          | 160,267 |   | 20.45 | % |
| Construction and  development                     |       | 9,360                                    |       | 1.17                                | %          | 5,645 |   | 0.72 | % |
| Total loans and  leases receivable (6)            |       | $                                        | 802,088    |                                | 100.00     | % | $ | 783,710 |   | 100.00 | % |

 

----

(1) Excludes $10,311 and $7,958 loans held forsale at September 30, 2008 and June 30, 2008, respectively.

(2) Includes $3,012 and $3,012 tax exempt leasesat September 30, 2008 and June 30, 2008, respectively.

(3) Excludes $223 commercial loans held for saleat September 30, 2008 and June 30, 2008.

(4) Excludes $2,837 and $614 student loans heldfor sale at September 30, 2008 and June 30, 2008, respectively.

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

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

 

**Deposit Composition**

 
| ** **                             | ** ** | **At September 30, 2008** | ** ** | **At June 30, 2008** | ** ** |
|----------------------------------------|------------|------------------------------------------|------------|-------------------------------------|------------|
| ** **                             | ** ** | **Amount**                               | ** ** | **Percent**                         | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| ** **                             | ** ** | **(Dollars in Thousands)**     | ** ** |
|                                   |       |                                     |       |                                |       |   |   |   |   |
| Noninterest  bearing checking accounts |       | $                                        | 76,844     |                                | 10.04      | % | $ | 90,598 |   | 11.55 | % |
| Interest bearing  checking accounts    |       | 81,366                                   |       | 10.64                               | %          | 90,125 |   | 11.49 | % |
| Money market  accounts                 |       | 165,409                                  |       | 21.62                               | %          | 171,689 |   | 21.89 | % |
| Savings accounts                       |       | 62,849                                   |       | 8.21                                | %          | 78,575 |   | 10.02 | % |
| In-market  certificates of deposit     |       | 343,474                                  |       | 44.90                               | %          | 325,995 |   | 41.57 | % |
| Out-of-market  certificates of deposit |       | 35,080                                   |       | 4.59                                | %          | 27,255 |   | 3.48 | % |
| Total deposits                         |       | $                                        | 765,022    |                                | 100.00     | % | $ | 784,237 |   | 100.00 | % |

 

**Analysis of Net Interest Income**

 

Net interest income represents the difference betweenincome on interest-earning assets and expense on interest-bearingliabilities.  Net interest income dependsupon the volume of interest-earning assets and interest-bearing liabilities andthe interest rates 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 interest expenseon average interest-bearing liabilities, expressed both in dollars and rates,and the net interest margin.  The tabledoes not reflect any effect of income taxes, except where noted.  Average balances consist of daily averagebalances for the Bank with simple average balances for all other subsidiariesof the Company.  The average balancesinclude nonaccruing loans and leases. The yields on loans and leases include origination fees, net of costs,which are considered adjustments to yield.

 

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| ** **                                     | ** ** | **Three Months Ended September 30,** | ** ** |
|------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                     | ** ** | **2008**                                                 | ** ** | **2007** | ** ** |
| ** **                                     | ** ** | **Average**                                              | ** ** | **Interest** | ** ** | ** ** | ** ** | **Average** | ** ** | **Interest** | ** ** | ** ** | ** ** |
| ** **                                     | ** ** | **Outstanding**                                          | ** ** | **Earned/** | ** ** | **Yield/** | ** ** | **Outstanding** | ** ** | **Earned/** | ** ** | **Yield/** | ** ** |
| ** **                                     | ** ** | **Balance**                                              | ** ** | **Paid** | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Paid** | ** ** | **Rate** | ** ** |
| ** **                                     | ** ** | **(Dollars in Thousands)**                     | ** ** |
| Interest-earning  assets:                      |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Loans and leases  receivable (1) (3)      |       | $                                                        | 805,722    |   | $ | 13,018 |   | 6.41 | % | $ | 776,254 |   | $ | 14,120 |   | 7.24 | % |
| Investment  securities (2) (3)            |       | 229,928                                                  |       | 2,692 |   | 4.65 | % | 145,195 |   | 1,804 |   | 4.94 | % |
| FHLB stock                                     |       | 12,090                                                   |       | 121 |   | 3.97 | % | 5,618 |   | 61 |   | 4.32 | % |
|                                           |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Total  interest-earning assets                 |       | 1,047,740                                                |       | $ | 15,831 |   | 5.99 | % | 927,067 |   | $ | 15,985 |   | 6.86 | % |
| Noninterest-earning  assets                    |       | 66,263                                                   |       |   |   |   |   | 68,334 |   |   |   |   |   |
| Total assets                                   |       | $                                                        | 1,114,003  |   |   |   |   |   | $ | 995,401 |   |   |   |   |   |
|                                           |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:                 |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Deposits:                                      |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Checking and  money market                     |       | $                                                        | 246,147    |   | $ | 858 |   | 1.38 | % | $ | 285,936 |   | $ | 2,581 |   | 3.59 | % |
| Savings                                        |       | 70,538                                                   |       | 261 |   | 1.47 | % | 54,777 |   | 410 |   | 2.98 | % |
| Certificates of  deposit                       |       | 364,434                                                  |       | 3,458 |   | 3.76 | % | 363,832 |   | 4,507 |   | 4.93 | % |
| Total  interest-bearing deposits               |       | 681,119                                                  |       | 4,577 |   | 2.67 | % | 704,545 |   | 7,498 |   | 4.23 | % |
| FHLB advances  and other borrowings            |       | 232,636                                                  |       | 2,109 |   | 3.60 | % | 92,296 |   | 1,156 |   | 4.98 | % |
| Subordinated  debentures payable to trusts (4) |       | 27,837                                                   |       | 456 |   | 6.50 | % | 27,837 |   | 663 |   | 9.48 | % |
|                                           |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Total  interest-bearing liabilities            |       | 941,592                                                  |       | 7,142 |   | 3.01 | % | 824,678 |   | 9,317 |   | 4.49 | % |
| Noninterest-bearing  deposits                  |       | 78,730                                                   |       |   |   |   |   | 78,968 |   |   |   |   |   |
| Other liabilities                              |       | 29,041                                                   |       |   |   |   |   | 29,150 |   |   |   |   |   |
| Total  liabilities                             |       | 1,049,363                                                |       |   |   |   |   | 932,796 |   |   |   |   |   |
| Equity                                         |       | 64,640                                                   |       |   |   |   |   | 62,605 |   |   |   |   |   |
| Total  liabilities and equity                  |       | $                                                        | 1,114,003  |   |   |   |   |   | $ | 995,401 |   |   |   |   |   |
|                                           |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Net interest  income; interest rate spread (5) |       |                                                     |       | $ | 8,689 |   | 2.98 | % |   |   | $ | 6,668 |   | 2.37 | % |
|                                           |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Net interest  margin (5) (6)              |       |                                                     |       |   |   | 3.29 | % |   |   |   |   | 2.86 | % |
|                                           |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Net interest  margin, TE (7)                   |       |                                                     |       |   |   | 3.35 | % |   |   |   |   | 2.92 | % |

 

----

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

(2)  Includes federal funds sold.

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

(4)  Includes $125 in July 2007 forunamortized debt issuance costs.

(5)  Percentages for the three months ended September 30,2008 and September 30, 2007 have been annualized.

(6)  Net interest margin is net interest incomedivided by average interest-earning assets.

(7)  Net interest margin expressed on a fullytaxable equivalent basis.

 

**Rate/VolumeAnalysis of Net Interest Income**

 

The following schedulepresents the dollar amount of changes in interest income and interest expensefor major components of interest-earning assets and interest-bearingliabilities.  It distinguishes betweenthe increases and decreases due to fluctuating outstanding balances due to thelevels and volatility of interest rates. For each category of interest-earning assets and interest-bearingliabilities, information is provided on changes attributable to (i) changesin volume (i.e., changes in volume multiplied by old rate) and (ii) changesin rate (i.e., changes in rate multiplied by old volume).  For purposes of this table, changesattributable to both rate and volume, which cannot be segregated, have beenallocated proportionately to the change due to volume and the change due torate.

 

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| ** **                                 | ** ** | **Three Months Ended September 30,** | ** ** |
|--------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                 | ** ** | **2008 vs 2007**                               | ** ** |
| ** **                                 | ** ** | **Increase**                                             | ** ** | **Increase** | ** ** | ** ** | ** ** |
| ** **                                 | ** ** | **(Decrease)**                                           | ** ** | **(Decrease)** | ** ** | **Total** | ** ** |
| ** **                                 | ** ** | **Due to**                                          | ** ** | **Due to** | ** ** | **Increase** | ** ** |
| ** **                                 | ** ** | **Volume**                                               | ** ** | **Rate** | ** ** | **(Decrease)** | ** ** |
| ** **                                 | ** ** | **(Dollars in Thousands)**                     | ** ** |
| Interest-earning  assets:                  |       |                                                     |       |   |   |   |   |
| Loans and leases  receivable (1)           |       | $                                                        | 561        |   | $ | (1,663 | ) | $ | (1,102 | ) |
| Investment  securities (2)                 |       | 1,056                                                    |       | (168 | ) | 888 |   |
| FHLB stock                                 |       | 71                                                       |       | (11 | ) | 60 |   |
|                                       |       |                                                     |       |   |   |   |   |
| Total  interest-earning assets             |       | $                                                        | 1,688      |   | $ | (1,842 | ) | $ | (154 | ) |
|                                       |       |                                                     |       |   |   |   |   |
| Interest-bearing  liabilities:             |       |                                                     |       |   |   |   |   |
| Deposits:                                  |       |                                                     |       |   |   |   |   |
| Checking and  money market                 |       | $                                                        | (356       | ) | $ | (1,367 | ) | $ | (1,723 | ) |
| Savings                                    |       | 119                                                      |       | (268 | ) | (149 | ) |
| Certificates of  deposit                   |       | 17                                                       |       | (1,066 | ) | (1,049 | ) |
| Total  interest-bearing deposits           |       | (220                                                     | )          | (2,701 | ) | (2,921 | ) |
| FHLB advances  and other borrowings        |       | 1,762                                                    |       | (809 | ) | 953 |   |
| Subordinated  debentures payable to trusts |       | —                                                   |       | (208 | ) | (208 | ) |
|                                       |       |                                                     |       |   |   |   |   |
| Total  interest-bearing liabilities        |       | $                                                        | 1,542      |   | $ | (3,718 | ) | $ | (2,176 | ) |
|                                       |       |                                                     |       |   |   |   |   |
| Net interest  income increase              |       |                                                     |       |   |   | $ | 2,022 |   |

 

----

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

(2)  Includes federal funds sold.

 

**Application of CriticalAccounting Policies**

 

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

 

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

 

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

 

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

 

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

 

The Company has includedMSRs as a critical accounting policy because the use of estimates fordetermining fair value using present value concepts may produce results whichmay significantly differ from other fair value analysis perhaps even to thepoint of recording impairment.  The riskto earnings is when the underlying mortgages pay off significantly faster thanthe assumptions used in the previously recorded amortization.  Estimating future cash flows on theunderlying mortgages is a difficult analysis and requires judgment based on thebest information available.  The Companylooks at alternative assumptions and projections when preparing a reasonableand supportable analysis.  Based on theCompany’s quarterly analysis of MSRs, there was no impairment to the MSRs at September 30,2008.

 

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

 

**Asset Quality and PotentialProblem Loans and Leases**

 

Nonperforming assets(nonaccrual loans and leases, accruing loans and leases delinquent more than 90days and foreclosed assets) decreased to $3.6 million at September 30,2008 from $3.7 million at June 30, 2008, a decrease of $139,000, or3.7%.  Accruing loans and leasesdelinquent more than 90 days increased $50,000 to $831,000 at September 30,2008 from $781,000 at June 30, 2008. Nonaccruing loans and leases decreased $146,000 to $2.2 million at September 30,2008 from $2.3 million at June 30, 2008. Foreclosed assets decreased $43,000 to $600,000 at September 30,2008, from $643,000 at June 30, 2008. In addition, the ratio of nonperforming assets to total assets, which isone indicator of credit risk exposure, was 0.32% at September 30, 2008,which is a decrease from 0.34% as reported at June 30, 2008.

 

Nonaccruing loans andleases decreased 6.3%, or $146,000, to $2.2 million at September 30, 2008compared to $2.3 million at June 30, 2008. Included in nonaccruing loans and leases at September 30, 2008 wereeight loans totaling $505,000 secured by one- to four-family real estate, twoloans totaling $439,000 secured by commercial real estate, 11 loans totaling$555,000 secured by commercial business, three loans totaling $244,000 securedby agriculture, two leases totaling $19,000 and 35 consumer loans totaling$416,000.

 

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

 

As of September 30,2008, foreclosed assets decreased by $43,000, or 6.7%, to $600,000 as comparedto $643,000 at June 30, 2008.  Thebalance at September 30, 2008 consisted of $375,000 of single-familycollateral owned, $132,000 of equipment finance leases and $93,000 of consumercollateral owned.

 

At September 30,2008, the Company had designated $23.8 million of its assets as special mentionand classified $11.2 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 September 30, 2008 the Company had $19.0 million inmulti-family, commercial business, commercial real estate and agriculturalparticipation loans purchased, of which $3.9 million were classified as of September 30,2008.  These loans and leases wereconsidered in determining the adequacy of the allowance for loan and leaselosses.  The allowance for loan and leaselosses is established based on management’s evaluation of the risks probable inthe loan and lease portfolio and changes in the nature and volume of loan andlease activity.  Such evaluation, whichincludes a review of all loans and leases for which full collectability may notbe reasonably assured, considers the estimated fair market value of theunderlying collateral, present value of expected principal and interestpayments, economic conditions, historical loss experience and other factorsthat warrant recognition in providing for an adequate loan and lease loss allowance.

 

Although the Company’s management believes the September 30,2008 recorded allowance for loan and lease losses was adequate to provide forprobable losses on the related loans and leases, there can be no assurance theallowance existing at September 30, 2008, will be adequate in the future.

 

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

 

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| ** **                                                                      | ** ** | **Nonperforming Assets As Of** | ** ** |
|---------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                      | ** ** | **September 30,**                        | ** ** | **June 30,** | ** ** |
| ** **                                                                      | ** ** | **2008**                                      | ** ** | **2008** | ** ** |
| ** **                                                                      | ** ** | **(Dollars in Thousands)**          | ** ** |
| Nonaccruing  loans and leases:                                                  |       |                                          |       |   |   |
| One- to  four-family                                                            |       | $                                             | 505        |   | $ | 503 |   |
| Commercial real  estate                                                         |       | 439                                           |       | 429 |   |
| Commercial  business                                                            |       | 555                                           |       | 555 |   |
| Equipment  finance leases                                                       |       | 19                                            |       | 27 |   |
| Consumer                                                                        |       | 416                                           |       | 566 |   |
| Agricultural                                                                    |       | 244                                           |       | 244 |   |
| Total                                                                           |       | 2,178                                         |       | 2,324 |   |
|                                                                            |       |                                          |       |   |   |
| Accruing loans  and leases delinquent more than 90 days:                        |       |                                          |       |   |   |
| One- to  four-family                                                            |       | 85                                            |       | 306 |   |
| Commercial real  estate                                                         |       | 87                                            |       | 24 |   |
| Commercial  business                                                            |       | 141                                           |       | 71 |   |
| Equipment  finance leases                                                       |       | 431                                           |       | 9 |   |
| Consumer                                                                        |       | 5                                             |       | 119 |   |
| Agricultural                                                                    |       | 82                                            |       | 252 |   |
| Total                                                                           |       | 831                                           |       | 781 |   |
|                                                                            |       |                                          |       |   |   |
| Foreclosed  assets: (1)                                                         |       |                                          |       |   |   |
| One- to  four-family                                                            |       | 375                                           |       | 76 |   |
| Equipment  finance leases                                                       |       | 132                                           |       | 443 |   |
| Consumer                                                                        |       | 93                                            |       | 124 |   |
| Total                                                                           |       | 600                                           |       | 643 |   |
|                                                                            |       |                                          |       |   |   |
| Total  nonperforming assets                                                     |       | $                                             | 3,609      |   | $ | 3,748 |   |
|                                                                            |       |                                          |       |   |   |
| Ratio of  nonperforming assets to total assets                                  |       | 0.32                                          | %          | 0.34 | % |
|                                                                            |       |                                          |       |   |   |
| Ratio of nonperforming loans and leases to total loans and leases  (2) (3) |       | 0.37                                          | %          | 0.39 | % |

 

----

(1)          Total foreclosed assetsdo not include land or other real estate owned held for sale.

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

(3)          Total loans and leasesinclude loans held for sale.

 

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

 
| ** **                                                                                               | ** ** | **Three Months Ended September 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                                                               | ** ** | **2008**                                                 | ** ** | **2007** | ** ** |
| ** **                                                                                               | ** ** | **(Dollars in Thousands)**                     | ** ** |
|                                                                                                     |       |                                                     |       |   |   |
| Balance at  beginning of period                                                                          |       | $                                                        | 5,933      |   | $ | 5,872 |   |
| Charge-offs:                                                                                             |       |                                                     |       |   |   |
| One- to  four-family                                                                                     |       | (1                                                       | )          | (2 | ) |
| Commercial  business                                                                                     |       | —                                                   |       | (557 | ) |
| Equipment  finance leases                                                                                |       | —                                                   |       | (33 | ) |
| Consumer                                                                                                 |       | (191                                                     | )          | (189 | ) |
| Total  charge-offs                                                                                       |       | (192                                                     | )          | (781 | ) |
|                                                                                                     |       |                                                     |       |   |   |
| Recoveries:                                                                                              |       |                                                     |       |   |   |
| One- to  four-family                                                                                     |       | 2                                                        |       | — |   |
| Commercial  business                                                                                     |       | 1                                                        |       | — |   |
| Consumer                                                                                                 |       | 52                                                       |       | 77 |   |
| Total recoveries                                                                                         |       | 55                                                       |       | 77 |   |
|                                                                                                     |       |                                                     |       |   |   |
| Net  (charge-offs)                                                                                       |       | (137                                                     | )          | (704 | ) |
|                                                                                                     |       |                                                     |       |   |   |
| Additions  charged to operations                                                                         |       | 387                                                      |       | 325 |   |
|                                                                                                     |       |                                                     |       |   |   |
| Balance at end  of period                                                                                |       | $                                                        | 6,183      |   | $ | 5,493 |   |
|                                                                                                     |       |                                                     |       |   |   |
| Ratio of net  (charge-offs) during the period to average loans and leases outstanding during  the period |       | (0.02                                                    | )%         | (0.09 | )% |
|                                                                                                     |       |                                                     |       |   |   |
| Ratio of  allowance for loan and lease losses to total loans and leases at end of  period (1)            |       | 0.76                                                     | %          | 0.70 | % |
|                                                                                                     |       |                                                     |       |   |   |
| Ratio of  allowance for loan and lease losses to nonperforming loans and leases at end  of period (2)    |       | 205.48                                                   | %          | 165.30 | % |

 

----

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

(2)  Nonperformingloans and leases include both nonaccruing and accruing loans and leases delinquentmore than 90 days.

 

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The distribution of the Company’s allowance for loanand lease losses and impaired loss summary as required by FASB Statement No. 114,“Accounting by Creditors for Impairment of a Loan” are summarized in thefollowing tables.  The combination ofFASB Statement No. 5 “Accounting for Contingencies” and FASB Statement No. 114calculations comprise the Company’s allowance for loan and lease losses.

 
| ** **                             | ** ** | **Allowance**                            | ** ** | **Impaired Loan**              | ** ** | **Allowance**              | ** ** | **Impaired Loan** | ** ** |
|----------------------------------------|------------|------------------------------------------|------------|-------------------------------------|------------|----------------------------|------------|------------------------|------------|
| ** **                             | ** ** | **for Loan and**               | ** ** | **Valuation**                       | ** ** | **for Loan and** | ** ** | **Valuation**          | ** ** |
| ** **                             | ** ** | **Lease Losses**                    | ** ** | **Allowance**                       | ** ** | **Lease Losses**      | ** ** | **Allowance**          | ** ** |
| **Loan and Lease Type** | ** ** | **At September 30, 2008** | ** ** | **At June 30, 2008** | ** ** |
| ** **                             | ** ** | **(Dollars in Thousands)**     | ** ** |
|                                   |       |                                     |       |                                |       |                       |       |                   |       |
| One- to  four-family                   |       | $                                        | 311        |                                | $          | —                     |       | $                      | 294        |   | $ | — |   |
| Commercial real  estate                |       | 727                                      |       | 50                                  |       | 740                        |       | —                 |       |
| Multi-family  real estate              |       | 135                                      |       | —                              |       | 135                        |       | —                 |       |
| Commercial  business                   |       | 1,731                                    |       | 14                                  |       | 1,678                      |       | —                 |       |
| Equipment  finance leases              |       | 537                                      |       | —                              |       | 496                        |       | —                 |       |
| Consumer                               |       | 1,150                                    |       | —                              |       | 1,190                      |       | —                 |       |
| Agricultural                           |       | 1,398                                    |       | 130                                 |       | 1,270                      |       | 130                    |       |
| Total                                  |       | $                                        | 5,989      |                                | $          | 194                        |       | $                      | 5,803      |   | $ | 130 |   |

 

**Impaired Loan Summary**

** **
| ** **                             | ** ** | ** **                               | ** ** | ** **                          | ** ** | **Impaired**  | ** ** | ** **       | ** ** | ** **  | ** ** | **Impaired**  | ** ** |
|----------------------------------------|------------|------------------------------------------|------------|-------------------------------------|------------|---------------|------------|------------------|------------|-------------|------------|---------------|------------|
| ** **                             | ** ** | **Number**                               | ** ** | ** **                          | ** ** | **Loan**      | ** ** | **Number**       | ** ** | ** **  | ** ** | **Loan**      | ** ** |
| ** **                             | ** ** | **of Loan**                         | ** ** | **Loan**                            | ** ** | **Valuation** | ** ** | **of Loan** | ** ** | **Loan**    | ** ** | **Valuation** | ** ** |
| ** **                             | ** ** | **Customers**                            | ** ** | **Balance**                         | ** ** | **Allowance** | ** ** | **Customers**    | ** ** | **Balance** | ** ** | **Allowance** | ** ** |
| **Loan and Lease Type** | ** ** | **At September 30, 2008** | ** ** | **At June 30, 2008** | ** ** |
| ** **                             | ** ** | **(Dollars in Thousands)**     | ** ** |
|                                   |       |                                     |       |                                |       |          |       |             |       |        |       |          |       |
| Commercial real  estate                |       | 1                                        |       | $                                   | 285        |          | $          | 50               |       | —      |       | $             | —     |   | $ | — |   |
| Commercial  business                   |       | 2                                        |       | 15                                  |       | 14            |       | —           |       | —      |       | —        |       |
| Agricultural                           |       | 2                                        |       | 321                                 |       | 130           |       | 2                |       | 316         |       | 130           |       |
| Total                                  |       | 5                                        |       | $                                   | 621        |          | $          | 194              |       | 2           |       | $             | 316        |   | $ | 130 |   |

 

The allowance for loanand lease losses was $6.2 million at September 30, 2008, as compared to$5.5 million at September 30, 2007. The ratio of the allowance for loan and lease losses to total loans andleases was 0.76% at September 30, 2008, compared to 0.70% at September 30,2007.  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 as economicconditions dictate.  Thecurrent level of the allowance for loan and lease losses is a result ofmanagement’s assessment of the risks within the portfolio based on theinformation revealed in credit reporting processes. The Company utilizes arisk-rating system on all commercial business, agricultural, construction andmulti-family and commercial real estate loans, including purchased loans andleases.  A periodic credit review isperformed on all types of loans and leases to establish the necessary reservebased on the estimated risk within the portfolio. This assessment of risk takesinto account the composition of the loan and lease portfolio, historical lossexperience for each loan and lease category, previous loan and leaseexperience, concentrations of credit, current economic conditions and otherfactors that in management’s judgment deserve recognition.

 

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

 

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

 

**Comparisonof the Three Months Ended September 30, 2008, and September 30, 2007**

 

*General*.  The Company’s net income was $2.0 million, or$0.50 in basic and $0.49 in diluted earnings per share for the three monthsended September 30, 2008, a $628,000 increase in earnings compared to $1.3million, or $0.34 in basic and $0.33 in diluted earnings per share for the sameperiod in the prior fiscal year.  For thethree months ended September 30, 2008, the return on average equity andthe return on average assets were 12.12% and 0.70%, respectively, compared to8.61% and 0.54%, respectively, for the same period in the prior fiscalyear.  As discussed in more detail below,the increases were due to a variety of key factors, including an increase innet interest income of $2.0 million and non-interest income of $234,000.  These increases were offset by an increase ofnon-interest expense of $1.3 million for the first quarter of Fiscal 2009 ascompared to the first quarter of Fiscal 2008.

 

*Interest, Dividend and Loan Fee Income.*  Interest, dividend and loan fee income was$15.8 million for the three months ended September 30, 2008 as compared to$16.0 million for the same period in the prior fiscal year, a decrease of$154,000 or 1.0%.  This decrease wasprimarily the result of declining average yields on the interest earningassets.  Loans and leases receivable hadan average yield of 6.41% for the three months ended September 30, 2008,which is 83 basis points less than the average yield of 7.24% for the threemonths ended September 30, 2007. Investment securities also had a decline in average yield of 29 basispoints when comparing the first quarter of Fiscal 2009 against the same periodof the prior year.  The averageinterest-earning assets for loans and leases receivables increased $29.4million, or 3.8% to $805.7 million for the three months ended September 30,2008.   Investment securities alsoincreased in average balance by $84.7 million, or 58.4% to $229.9 million forthe first quarter of Fiscal 2009, when compared to the average balance of theprior fiscal year.  The net revenuedecrease attributable to the overall declining yields was $1.8 million whencomparing the three months ended September 30, 2009 against the sameperiod ended September 30, 2007. This net revenue decrease was offset by $1.7 million of revenueincreases from larger average assets invested for the first quarter of Fiscal2009 as compared to the first quarter of Fiscal 2008.

 

*InterestExpense.*  Interestexpense was $7.1 million for the three months ended September 30, 2008 ascompared to $9.3 million for the same period in the prior fiscal year, adecrease of $2.2 million or 23.3%.  A$2.7 million decrease in interest expense was the result of a decrease in theaverage rate paid of 4.23% on interest-bearing deposits for the three monthsended September 30, 2007 to an average rate paid of 2.67% for the threemonths ended September 30, 2008. $220,000 of the total decrease was due to a 3.3% decrease in the averagevolume on interest-bearing deposits. Offsetting the overall decrease in interest expense was an increase of$1.8 million due to a 152.1% increase in the average volume of FHLB advancesand other borrowings.  This increase inaverage volume of FHLB advances and other borrowings was partially offset by$800,000 due to yield’s declining from 4.98% for the three months ended September 30,2007 to 3.60% for the three months ended September 30, 2008.  Interest expense for subordinated debenturespayable to trusts also declined by $245,000 as a result of the yield decliningfrom 9.48% to 6.50% during the same comparable quarters.  The average rate paid on totalinterest-bearing liabilities was 3.01% for the three months ended September 30,2008 as compared to 4.49% for the same period in the prior fiscal year.

 

*NetInterest Income.* The Company’s net interest income for thethree months ended September 30, 2008 increased $2.0 million, or 30.3%, to$8.7 million compared to $6.7 million for the same period in the prior fiscalyear.  The increase in net interestincome was due primarily to decreases in the average rate paid oninterest-bearing liabilities and increases in the average volume of interest-earningassets for the three months ended September 30, 2008 compared to the sameperiod in the prior fiscal year.  TheCompany’s net interest margin on a fully taxable equivalent basis was 3.35% forthe three months ended September 30, 2008 as compared to 2.92% for thesame period in the prior fiscal year.

 

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*Provisionfor Losses on Loans and Leases.*The allowance for loan and lease losses ismaintained at a level which is considered by management to be adequate to absorbprobable losses on existing loans and leases that may become uncollectible,based on an evaluation of the collectability of loans and leases and prior loanand lease loss experience.  Theevaluation takes into consideration such factors as changes in the nature andvolume of the loan and lease portfolio, overall portfolio quality, review ofspecific problem loans and leases, and current economic conditions that mayaffect the borrower’s ability to pay. The allowance for loan and lease losses is established through aprovision for losses on loans and leases charged to expense.

 

During the threemonths ended September 30, 2008, the Company recorded a provision forlosses on loans and leases of $387,000 compared to $325,000 for the threemonths ended September 30, 2007, an increase of $62,000.  See “Asset Quality” for further discussion.

 

*Non-interestIncome.*  Non-interest income was $3.0 million for thethree months ended September 30, 2008 as compared to $2.8 million for thesame period in the prior fiscal year, an increase of $234,000, or 8.3%.  The increase in non-interest income wasattributable to increases of $52,000 in loan servicing income, $138,000 in feeson deposits, $80,000 net gain on sale of securities and to a decrease of $36,000in other non-interest income for the three months ended September 30, 2008as compared to the same period in the prior fiscal year.

 

Loan servicing income increased $52,000 from $505,000for the three months ended September 30, 2007 to $557,000 for the threemonths ended September 30, 2008, primarily due to an increase of $46.1million in the balances of loans serviced by the Bank from $1.00 billion at September 30,2007 to $1.05 billion at September 30, 2008.  Fees on deposits increased$138,000 for the three months ended September 30, 2008 as compared to thesame period in the prior fiscal year primarily due to increased point-of-saleinterchange revenue and fee schedule adjustments.  Net gain on sale of securities increased$80,000 for the three months ended September 30, 2008 as compared to thesame period in the prior fiscal year primarily due to the sale of securities,which did not occur in the prior year.

 

*Non-interestExpense.*  Non-interest expense was $8.4 million for thethree months ended September 30, 2008 as compared to $7.1 million for thethree months ended September 30, 2007, an increase of $1.3 million, or17.6%.  The increase in non-interestexpense was primarily due to increases in compensation and employee benefits of$678,000, and other non-interest expense of $383,000.

 

Compensation and employeebenefits increased $678,000, or 15.3%, from $4.4 million for the three monthsended September 30, 2007 to $5.1 million for the three months ended September 30,2008.  Regular employee compensationincreased $244,000, variable pay relating to employee incentives increased$270,000, net healthcare costs increased $137,000, and recruiting expenseincreased $41,000.

 

Other non-interestexpense increased $383,000, or 45.3%, from $845,000 for the three months ended September 30,2007 to $1.2 million for the three months ended September 30, 2008,primarily due to increases in federal deposit insurance premiums, audit andregulatory exams, and legal expenses of $118,000, $62,000, and $150,000,respectively.  Previously, the Companyhad credits to offset federal deposit insurance premiums.  In the first quarter of Fiscal 2009, thesecredits expired causing the expense to increase.  No future credits exist to offset this costin the future.  Audit and regulatoryexams expenses increased due to increased requirements and procedures.  Legal costs increased due in part to alawsuit, which was settled subsequent to September 30, 2008.  See Part II, Item 1 “Legal Proceedings”of this Form 10-Q.

 

*Income tax expense.*  The Company’s income tax expense for thethree months ended September 30, 2008 increased $306,000 or 45.9% to$973,000 compared to $667,000 for the same period in the prior fiscalyear.  The effective tax rate was 33.0%and 33.1% for the three months ended September 30, 2008 and 2007,respectively.

 

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**Liquidity and Capital Resources**

 

The Bank’s primary sources of funds are earnings,in-market deposits, FHLB advances and other borrowings, repayments of loanprincipal, mortgage-backed securities and callable agency securities and, to alesser extent, sales of mortgage loans, sales and maturities of securities,out-of-market deposits and short-term investments.  While scheduled loan payments and maturingsecurities are relatively predictable, deposit flows and loan and securityprepayments are more influenced by interest rates, general economic conditionsand competition. The Bank attempts to price its deposits to meet itsasset/liability objectives consistent with local market conditions.  Excess balances are invested in overnightfunds.

 

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

 

The Bankanticipates it will have sufficient funds available to meet current loancommitments.  At September 30, 2008,the Bank had outstanding commitments to originate and purchase mortgage andcommercial loans of $25.5 million  Inaddition, the Bank had outstanding commitments to sell mortgage loans of $19.8million.  Commitments by the Bank to originateloans are not necessarily executed by the customer.  The Bank monitors the ratio of commitments tofunding for use in liquidity management. At September 30, 2008, the Bank had no outstanding commitments topurchase investment securities available for sale and no commitments to sellinvestment securities available for sale.

 

Although in-market deposits are the Bank’s primarysource of funds, the Bank’s policy has been to utilize borrowings where thefunds can be invested in either loans or securities at a positive rate ofreturn or to use the funds for short-term liquidity purposes.  The Bank has unsecured federal fundsaccommodations totaling $15.0 million with correspondent banks.  In addition, the Company has a revolving lineof credit totaling $6.0 million with a correspondent bank.  There were no funds drawn on either line ofcredit at September 30, 2008. Additionally, as of September 30, 2008, the Bank had $35.1 millionin out-of-market certificates of deposit. The Bank may also seek other sources of contingent liquidity includingadditional federal funds purchased lines with correspondent banks and lines ofcredit with the Federal Reserve Bank.

 

The Company uses its capital resources to pay dividends to itsstockholders, to repurchase Company stock pursuant to Board of Directorsapproved plans, to support organic growth, to make acquisitions, to service itsdebt obligations and to provide funding for investment into the Bank of Tier 1(core) capital.

 

On September 30,2008, the Company had in effect a stock buyback program in which up to 10% ofthe common stock of the Company outstanding on May 1, 2008 could beacquired through April 30, 2009. The Company did not utilized its stock buyback program during the firstquarter of Fiscal 2009, but is authorized to repurchase an additional 388,794shares of common stock through April 30, 2009.  See Part II, Item 2 “Unregistered Salesof Equity Securities and Use of Proceeds” of this Form 10-Q for moredetails.

 

Savings institutions insured by the Federal DepositInsurance Corporation are required by the Financial Institutions Reform,Recovery and Enforcement Act of 1989 to meet three regulatory capitalrequirements.  If a requirement is notmet, regulatory authorities may take legal or administrative actions, includingrestrictions on growth or operations or, in extreme cases, seizure.  Institutions not in compliance may apply foran exemption from the requirements and submit a recapitalization plan.  At September 30, 2008, the Bank met allcurrent regulatory capital requirements.

 

The minimum OTS Tier 1(core) capital requirement for well-capitalized institutions is 5.00% of totaladjusted assets for thrifts.  The Bankhad Tier 1 (core) capital of 7.76% at September 30, 2008.  The minimum OTS total risk-based capitalrequirement for well-capitalized institutions is 10.00% of risk-weightedassets.  The Bank had total risk-basedcapital of 10.76% at September 30, 2008.

 

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**Impact ofInflation and Changing Prices**

 

The unaudited consolidated financial statements andnotes thereto presented in this Quarterly Report on Form 10-Q have beenprepared in accordance with GAAP, which require the measurement of financialposition and operating results in terms of historical dollars withoutconsidering the change in the relative purchasing power of money over time dueto inflation.  The impact of inflation isreflected in the increased cost of the Bank’s operations. Unlike mostindustrial companies, nearly all the assets and liabilities of the Bank aremonetary in nature.  As a result,interest rates have a greater impact on the Bank’s performance than do theeffects of general levels of inflation. Interest rates do not necessarily move in the same direction or to thesame extent as the prices of goods and services.

 

**RecentAccounting Pronouncements**

 

In September 2006,FASB issued Statement of Financial Accounting Standards No. 157 (SFAS157), “Fair Value Measurements.”  SFAS157 provides a common definition of fair value and a framework for measuringassets and liabilities at fair values when a particular standard prescribesit.  In addition, the Statement expandsdisclosures about fair value measurements. The Company adopted SFAS No. 157 effective July 1, 2008, andthe adoption did not have a material impact on its results of operations,financial position, and liquidity.

 

In February 2007,FASB issued Statement of Financial Accounting Standards No. 159 (SFAS159), “The Fair Value Option for Financial Assets and Financial Liabilities –Including an Amendment of FASB Statement No. 115.”  SFAS 159 allows companies the choice tomeasure many financial instruments and certain other items at fair value.  This gives a company the opportunity tomitigate volatility in reported earnings caused by measuring related assets andliabilities differently without having to apply complex hedge accounting provisions.  The Company adopted SFAS No. 159effective July 1, 2008, and the adoption did not have a material impact onits results of operations, financial position, and liquidity.  The Company did not adopt fair value for anyadditional financial instruments or other items.

 

In December 2007,FASB issued Statement of Financial Accounting Standards No. 141R (SFAS141R), “Business Combinations.”  SFAS141R improves reporting by creating greater consistency in the accounting andfinancial reporting of business combinations, resulting in more complete,comparable, and relevant information for investors and other users of financialstatements.  SFAS 141R is effective July 1,2009.  Management has reviewed SFAS 141Rand does not expect the adoption of this statement to have a material impact onthe Company’s consolidated financial condition, results of operations or cashflow.

 

In December 2007,FASB issued Statement of Financial Accounting Standards No. 160 (SFAS160), “Noncontrolling Interests in Consolidated Financial Statements – anamendment of ARB No. 51.”  SFAS 160is effective for the Company beginning July 1, 2009.  SFAS 160 improves the relevance,comparability, and transparency of financial information provided to investorsby requiring all entities to report noncontrolling (minority) interest insubsidiaries in the same way – as equity in the consolidated financialstatements.  The Company does notcurrently have any noncontrolling interest in the consolidated financialstatements.

 

In March 2008,FASB issued Statement of Financial Accounting Standards No. 161 (SFAS161), “Disclosures about Derivative Instruments and Hedging Activities.”  SFAS 161 is intended to improve financialreporting about derivative instruments and hedging activities by requiringenhanced disclosures to enable investors to better understand their effects onan entity’s financial position, financial performance, and cash flows.  The Company will adopt SFAS 161 effective January 1,2009.  Management has reviewed SFAS 161and does not expect the adoption of this statement to have a material impact onthe Company’s consolidated financial condition, results of operations or cashflow.

 

In May 2008,the FASB issued SFAS No. 162, “The Hierarchy of Generally AcceptedAccounting Principles” (“SFAS 162”). This statement makes the hierarchyexplicitly and directly applicable to preparers of financial statements, a stepthat recognizes preparers’ responsibilities for selecting the accountingprinciples for their financial statements. SFAS 162 provides for slight modifications to the current hierarchy inplace by adding FASB Staff Positions, Statement 133 Implementation Issues, andEITF D-Topics to it.  The Company willadopt SFAS 162 effective November 15, 2008.   Management has reviewed SFAS 162 and doesnot expect the adoption of this statement to have a material impact on theCompany’s consolidated financial condition, results of operations or cash flow.

 

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In May 2008,the FASB issued SFAS No. 163, “Accounting for Financial GuaranteeInsurance Contracts – An Interpretation of FASB Statement No. 60” (“SFAS163”).  This statement requires that aninsurance enterprise recognize a claim liability prior to an event of defaultwhen there is evidence that credit deterioration has occurred in an insuredfinancial obligation. SFAS 163 also clarifies how Statement 60 applies tofinancial guarantee insurance contracts, including the recognition and measurementto be used to account for premium revenue and claim liabilities. Expandeddisclosures about financial guarantee insurance contracts are also required bythis statement.  SFAS 163 is effective July 1,2009.  The Company is in the process ofassessing the impact on its results of operations, financial position, and cashflow.

 

**Item 3.                    Quantitativeand Qualitative Disclosures About Market Risk**

 

The Company’s netincome is largely dependent on its net interest income.  Net interest income is susceptible to interestrate risk to the degree that interest-bearing liabilities with short- andmedium-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.

 

In an attempt to manage its exposure to change in interest rates,management monitors the Company’s interest rate risk.  The Company’s Asset/Liability Committee meetsperiodically to review the Company’s interest rate risk position andprofitability, and to recommend adjustments for consideration by executivemanagement. Management also reviews the Bank’s securities portfolio, formulatesinvestment strategies, and oversees the timing and implementation oftransactions to assure attainment of the Board’s objectives in the mosteffective manner.  In managing marketrisk and the asset/liability mix, the Bank has placed its emphasis ondeveloping a portfolio in which, to the extent practicable, assets andliabilities reprice within similar periods. Notwithstanding the Company’s interest rate risk management activities,the potential for changing interest rates is an uncertainty which may have anadverse effect on net income.

 

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

 

As set forth below, the volatility of a rate change, the change in assetor liability mix of the Company or other factors may produce a decrease in netinterest margin in an upward moving rate environment even as the net portfoliovalue (“NPV”) estimate indicates an increase in net value.  The inverse situation may also occur.  One approach used by the Company to quantify interest rate risk is an NPVanalysis.  This analysis calculates thedifference between the present value of the liabilities and the present valueof expected cash flows from assets and off-balance sheet contracts.  The following tables set forth, at September 30,2008 and 2007, respectively, an analysis of the Company’s interest rate risk asmeasured by the estimated changes in NPV resulting from instantaneous andsustained parallel shifts in the yield curve. Management does not believe that the Company has experienced anymaterial changes in its market risk position from that disclosed in the Company’sAnnual Report on Form 10-K for Fiscal 2008 or that the Company’s primarymarket risk exposures and how those exposures were managed during the threemonths ended September 30, 2008 changed significantly when compared to June 30,2008.

 

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

 

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

 
| **September 30, 2007** | ** ** |
|----------------------------------|------------|
| ** **                       | ** ** | **Estimated** | ** ** | **Estimated Increase** | ** ** |
| **Change in**               | ** ** | **NPV** | ** ** | **(Decrease) in NPV** | ** ** |
| **Interest Rates**          | ** ** | **Amount** | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| **Basis Points**            | ** ** | **(Dollars in Thousands)** | ** ** | ** ** | ** ** |
|                             |       |   |   |   |   |   |   |
| +300                             |       | $ | 96,638 |   | $ | (6,719 | ) | (7 | )% |
| +200                             |       | 99,149 |   | (4,208 | ) | (4 | ) |
| +100                             |       | 103,072 |   | (285 | ) | (0 | ) |
| —                           |       | 103,357 |   | — |   | — |   |
| -100                             |       | 98,131 |   | (5,226 | ) | (5 | ) |
| -200                             |       | 87,527 |   | (15,830 | ) | (15 | ) |
|                                  |            |  |  |  |  |  |  |  |  |

 

Inmanaging market risk and the asset/liability mix, the Bank has placed anemphasis on developing a portfolio in which, to the extent practicable, assetsand liabilities reprice within similar periods. The goal of this policy is to provide a relatively consistent level ofnet interest income in varying interest rate cycles and to minimize thepotential for significant fluctuations from period to period.

 

**Item 4.                    Controlsand Procedures**

 

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

 

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**PART II - OTHER INFORMATION**

 

**Item 1.                    Legal Proceedings**

 

On June 26, 2006, the Company filed a $3.8 million lawsuit against MetaBank and two individuals, J. Tyler Haahr and DanielA. Nelson, for their role in a participation loan,alleging fraud, breach of fiduciary duty, conspiracy and negligentmisrepresentation.  These damages were the result of a failure by the leadbank to make disclosures regarding an investigation of the commercial customerby the Iowa Attorney General at the time the Bank agreed to an extension ofloan participation agreements.

 

Subsequent to the end of the quarterended September 30, 2008 and referenced in the 8K filed October 27,2008, the lawsuit was settled for $2.75 million inclusive of the remainingamount of receivables from certain loan participation interests of $223,000.  The settlement amount, less attorney fees of$292,000, will be recorded as other non-interest income for the second quarterof Fiscal 2009.

 

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

 

**Item 1A.                 Risk Factors**

 

There have been nomaterial changes from the risk factors disclosed in Part 1, Item 1A “RiskFactors” in the Company’s Annual Report on Form 10-K for Fiscal 2008.

 

**Item 2.                    Unregistered Sales of Equity Securities andUse of Proceeds**

 

The followingtable sets forth the purchases by the Company of its common stock and theremaining amount that can be purchased in the current program during thequarterly period ended September 30, 2008:

 
| ** **                  | ** ** | **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**      | ** ** |
| July 1 - 31, 2008      |       | —             |       | $                   | 0.00       |                                   | —     |                                   | 388,794    |   |
| August 1 - 31, 2008    |       | —             |       | $                   | 0.00       |                                   | —     |                                   | 388,794    |   |
| September 1 - 30, 2008 |       | —             |       | $                   | 0.00       |                                   | —     |                                   | 388,794    |   |
| 1st Quarter  Total          |       | 0                  |       | $                   | 0.00       |                                   | 0          |                                   |       |   |

 

On September 30,2008, the Company had in effect a stock buyback program in which up to 10% ofthe common stock of the Company outstanding on May 1, 2008 could beacquired through April 30, 2009. The Company did not utilized its stock buyback program during the firstquarter of Fiscal 2009, but is authorized to repurchase an additional 388,794shares of common stock through April 30, 2009.

 

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**Item 6.                    Exhibits**

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

 

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**HF FINANCIAL CORP.**

 

**FORM 10-Q**

**SIGNATURES**

 

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

 

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

 

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**Index to Exhibits**

 

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

 

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